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Inventory Management

Inventory System Defined

Inventory is the stock of any item used in an organization. These items include: raw materials, finished products, component parts, supplies, and work-in-process. An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be.

Purposes of Inventory
Avoid stock outs ( safety stock) satisfy expected customer demand esp periods of high seasonal demand (anticipation/seasonal inv) Provide a safeguard for variation in raw material delivery time Take advantage of economic quantity discounts and protect against price rise

Maintain independence of operations (buffer between successive operations

Objective of Inventory Control


To achieve satisfactory levels of customer service while keeping inventory costs within reasonable bounds

Level of customer service


Costs of ordering and carrying inventory

Independent vs. Dependent Demand


Independent Demand (Demand not related to other items or the final end-product) Dependent Demand (Derived demand items for component parts, subassemblies, raw materials, etc.)

E(1)

Inventory Planning
Finished goods and spare parts typically belong to independent demand items in manufacturing organisations Inventory planning of items must address the following two key questions:
How much? When?

Why Inventory is Important


On the balance sheet it represents about 30 to 50 % of the assets. Ratios Inventory Turns is the ratio of the annual sales to the investment in inventory For ex, if the annual sales is 200 million and the average investment in inventory is 40 million then the ratio is 5. It shows how effectively inventory is used. Days of .supply is the ratio of inventory on hand to the avg daily usage. Types Of Inventory: Raw material WIP Finished goods. Distribution inventories MRO items (Maintenance, Repairs and Operational Suppliers

Substantial improvement in the productivity of inventory can be achieved by re-engineering supply chain processes. Poor inventory management may lead to stock outs and hence cancellation of customers orders, overstocking leading to insufficient storage space and increase in the number and rupee value of obsolete products. Consequently, inventory management has a large financial impact on the firm. Investments blocked in inventory cannot be used to obtain other goods or assets that could improve the enterprise performance.

Types of Inventory
Cycle Stock/ Lot size
It is portion of inventory that depleted as customer orders come in and replenished as suppliers orders are received. Periodic replenishment is required. Example hospital ordering 10000 syringes and daily use is 500. If Q is the order quantity per cycle then average inventory = Q/2

Transportation/Pipeline Inventory:

Exists because of the time needed to move the goods from one location to another such as plant to distribution center called as Pipeline or movement inventories.

Safety Stock

is held to cover the unpredictable fluctuations in supply or demand or lead time, so that stock out will not happen.

Cyclic, Pipeline and Safety Stocks


A graphical illustration

Cyclic Stock

Quantity

Pipeline inventory L Safety stock

Time
Cyclic inventory, pipeline inventory and safety stocks are critically linked to how much and when decisions in inventory planning

Types of Inventory
Anticipation inventory / Seasonal these are built up in anticipation of a future demand for example, ahead of a peak selling season, promotion etc. Dead stock- It is obsolete stock that part of the non moving inventory that is unlikely to be of any further use. Example electronics
Decoupling Inventory Complexity of production control is reduced by splitting manufacturing into stages and maintaining inventory between these stages

Costs in Inventory Planning Carrying Cost


Interest for short-term borrowals for working capital Cost of stores and warehousing Administrative costs related to maintaining and accounting for inventory Insurance costs, cost of obsolescence, pilferage, damages and wastage All these costs are directly related to the level of inventory

Costs in Inventory Planning Ordering Cost


Search and identification of appropriate sources of supply Price negotiation, contracting and purchase order generation Follow-up and receipt of material Eventual stocking in the stores after necessary accounting and verification A larger order quantity will require less number of orders to meet a known demand and vice versa

Cost of carrying and cost of ordering are fundamentally two opposing cost structures in inventory planning

Costs in Inventory Planning


Shortage Cost
Costs arising out of rescheduling the production system to accommodate these changes Rush purchases, uneven utilisation of available resources and lower capacity utilisation Missed delivery schedules leading to customer dissatisfaction and loss of good will The effects of shortage are vastly intangible, it is indeed difficult to accurately estimate

EOQ Model A graphical representation


Sum of the two costs
Total cost of carrying

Cost of Inventory

Minimum Cost

Total cost of ordering

Economic Order Qty.

