INVENTORY MANAGEMENT

INVENTORY--A physical resource that a firm holds in stock with intent of selling it or transforming it into more valuable state. INVENTORY SYSTEMS--A set of policies that determines what levels should be maintained, when the stock should be replenished, and how large the orders should be.

INVENTORY MANAGEMENT
Inventory is needed for the definite consumption of materials, and to take care of the uncertainty involved in the usage or availability of the material. The inventory taking care of the first aspect of normal consumption is called the normal inventory & the inventory taking care of the second aspect of uncertainty is called the safety or buffer stock of inventory

REASONS FOR INVENTORIES

Improve customer service Economies of Purchasing Economies of Production Uncertainty in lead time. Transportation savings Hedge against future.( Uncertainty of Demand) Price increase. Inventory covers up problem.

OBJECTIVES OF INVENTORY
Maximum customer service. Low cost plant operations. Minimum inventory investments.

INVENTORY
Types of inventory--Raw material Work in progress Finished goods Classification of inventory--Anticipation inventory Fluctuation inventory Lot size inventory Transportation inventory

INVENTORY
The average amount of inventory in transit is--I = t*A/365. I = average annual inventory in transit t = transit time in days. A = annual demand.

INVENTORY COSTS
Item cost it is the price paid for a purchased price, which consists of the cost of the item & any other direct costs associated in getting the item in the plant.These could include cost of transportation , custom duties , insurance etc. The inclusive cost is often called as LANDED PRICE.

INVENTORY COSTS
INVENTORY CARRYING COSTS.This is expressed as fraction of value of goods stocked every year. Cost of incurring shortages. Storage costs ( Space,workers & equipment) Cost due to obsolescence Capital ( Interest rate) Pilferage , damage. Cost of insurance. Deterioration.

INVENTORY CARRYING COSTS

A company carries an average annual inventory of Rs.20,00,000. If they estimate the cost of capital is 10%, storage costs are 7%,& risk costs are 6%,what does it costs per year to carry this inventory? Total cost of carrying inventory = 10% + 7% +6% = 23%. Annual cost of carrying inventory =0.23 * 20,00,000 = 4,60,000.

INVENTORY COSTS
ORDERING COSTThis is also called as cost of acquisition.This is basically the expenditure for placement of the order & further activities in company such as receiving,inspection, binning etc. Purchase cost.Higher is the qty. , more is the bargaining power in terms of qty. discount. Set-up & Ordering cost. Costs associated with frequent set-up changes at vendor & with expense associated with each purchase ,salaries & overhead in purchase dept.

ORDERING COSTS
Given the following annual costs, calculate the average cost of placing one order. Production control salaries = Rs. 60,000. Supplies & operating expenses for production control department = 15,000. Cost of setting up work centers for an order = 120 Orders placed each year = 2000. Average cost = fixed cost / no. of orders + variable cost. = 60,000 + 15000 / 2000 + 120 = Rs. 157.50.

INVENTORY COSTS
Behavior of Two Distinct Cost
Carrying cost
80 60
Cost

Order cost
TOTAL INVENTORY COST

40 20 0 1

E.O.Q.

INVENTORY CARRYING COST ORDERING COST

Average Level of Inventory

INVENTORY MANAGEMENT
Re-Order Point:When Quantity on hand of a item drops to this level, item is recorded. Safety Stock: Stock that is held in excess of expected demand due to variable demand rate and/or lead time.It is intended to protect against uncertainty in supply & demand. ( Qty. uncertainty-SS & timing uncertaintysafety lead time ) Service Level: Probability that demand will not exceed supply during lead time.

Order quantity Average inventory INVENTORY QUANTITY Reorder point

Lead time in quantity Safety stock TIME

Lead time w.r.t. Time factor

INVENTORY CALCULATIONS
LET D = Annual Demand=yearly usage of items. Q = Procurement Quantity per order = number of items ordered in each replenishment period( E.O.Q.) O = Order Cost Per Order. p = Price of an item. i = Rate of interest charged per unit per year. ip = Capital Cost H = Additional Holding cost, if any. C = Total annual inventory cost.

