Managing Inventories

8/3/2019 Managing Inventories

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Managing Inventories


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Inventory Management

Importance Single largest asset on the balance sheet

Accounts for 40-60% of current assets

Helps to improve ROA & working capital

Inventories have 4 accounting categories Raw Material (RM); Purchased components etc

WIP; Parts/products in stages of completion

FG; Completed goods waiting for delivery

Maintenance parts & Supplies; Parts used tomaintain processing equipment

FG for one division may be RM for other


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Inventories: Functional Categories

Cycle Stock Inv: Avg inventory held b/wreordering cycles, for batching of FG

Pipeline Inv: Stock moving from one point toanother, to provide for transit of inventory

Safety Stock: To protect uncertainties in supplyor demand e.g hoarding, strikes

Seasonal Inv: To smooth the mismatch b/wdemand and supply, cyclical demands

Speculation Inv: To deal with special buying


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Inventory Holding Cost & Benefits

Benefits

Volume purchasediscounts

Economies of scale

Protection againstuncertainties in demand& supply

Protection againstuncertainty in supplychain

Costs

Capital costs; interest

Facility costs; property

tax, insurance, maint etc Possession costs;

pilferage, obsolescence

Large scrap losses

Setup expenses Extensive transportation

Opportunity costs


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Managing Cycle Stock Inventories

Economic Order Quantity; How much to order inan economic approach

Tot cost =Order cost+Prod cost+Inv hold cost Tot annual cost = R/Q(S)+CR+KC(Q/2)

Differential of above would lead to Min Annual Costfor a particular level of Q (denoted by Q*) and also

known as Economic Order QuantityQ* = [2RS/(KC)]1/2

Where K= annual inv carrying costs as a fraction ofunit cost


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Assumptions in EOQ

Demand is level throughout the year

No quantity discounts

Inv carrying charge is proportional to theunit cost of the item

Sometimes it is proportional to max units in

inventory e.g storage costs


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Sensitivity Analysis

The assumptions in EOQ may lead to;

Incorrect input parameters

Non-optimal order quantity Error in terms of cost

However, the % cost error is relatively small;

Q=(1+f)Q*

Thus, TAC(Q)=[TAC(Q)-TAC(Q*)]/TAC(Q*)

TAC(Q)=8.33%


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Inventory Control Models

PP&C techniques like MRP are toocomplicated for small companies

An alternative is to have simple inventorycontrol system

Where inventory is replenished using some

mechanism as it is consumed


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Re-Order Cycle Control (ROCC)

Level of inventory of an item is checkedperiodically; also known as review period High turnover items require frequent checking

Longer the review period and more is the risk

A replenishment order is placed for a sufficientqty to bring the inv level to a target level

This is also known as Periodic Inventory System

ROCC reflects the; Expected demand over the inter-review period

Potential variation in demand and Expected Rep. LT

Potential variation in Rep. LT and delivery quantity


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Re-Order Point Control

The level of inventory of an item is checked eachtime any item is issued

If the inv. level has fallen to the re-order point, anorder is placed for a pre-determined reorder qty(ROQ)

It is also known as continuous or perpetualinventory system

ROPC should reflect; Expected demand during the Rep. LT

Potential variability in demand over the Rep LT

Supplier reliability in terms of Rep. LT and delivery qty


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Simple Stock Control Techniques

ROCC and ROPC only react after the inv. hasbeen issued

In cases of unexpected high demand, shortageswill be inevitable In such cases, systems which predict future reqts and

forecast orders are more effective

When demand variability is low, ROPC approachcan be developed in combination with low LTMfg or supplier and kanban systems To have fast reactions associated with JIT

Managing Inventories

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