VARIOUS FORMS OF INVENTORY 1. Raw material 2. Work in progress 3. Consumables 4. Finished goods 5. spares PURPOSE/ BENEFITS OF HOLDING INVENTORIES.

CHAPTER NO. 8INVENTORY MANAGEMENT

INVENTORY MANAGEMENT

The dictionary meaning of inventory is “stock of goods, or a list of goods” consisting of various forms.Inventory

serves as a link between production &

distribution processes. It serves the link between production & distribution processes. The investments

In Inventories constitutes the most significant part. It also provides cushion for future price fluctuations. One of

the most expensive assets of many

Companies inventory system representing as much as 50% of total invested capital. Operations managers

must balance inventory investment and customer service.

INVENTORY

VARIOUS FORMS OF INVENTORY

1. Raw material2. Work in progress3. Consumables4. Finished goods5. spares

PURPOSE/ BENEFITS OF HOLDING INVENTORIES

1) Transaction motive

2) Precautionary motive

3) Speculative motive

TYPES OF INVENTORY

Raw material Purchased but not processed

Work-in-process Undergone some change but not

completed A function of cycle time for a product

Maintenance/repair/operating (MRO) Necessary to keep machinery and

processes productive Finished goods

Completed product awaiting shipment

Types of Inventory

Work inprocess

Work inprocess

Work inprocess

Finishedgoods

RawMaterials

Vendors Customer

TYPES OF INVENTORY

Inputs• Raw Materials• Purchased parts• Maintenance and Repair

Materials

Outputs • Finished Goods• Scrap and Waste

Process

In Process• Partially Completed

Products and Subassemblies

(in warehouses, or “in transit”)

(often on the factory floor)

FUNCTIONS OF INVENTORY

1. To decouple or separate various parts of the production process

2. To decouple the firm from fluctuations in demand and provide a stock of goods that will provide a selection for customers

3. To take advantage of quantity discounts

4. To hedge against inflation

REASONS TO HOLD INVENTORY Meet variations in customer demand:

Meet unexpected demandSmooth seasonal or cyclical demand

Pricing related:Temporary price discountsHedge against price increasesTake advantage of quantity discounts

Process & supply surprisesInternal – upsets in parts of or our own processesExternal – delays in incoming goods

Transit

Reasons To NOT Hold Inventory

Carrying costFinancially calculable

Takes up valuable factory spaceEspecially for in-process inventory

Inventory covers up “problems” …That are best exposed and solved

Two Forms of Demand

DependentDemand for items used to produce final

products Tires stored at a Goodyear plant are an

example of a dependent demand item

IndependentDemand for items used by external

customersCars, appliances, computers, and houses

are examples of independent demand inventory

INVENTORY HIDES PROBLEMS

Poor Quality

UnreliableSupplier

MachineBreakdownInefficient

Layout

BadDesign

LengthySetups

TO EXPOSE PROBLEMS:REDUCE INVENTORY LEVELS

Poor Quality

UnreliableSupplier

MachineBreakdownInefficient

Layout

BadDesign

LengthySetups

Remove Sources of Problems & Repeat the

Process

Poor Quality

UnreliableSupplier

MachineBreakdownInefficient

Layout

BadDesign

LengthySetups

Typical Inventory Carrying Costs

Housing cost:Building rent or depreciationBuilding operating costTaxes on buildingInsurance

Material handling costs:Equipment, lease, or depreciationPowerEquipment operating cost

Manpower cost from extra handling and supervision

Investment costs:Borrowing costsTaxes on inventoryInsurance on inventory

Pilferage, scrap, and obsolescence

Overall carrying cost

6% (3% - 10%)

3% (1% - 4%)

3% (3% - 5%)

10% (6% - 24%)

5% (2% - 10%)

(15% - 50%)

Costs as % of Inventory Value

The Material Flow Cycle

Figure 12.1

Input Wait for Wait to Move Wait in queue Setup Run Outputinspection be moved time for operator time time

Cycle time

95% 5%

RISK & COSTS OF HOLDING INVENTORIES

CAPITAL COSTSSTORAGE & HANDLING COSTS RISK OF PRICE DECLINERISK OF OBSOLESCENCERISK OF DETERIORATION IN

QUALITY

Nature of Inventory: Adding Value through Inventory

Quality - inventory can be a “buffer” against poor quality; conversely, low inventory levels may force high quality

Speed - location of inventory has gigantic effect on speed

Flexibility - location, level of anticipatory inventory both have effects

Cost - direct: purchasing, delivery, manufacturing

indirect: holding, stock out.

INVENTORY MANAGEMENT The investment in inventory is very high than in other

assets, in most of the undertakings engaged in manufacturing, whole-sale & retail trade .In India study of 29 major industries has revealed that the average cost of materials is 64 paisa & labour and overheads is 36 paisa in a rupee.

In sugar industries, raw material cost is 68.75% of the total costs.

About 90% of the working capital is invested in inventories. A proper planning of purchasing ,storing & accounting

should form a part of inventory management. An efficient system of inventory management will determine

What to purchase How much to purchase From where to purchase Where to store.