INVENTORY CALCULATIONS
Total Inventory Cost = Annual Procurement cost + Annual Inventory Carrying Cost. Annual procurement cost = Cost per order * number of units demanded per year / number of units per order i.e.= O * D / Q. Annual carrying cost = ( Holding cost + interest charge per unit per year ) * Average inventory i.e. = ( H + ip ) * Q/2. Total Inventory Cost = O * D / Q + ( H + ip ) * Q/2

INVENTORY CALCULATIONS
Q= 2 O D / H+ip

No. Of orders to place in year = D / Q Order interval = t = No. of working days in a year / D/Q Total Annual Stocking Cost = OD/Q + (H+ip) Q/2+ PD. Average inventory = Q/2+ Safety stock Order point(OP) = Demand during lead time (DDLT) + Safety Stock (SS)

ASSUMPTIONS
Assumptions on which EOQ formula is based are as follows Demand is relatively constant & is known. The item is produced or purchased in lots or batches & not continuously. Order preparation cost & inventory carrying costs are constant & known.

 The annual demand is 10,000 units,the ordering cost is Rs. 30 per order, the carrying cost is 20% & the unit cost is Rs. 15. The order quantity is 600 units.Calculate Annual ordering cost , Annual carrying cost & Total annual cost. D = 10,000 UNITS. O = Rs. 30 i= 0.20 P = Rs. 15 Q = 600 units

EXAMPLES

 Annual ordering cost = O*D /Q= 10,000/600*Rs. 30 = Rs. 500 Annual carrying cost = Q / 2 * i*P=600/2*0.2*Rs.15 = Rs. 900 Total cost = Rs.500 + Rs. 900 = Rs. 1400.

EXAMPLES

EXAMPLES
The annual demand for an item is 10,075 units & it is ordered in quantities of 650 units. Calculate average inventory & no. of orders placed per year. Average inventory = order quantity / 2 = 650 / 2 = 325 units. Number of orders per year = Annual demand / order quantity. = 10075 / 650 = 15.5 = 16.

EXAMPLE
Demand is 200 units a week, the lead time is three weeks, & safety stock is 300 units. Calculate the order point. OP( Ordering Point ) = DDLT ( Demand During Lead Time ) + SS (Safety Stock ) = 200 * 3 + 300 = 900 UNITS.

EXAMPLE
Order quantity is 100 units & safety stock is 300 units. What is the average annual inventory ? Average inventory = Q / 2 + Safety Stock = 1000 / 2 + 300 = 800 units.

INVENTORY CALCULATIONS
An item has an annual demand of 25,000 units. Every unit costs Rs.10.Order preparation cost is Rs.10 & carrying cost is 20 %. It is ordered on basis of an EOQ,but the supplier has offered a discount of 2% on orders of Rs. 10,000 or more. Should the order be accepted ? Q = 2 O * D / i*P = 2*10*25,000 / 0.20 * 10 = 500 UNITS = 500 * Rs. 10 = Rs. 5000. Discounted order qty.= Rs. 10,000*0.98 = Rs. 9,800.

INVENTORY CALCULATIONS
N O D IS C O U N TC O U N T L O D IS 1 2 3 4 5 6 7 8 U N IT P R IC E IN R S . L O T S IZ E IN R S . 10 5000 9 .8 9800 4900 25 2 ,4 5 ,0 0 0 980

A V E R A G E L O T S IZ E IN V E N T O R Y = Q .P2 5 0 0 IN R S . /2 N O .O F O R D E R S P E R Y E A R P U R C H A S E C O S T IN R S . 50 2 ,5 0 ,0 0 0

IN V E N T O R Y C A R R Y IN G C O S T ( 2 0 % ) 5IN 0R S . 0

O R D E R P R E P A R A T IO N C O S T ( R s .1 0 e 5 0 0 ) IN R S . 2 5 0 ach T O T A L C O S T ( IN R S . ) 2 ,5 1 ,0 0 0 2 ,4 6 ,2 3 0 .

