Invt Management

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INVENTORY

MANAGEMENT


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Inventories are materials and supplies that a

business or institution carries either for sale or

provide inputs to the production process.

Inventories are stock of materials of any kind storedfor future use, mainly in the production process.

Inventory are the physical stocks of items that a

manufacturing or service organization keeps in handfor efficient running of its office or manufacturing

activity.


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Financially inventories are very important to

manufacturing companies.

On the balance sheet, they usually represent from

20% to 60 % of total assets.

As inventories are used, their value is converted into

cash, which improve cash flow and return oninvestment.


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There is a cost for carrying inventories, which

increases operating costs and decreases profits.

Hence good inventory management is essential.


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Type of Inventory needed

Inventories are classified as,

Raw Materials :- Purchased items which are not enteredthe production process

Work-in-process :- Raw materials that have entered themanufacturing process and are being worked on orwaiting to be worked on.

Finished goods :- They are ready to be sold ascompleted items. They may be held at factory or centralwarehouses or at various points in the distributionsystem.


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Distribution Inventories :- Finished goods located

in the distribution system.

Maintenance, repair and operational supplies(MROs) :- Items used in production that do not

become part of the product. It include hand tools,

spare parts, lubricants, cleaning supplies.


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Inventory Management

Inventory Management is responsible for planning

and controlling inventory from the raw material stage

to customer.

Inventory must be considered at each of the

planning level and is thus a part of production

planning, master production scheduling, Material

requirement planning.


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The basic objective of Inventory Management is to

be able to determine,

1. What to order

2. When to order

3. How much to order

4. And How much to carry in stock so as to gain

economy in purchasing, storing, manufacturing

and selling.


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Why does a firm carry Inventories?

1. To economize on buying / manufacturing cost.

2. To keep pace with changing market condition.

3. To satisfy demand during period of replenishment.

4. To take care of contingency (ie prevent stockout)


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5. To stabilize production

6. To prevent loss of sale

7. To satisfy other business constraints ie,

Suppliers condition of minimum quantity.

Government regulation Seasonal availability


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Symptoms of poor Inventory Management

Uneven Production with frequent layoffs and

overtime working.

Increase in inventory investment as

compared to increase in sales.

Partial utilization of machines due to frequent

shortage of materials.

Periodic backlog of orders or frequent failuresin delivery commitments.


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Inventory Management Techniques

ABC Analysis

HML Analysis

VED Analysis

SDE Analysis

GOLF Analysis

SOS Analysis

M-N-G Analysis

XYZ Analysis

Usage value (Consumption per period * price per unit )

(High Medium Low) Unit Price

(Vital-Essential-Desirable) Criticality of the item

(Scare-Difficulty-Easy) Procurement difficulties

(Govt.- Ordinary-Local-Foreign) Source ofProcurement

(Seasonal-OF-Seasonal) Seasonality

(Moving and Non-moving item)

Investment


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ABC Analysis

It tends to segregate all items or materials into three

categories: A,B & C on the basis of their annual

usage

Items called A hold a key to business

Other items are numerous in number but there

contribution is less significant.( Items B and C)


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A-Items : It is usually found that hardly 5-10% ofthe items account for 70-75% of the total money

spent on the materials.

These items require detailed and rigid control and

need to be stocked in smaller quantities.

These items should be procured frequently, the

quantity per occasion being small


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B-Items : These items are generally 10-15% of thetotal items and represent 10-15% of the total

expenditure on the materials.

C-Items : These are numerous, as many as 70-80% of the total items and inexpensive, 5-10% of

the total annual expenditure on materials.


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5. Calculate cumulative annual usage and expressthe same as cumulative usage percentage andcumulative item percentage

6. Graph cumulative usage percentage againstcumulative items percentage and segregate theitems into A, B, and C

7. Decide the policies of control for the threecategories.


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0 10 20 40 5030 60 8070 10090

10

20

30

40

50

60

70

80

90

100

A B C

X

Y

Graphical analysis ofABCClassification

Items

C

os

t


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Control of ABC Material

The Fix-Order-Interval system useful for high value

items i.e. Acategory of items requiring strict control

on stock level.

The Fix-Order-Quantity system is suitable forB-class

of items and low value items ordered infrequently in

large quantity

Two bin system is best suited forC-class of items.


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Inventory Cost

1. Item cost

2. Carrying Cost

3. Ordering cost

4. Stockout cost

5. Capacity associated cost


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Item cost It is the price paid for purchased item, which consist of

cost of item and any other direct costs associated ingetting the item into the plant.

This could include such as transportation, custom

duties, insurance.

The inclusive cost is often called as landed price.