Level of Inventory

Inventory Control for deterministic demand:


EOQ Model
Demand during the planning period Order quantity The cost of ordering per order Inventory carrying cost per unit per unit time = =D =Q =

Co Cc
Q 2

The average inventory carried by an organisation= The cost associated with carrying inventory = The total ordering cost is given by

Total cost of the plan = Total cost of carrying inventory + Total cost of ordering
TC(Q)

D * C o Q

Q * Cc 2

Q = * C c + 2

D * C o Q

Inventory Control for deterministic demand:


EOQ Model

Denoting EOQ by Q*, we obtain the expression of Q* as:

Q
*

2C o D Cc
D Q*

The optimal number of orders =

Time between orders =

Q* D

Issues in using EOQ Model


Model assumptions
1. 2. 3. 4. 5. The demand is known with certainty Demand is continuous over time There is an instantaneous replenishment of items The items are sourced from an outside supplier Assumptions about order quantity
a) b) c) There are no restrictions in the quantity that we can order There are no preferred order quantities for the items No price discount is offered when the order size is large

Despite this, the EOQ model could be applied with suitable modifications because it is robust Q can be a minimum order quantity if EOQ value is lesser Have a preferred quantity based on truckload quantity, economies of scale, quantity discounts etc

Continuous Review (Q) System


An illustration
Q Inventory Position Physical Inventory

Inventory Level

ROP

Mean Demand during LT SS

Safety Stock

Time

Periodic Review (P) System


An illustration
Q2R Q3R Inventory Position Physical Inventory QR S Order Up to Level

Inventory Level
SS

Safety Stock

R L

2R

3R

Time

Basic Fixed-Order Quantity Model and Reorder Point Behavior


Number of units on hand

Q R

L
R = Reorder Point Q = Economic Order Quantity L = Lead Time Time

Use of Q and P systems Q system is based on perpetual monitoring Q system is less responsive to demand changes when demand declines, the ROP moves to the right and system will continue to order even if demand is less, so carrying cost may rise If demand increases, ROP will happen frequently and ordering cost will increase Another issue is ordering of multiple items A, B,C from the same supplier. P system overcomes limitation of Q system. Greater chances of linkage between MRP and planning system. For high value/ A class use P system

Inventory Analysis
ABC Analysis
FSN Analysis VED Analysis

Product Classification Analysis (ABC)


Product Number 1 2 3 4 5 6 7 8 9 10 11 12 20 Sales (000) Percent of Cumulative Sales Sales Percent 30.0 23.3 16.7 10.0 5.3 3.3 2.7 2.0 1.3 0.7 0.7 0.7 0.2 30.0 53.3 70.0 80.0 85.3 88.7 91.3 93.3 94.7 95.3 96.0 96.7 100.00 Cumulative Products Percent 5 10 15 20 25 30 35 40 45 50 55 60 100 Category

45,000 35,000 25,000 15,000 8,000 5,000 4,000 3,000 2,000 1,000 1,000 1,000 250

A A A A B B B B B B C C C

Selective Control of Inventories


Alternative Classification Schemes
ABC Classification (on the basis of consumption value) XYZ Classification (on the basis of unit cost of the item)
High Unit cost (X Class item) Medium Unit cost (Y Class item) Low unit cost (Z Class item)

FSN Classification (on the basis of movement of inventory)


Fast Moving Slow Moving Non-moving

VED Classification (on the basis of criticality of items)


Vital Essential Desirable

On the basis of sources of supply


Imported Indigenous (National Suppliers) Indigenous (Local Suppliers)

A graphical illustration
100% 90%
Class C

ABC Classification

80%

Consummption value (%)

Class B

70% 60%
Class A

50% 40% 30% 20% 10% 0%

0%

% 90

10

20

30

40

50

60

70

80

No. of items (% )

10

0%

Inventory Planning & Control


Chapter Highlights
A fixed order quantity (Q system) or continuous review system of inventory planning and control is useful for B class and C class items of inventory.
A popular application of the continuous review system in organisations is the two-bin system.

A fixed order interval or a periodic review system (P system) is useful for planning and control of high value and A class items.
The P system is more responsive to changes in demand patterns than the Q system.

Selective control of inventories is achieved through alternative classification methodologies. The ABC, VED and XYZ classifications are often used by organisations.

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