FINANCIAL INVENTORY PERFORMANCE MEASURES

Inventory is an asset & represents money that is tied up & can not be used for any other purpose.Lesser the inventory,better it is.Total inventory is one measure which does not relate to sales. Two measures that do relate to sales are inventory turnover ratio & days of supply. Inventory turnover ratio = annual sales / average inventory. ( unit of measurement is either qty. or money. ) Days of supply = inventory on hand / av.daily usage

EXAMPLE PROBLEMS
Calculate inventory turnover ratio if annual sales ( Cost of good sold ) is Rs. 2,40,00,000 & average inventory is Rs.60,00,000. Inventory turns = annual cost of good sold / average inventory. = 2,40,00,000 / 60,00,000 = 4. What would be reduction in inventory if inventory turns were increased to 12 times a year. Average inventory = annual cost of good sold / inventory turns = 2,40,00,000 / 12 = 20,00,000. Reduction in inventory = 60,00,000 20,00,000= 40,00,000.

EXAMPLE PROBLEMS
If the cost of carrying the inventory is 25 % of the average inventory , what will be the savings ? Reduction in inventory = 40,00,000 Savings = 40,00,000 * 0.25 = 10,00,000. A company has 9000 units on hand & the annual usage is 48,000 units.There are 240 working days in the year. What is the days of supply? Average daily usage = 48,000 / 240 = 200 units. Days of supply = inventory on hand / average daily usage = 9000 / 200 = 45 days.

PERIOD ORDER QUANTITY

The POQ uses the EOQ formula to calculate an economic time between orders. This is calculated by dividing the EOQ by demand rate. This produces time interval for which orders are placed. Instead of ordering same quantity (EOQ) , orders are placed to satisfy requirements for the calculated time interval. The no. of orders placed in a year are same as for EOQ, but the amount ordered each time varies. Thus ordering cost is same . Because the order quantities are determined by actual demand , the carrying cost is reduced. POQ = EOQ / AV.WEEKLY USAGE

EXAMPLE
Given is MRP record & an EOQ of 250 units,calculate the planned order receipts using the EOQ. Next, calculate the POQ & planned order receipts. In both cases, calculate the ending inventory & the total inventory carried over the ten weeks.

W E E 1 K2 3 4 5 6 7 8 9 1 T0 O N E T R 1 E 50 1Q0 5 U7 0 25I R50 850E10 M35 08E 9N 0

E O Q = 2 5 0 U N IT S W E E K 1 2 3 4 5 6 7 8 9 1 0T O N E T R E 1 Q 05 U01 5I R 07 E25 M05 058 E 10 N 53 T0 8 S 9 P L A N N E 2D 5 0O2 5 R 0 D2 E5 0R 2 R5 0E C E N D I N G 1 51I N02 02V 01E 021 N 571 T524 O01 41R 01 Y1 0 3

P E R IO D O R D E R W EEK LY AVER A 890 / 10 = 89 U PO Q = 250 / 89 =

Q U A N T IT Y G E D EM AN D = N IT S 2 .8 1 = 3 W e e k s

W EEK 1 2 3 4 5 6 7 8 9 10T O T N E T R E Q U I R1 E0 50 01E 5N0 T 7S 52 0 50 5 8 01 5 30 0 8 9 0 M P L A N N E D O R 3D0 E0 R R E 3 C3 E I P T2 6 0 0 E N D I N G I N V 2E 0 N0 5T 0O R 2 5 5 5 0 1 8 30 0 0 8 7 0 1 0 Y

PROBABILISTIC INVENTORY MODELS

In the inventory models described earlier,we assumed that there was no uncertainty associated with demand & lead times. However in reality there is always some uncertainty associated with demand & lead times. Extra buffer stock is required to account for these uncertainties. This extra stock will be added to the expected demand during lead times , to obtain reorder point. There will still be probability of stock out even after carrying this extra buffer stock.