For an item manufactured in house the cost includes

direct material, labour and factory overhead which can

usually be obtained from either purchasing or

accounting.


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CarryingCost

It include all expenses incurred by the firmbecause of volume of inventory carried.

As inventory increases this cost increase.

They are broken down into threecategories,

1. Capital cost

2. Storage cost3. Risk cost


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Ordering cost

Cost associated with placing an order either with the

factory or a supplier.

The cost of placing an order does not depend upon

the quantity order.

Annual cost of ordering depends upon the numberof orders placed in a year.


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Stockout cost

If demand during the lead time exceeds forecast wecan expect a Stockout.

A Stockout can potentially be expensive because of

back order cost, lost sales, and possibly lostcustomer.

It can be reduced by carrying extra inventory to

protect against those times when the demand duringlead time is greater than forecast.


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Capacityassociated cost

When output levels required to change, there maybe cost of overtime, hiring, training, extra shift.

These cost can be avoided by leveling production byproducing items in slack periods for sale in peakperiods.

However, this builds inventory in the slack period.


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ECONOMICORDERQUANTITY

(EOQ)

One of the important decisions in stock system is

that of determining the ordering / manufacturing

quantities of different items.

Investment in inventories largely depends upon the

quantities in which they are ordered/manufactured.


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Ordering/manufacturing large lots infrequentlyreduces administrative work but makes investmentin stocks large.

Ordering/manufacturing small lots frequently keepinvestment low but increase administrative work.

The economic lot size for an order or the economicorder quantity depends upon two types of costs :


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a). Inventory procurement costs, which

consist ofexpenditure connected with :

Receiving quotations

Processing purchase requisition

Following up and expediting purchase order

Receiving material and then inspecting it

Processing vendors invoice.


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b).Carrying costs, which vary with

quantity ordered, base on average

inventory and consist of :

Interest on capital investment

Cost of storage facility, up-keep of material

(preservation), record keeping, etc

Cost involving deterioration and obsolescence Cost of insurance, property tax, etc.


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Economic Order QuantityModel

Assumptions :

The demand of the item occurs uniformly over the

period at the known rate

The replenishment of stock is instantaneous.

The price per unit is fixed & is independent of order

size.

The cost to place the order & process the delivery is

fixed & does not vary with the lot size.


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The inventory carrying charges vary directly &

linearly with the size of the inventory & are

expressed as a percentage of average inventory

investment.

The item can be procured free from restrictions of

any kind.

The item has fairly long shelf life, there being no fear

of deterioration or spoilage


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Derivation of EOQ Formula :

Annual consumption of the item (units): S

Unit Price : Cu

OrderQuantity ( Units) : q Procurement cost per order ( Rs.) : Cp

Inventory carrying cost expresses as a

Percentage of Average inventory investment : i


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1. Annual procurement cost =[ No. of ordersper year ] * [ Procurement cost per order

APC = S/q * Cp ------ (1)

2.Annual inventory carrying cost =[Averageinventory investment ] * [Inventory carrying cost ]

= [ OrderQty. x Price per unit ] * i

ACC = q/2 * Cu * i ------ (2)


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3. Annual Total Cost ( ATC )

= S/q * Cp + q/2 * Cu* i ------(3)

To get , EOQ, differentiate ATC with respect to q

d( ATC) =-S.Cp + Cu.i = 0

dq q02 2


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q02 = 2. S.Cp

Cu.i

q0 = 2. S.Cp

Cu.i


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Economic

OrderQuantity

=

2 X [ Annual consumption (units)]

X [Procurement Cost / Order]

Price per unit X Inventory Carrying Cost


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Investment in inventories to a large extent dependson the quantities in which the items are ordered for

replenishment.

Ordering bigger lots reduces procurement cost butincreases investment in stocks.

Ordering small lots keeps investment in inventories

low but increases procurement cost


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The two costs Procurement cost and Inventory

carrying cost are diametrically opposite to each

other.

When these costs have been properly balanced, the

total cost is minimum and the resultant quantity is

called Economic OrderQuantity.


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LOT SIZE

C

o

s

t

50 100 150 200 250 300 400350

100

200

300

400

500

Carrying Cost

Ordering Cost

Total Cost

EOQ


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EOQ ?

Suppliers minimum order quantity condition

Lead time

Government regulation

Seasonal availability

Packing size

Space restriction

Risk of obsolesce and deterioration

Price discounts

Unstable market conditions


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Service levels and safety stocks

The replenishment action is taken at the right

time

There is no increase in demand during the

lead time

There is no delay in getting the supplies


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Replenishment Systems

1. Fixed order quantity system

2. Fixed order interval system

Invt Management

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