PROBABILISTIC INVENTORY MODELS

From statistics , we can determine that The actual demand will be within +/- 1 sigma of the forecast average approximately 68 % of the time , +/- 2 sigma 95 % of the time & +/- 3 sigma 99.88% of the time. One property of the normal curve is that it is symmetrical about the average. This means that half the time the actual demand is less than the average & half the time it is greater.

PROBABILISTIC INVENTORY MODELS

Safety stocks are needed to cover only those periods in which the demand during the lead time is greater than the average. Thus the service level of 50% can be attained without any safety stock. Suppose the std.dev. Of demand during lead time is 100 units & this amount is carried out as safety stock.This safety stock is able to provide protection for 84% of time. The service level is a statement of percentage of time there is no stock out.

PROBABILISTIC INVENTORY MODELS

The service level is directly related to the number of std. Deviations provided as safety stock & is usually called the SAFETY FACTOR.
TBE F A T FCO AL OSF Y AT R E SRI E EE (% EV LVL ) C 5 0 7 5 8 0 8 5 9 0 9 4 9 5 9 6 9 7 9 8 9 9 9. 6 9 8 9. 9 9 9 SFT FCO A Y AT R E 0 07 . 6 04 . 8 14 . 0 18 . 2 16 . 5 15 . 6 15 . 7 18 . 8 25 . 0 23 . 3 3 4

PROBABILISTIC INVENTORY MODELS--EXAMPLE

SIGMA IS 200 UNITS.--- Calculate the safety stock & order point for an 84% service level. If a safety stock equal to two std. Deviations is carried,calculate the safety stock & the order point. A) Safety stock = 1 sigma = 1 * 200 = 200 units. Order point = DDLT + SS =1000 + 200 =1200 units. B) SS = 2 * 200 = 400 UNITS. OP = DDLT + SS = 1000 + 400 = 1400 UNITS.

PROBABILISTIC INVENTORY MODELS--EXAMPLE

If the Std. Dev.is 200 units ,what safety stock should be carried to provide a service level of 90% ?If the expected demand during the lead time is 1500 units,what is the order point ? The safety factor for a service level of 90% is 1.28. Safety stock = sigma * safety factor = 200 * 1.28 = 256 units. Order point = DDLT + SS = 1500 + 256 = 1756 units.

PROBABILISTIC INVENTORY MODELS--EXAMPLE

Suppose management of a company decides that only one stock-out in a year is allowed for a specific item.For this particular item , the annual demand is 52,000 units.It is ordered in quantities of 2600, & std. Dev. Of demand during the lead time is 100 units.The lead time is one week. Calculate : Number of orders per year. Service level Safety stock. Order point.

PROBABILISTIC INVENTORY MODELS--EXAMPLE

Number of orders per year = annual demand / order quantity. = 52,000 / 2600 = 20 times a year. Since one stock out per year is tolerable, there must be no stock outs 19 ( 20-1 ) times a year. Service level = 20-1 / 20 = 95 % From table safety factor = 1.65 Safety stock=safety factor*sigma=1.65*100=165uts. Demand during lead time = (1 week) (52,000)/52=1000 units. OP = DDLT + SS = 1000+ 165 = 1165 units.

ABC ANALYSIS
ABC analysis is a basic analytical management tool which enables top management to place the efforts where the results will be greatest. Always Better Control. The technique tries to analyze distribution of any characteristic by money value of importance in order to determine its priority. The analysis does not depend upon unit cost of the items but only on its annual consumption value.

ABC ANALYSIS
ABC analysis enables the material manager to exercise selective control when he is handling with very large number of items. Tighter & accurate controls are required for A value items . The degree of control should be rigorous for A items & should be minimum for C items.

ABC ANALYSIS
METHOD OF ABC ANALYSIS Calculate annual consumption of each item. i.e.Unit cost * annual consumption. Prepare the list of all items showing item no., unit cost,annual consumption value etc. Sort all items in descending order. Compute a running total . Compute percentage.

ABC ANALYSIS
Normally top 5% to 10 % items contribute 70 % of value.A items. Next 15 % to 20 % items contribute 20 % of total consumption value----B items. The remaining no. of items account for balance 15 % of the total consumption value.----C items.

ABC ANALYSIS
Guidelines for ABC are to be used along with individual industry norms & with V.E.D. analysis. Some items ,though negligible in monetary value, may be vital for running of the plant & constant attention is needed. The results of ABC analysis have to be periodically reviewed & updated.

ABC ANALYSIS
1 2

A items Very strict control Very low stocks Frequent ordering Daily control statements Maximm follow-up & expediting Rigorous value analysis. Accurate forecast in material planning Maximum efforts to reduce lead time Highest priority for minimisation of waste, obsolescence & surplus.

B items Moderate control Low stocks Once in fortnight / month Monthly control statements Periodic follow-up. Moderate value analysis. Estimates based on past data. Moderate

C items Loose control High stocks Once in month / two / threee months. Quarterly control statements Follow-up in exceptional cases. Minimum value analysis. Rough estimates. Minimum.

Moderate

Minimum.

ANALYSIS OF INVENTORY
ABC ANALYSIS Calculate the annual usage for each item. List the items according to their annual usage. Calculate the cumulative annual usage & the cumulative percent of items. Group the items into A,B,C classification. VED ANALYSIS FSN ANALYSIS

ABC ANALYSIS
P R N . A T O 1 2 3 4 5 6 7 8 9 10 TO L TA U IT U A E N S G 1100 600 100 1300 100 10 100 1500 200 500 5510 U IT C S N O T 2 40 4 1 60 25 2 2 2 1 A N A U A E N U L S G 2200 24000 400 1300 6000 250 200 3000 400 500 38250

ABC ANALYSIS
PART NO . ANNUAL USAGE CUM ULATIVE USAG E CUM ULATIVE % USAG ECLASS 2 24000 24000 62.75 A 5 8 1 4 10 9 3 6 7 6000 3000 2200 1300 500 400 400 250 200 30000 33000 35200 36500 37000 37400 37800 38050 38250 78.43 86.27 92.03 95.42 96.73 97.78 98.82 99.48 100 A B B B C C C C C

ABC ANALYISIS
CUMULATIVE % OF USAGE 120 100 80 60 40 20 0 1 10 2 20 3 30 4 40 5 50 6 60 7 70 8 80 9 90 10 100

Series1 62.75 78.43 86.27 92.03 95.42 96.73 97.78 98.82 99.48 100 Series2 CUMULATIVE % OF ITEMS

VED analysis Nuisance value of materials is cost associated with material due to their absence. If, these materials are not available they hold up production & therefore, there are high cost of shut down or slow-down of production. The investment in these materials may be small but for lack of any of them, the production process may come to grinding halt. These are critical items, which are required in adequate quantity. VED stands for Vital items, which have extreme criticality, Desirable items are not that critical & Essential items are somewhere In between. VED ranking can be done on the basis of the shortage cost of materials, which can be either quantified or qualitatively expressed. XYZ Sometimes the bulk versus weight of the materials is of importance in terms of providing space for the materials in the stores & therefore another XYZ classification such as 1) Bulky 2) Medium bulky 3) Not bulky may also be of interest.

HML (high, moderate, lower) Basis unit price of material Use mainly control purchases FSN Materials can be classifies on the rate of movement of the materials in the stores; fast moving, slow moving & non-moving. The non-moving items can be in such cases listed & the list be sent to the different department which might be interested in these materials to ascertain whether they still desire storing of these materials in the stores. The items, which have become obsolete, can be sold off, some time it raises huge amount of salvage value. SDE Base Problem in procure Scarce Difficult Easy Use Lead time analysis, Purchasing strategies GOLF (Govt., Local, Foreign source) Base Source Use Purchase strategies

PRICING OF INVENTORY
LIFO FIFO WEIGHTED AVERAGE METHOD

M T R L- C T O Y R A E IA OT N A N DT AE 1 /2 0 /8 0 4 3 /2 0 /8 0 4 6 /2 0 /8 0 4 8 /2 0 /8 0 4 1 /8 0 4 2 /2 0 1 /8 4 4 /0 2 /8 4 0 /0 2 /8 4 4 /0 2 /8 4 5 /0 2 /8 4 8 /0

EXAMPLE
QY T. 50 0 30 0 80 0 40 0 30 0 40 0 60 0 50 0 30 0 10 0

U IT- K O N IL S RT AE 2 VLE AU 10 00

T A S C IO RNAT N BLNE AA C IS U SE PRHS U C AE IS U SE IS U SE PRHS U C AE IS U SE PRHS U C AE IS U SE IS U SE

2 .2

16 70

2 .5

10 00

2 .8

10 40

FIFO
DATE PURCHASE QTY. RATE VALUE QTY. ISSUE RATE VALUE QTY. 500 300 800 2.20 1760 200 200 2.00 2.20 2.00 600 200 800 840 600 2.00 2.20 2.20 BALANCE RATE VALUE 2.00 1000

1/8/2004 3/8/2004 6/8/2004 8/8/2004 12/8/2004 14/8/04 20/8/04 24/8/04 25/8/04 28/8/04 VALUE OF CONSUM PTION -VALUE OF CLOSING STOCK

2160 1320

LIFO
DATE PURCHASE QTY. RATE VALUE QTY. ISSUE RATE VALUE QTY. 500 300 800 2.20 1760 400 300 2.20 2.20 880 660 2.00 600 200 800 200 400 200 100 2.00 2.20 2.00 2.20 2.00 2.20 BALANCE RATE VALUE 2.00 1000

1/8/2004 3/8/2004 6/8/2004 8/8/2004 12/8/2004 14/8/04 20/8/04 24/8/04 25/8/04 28/8/04 VALUE OF CONSUM PTION -VALUE OF CLOSING STOCK

2160 1280 620

WEIGHTED AVERAGE RATE:-QTY500 KGS. @ 2.00 RS. & QTY.800 @ 2.20 RS THEREFORE W.A.R.= 500 * 2.00 + 800 * 2.20 / (500 + 800) = 2.12

WEIGHTED AVERAGE RATE

DATE PURCHASE QTY. RATE VALUE QTY. ISSUE RATE VALUE QTY 500 300 800 2.20 1760 400 300 2.12 2.12 848 636 2.00 600 200 1000 600 300 BALANCE RATE VALUE 2.00 2.00 2.12 2.12 2.12 1000 400 2120 1272 636

1/8/2004 3/8/2004 6/8/2004 8/4/04 12/8/2004 14/8/04 20/8/04 24/8/04 25/8/04 28/8/04

VALUE OF COSUMPTION VALUE OF STOCK

MRP :-One product consists of many items. If we know production plan, we come to know requirement of raw materials. It is better to depend on this than statistics & probabilities. It is simple method of calculating requirement based on production plan. This system works well for items that do not have direct demand but have derived demand. Pre-requisites of system :-1) COMPUTERIZATION 2) Suitable for dependent demand situation 3) Demand derived from MPS & Lead-time 4) Firm schedule for final product 5) Efficient information feedback system Handling uncertainties of MRPSafety stock: One cannot do away the safety stock concept. Continue MRP & EOQ to handle uncertainties

M aterial requirem planning process ent Forecasts Firm orders M aster schedule For production Revise the m aster Production schedule

Inventory Status Inform ation O product n D esign, Sruc ture. M at erial Requirem plan ent M anufacturing A procure nd m lead ent -tim e Capacity Adequate ? Y es Final m aster production Schedule and M RP N o -