INVENTORY MANAGENENT To ensure continuous supply To avoid over stocking & under stocking Maintain investment in inventories To keep material cost under control To eliminate duplication in ordering stocks To minimize the losses To design proper organization for inventory

management To ensures perpetual inventory control To ensure right quality goods at reasonable

prices To facilitate furnishing of data for short-term &

long term.

TOOLS & TECHNIQUES OF INVENTORY MANAGEMENT

1. DETERMINATION OF STOCK LEVELS

2.DETERMINATION OF SAFETY STOCKS

3. PROPER SYSTEM OF ORDERING FOR INVENTORIES

4. ECONOMIC ORDER QUANTITY

5. ABC ANALYSIS

6. VED ANALYSIS

7. INVENTORY TURNOVER RATIO

8. AGING SCHEDULE OF INVENTORIES

9. CLASSIFICATION & CODIFICATION OF INVENTORIES

10. INVENTORY REPORTS

11. PREPETUAL INVENTORY SYSTEM

12. JIT CONTROL SYSTEM

13. LEAD TIME

ABC ANALYSIS

The materials are divided in to a number of categories for adopting a selective approach for material control.

Classification of items as a, b, or c

Purpose: set priorities for management attention. ‘A’ items: 20% of the items contributes, 80% value ‘B’ items: 30 % of Items contributes , 15% Value ‘C’ items: 50 % of Items contributes , 5% value Three classes is arbitrary; could be any number. Percents are approximate.

ABC Analysis Example

10 20 30 40 50 60 70 80 90 100

Percentage of items

Per

cen

tag

e o

f d

oll

ar v

alu

e

100 —

90 —

80 —

70 —

60 —

50 —

40 —

30 —

20 —

10 —

0 —

+Class C

Class A

+Class B

DETERMINATION OF ECONOMIC ORDER QUANTITY (EOQ)

Economic order quantity is the size of the lot to be purchased which is economically viable. This the quantity of materials which can be purchased at minimum costs.

ASSUMPTIONS Demand rate D is constant, recurring, and known Amount in inventory is known at all times Ordering (setup) cost S per order is fixed Lead time L is constant and known. Unit cost C is constant (no quantity discounts) Annual carrying cost is i time the average RUPEE value of

the inventory No stock outs allowed. Material is ordered or produced in a lot or batch and the

lot is received all at once

EOQ Lot Size Choice

There is a trade-off between lot size and inventory level.Frequent orders (small lot size): higher

ordering cost and lower holding cost.Fewer orders (large lot size): lower

ordering cost and higher holding cost.

EOQ Inventory Order Cycle

Demand rate

0 TimeLead time

Lead time

Order Placed

Order Placed

Order Received

Order Received

Inve

nto

ry

Lev

el

Reorder point, R

Order qty, Q

As Q increases, average inventory level increases, but number of orders placed decreases

ave = Q/2

Total Cost of Inventory – EOQ Model

.

EOQ Cost Model

Co - cost of placing order D - annual demand

Cc - annual per-unit carrying cost Q - order quantity

Annual ordering cost =CoD

Q

Annual carrying cost =CcQ

2

Total cost = +CoD

Q

CcQ

2

CALCULATION OF ECONOMIC ORDER QUANTITY

WHERE- A= ANNUAL CONSUMPTIONS= COST OF REPLACING AN ORDER

I= INVENTORY CARRYING COSTS OF ONE UNIT

EOQ=2AS

I

EOQ Cost Model (cont.)

Order Quantity, Q

Annual cost Total Cost

Carrying Cost =CcQ

2

Slope = 0

Minimum total cost

Optimal order Qopt

Ordering Cost =CoD

Q

ECONOMIC ORDER QUANTITY

ORDERING COSTSA. Cost of staffB. Transportation

expensesC. Inspection costsD. Cost of stationary,

typing, postage etc.

CARRYING COSTSa) Cost of capital

investedb) Cost of storagec) Cost of loss of

material due to natural factors

d) Insurance coste) Cost of spoilage in

handling of material

Holding, Ordering, and Setup Costs

Holding costs - the costs of holding or “carrying” inventory over time

Ordering costs - the costs of placing an order and receiving goods

Setup costs - cost to prepare a machine or process for manufacturing an order

Production QuantityModel

An inventory system in which an order is received gradually, as inventory is simultaneously being depleted

Non-instantaneous receipt model› assumption that Q is received all at once is

relaxed p - daily rate at which an order is received

over time d - daily rate at which inventory is

demanded

PRODUCTION QUANTITY MODEL

Q(1-d/p)

Inventorylevel

(1-d/p)Q2

Time0

Orderreceipt period

Beginorder

receipt

Endorder

receipt

Maximuminventory level

Averageinventory level

SAFETY STOCKS

Safety stockbuffer added to on hand inventory during lead

timeStockout

an inventory shortageService level

probability that the inventory available during lead time will meet demand

Safety Stock

Reorderpoint, R

Q

LT

Time

LT

Inve

nto

ry le

vel

0

Safety Stock

Reorder Point

Quantity to which inventory is allowed to drop before replenishment order is made

Need to order EOQ at the Reorder Point:

ROP = D X LTD = Demand rate per periodLT = lead time in periods

an alternative to ROP/Q-system control is periodic review method

Q-system - each stock item reordered at different times - complex, no economies of scope or common prod./transport runs

P-system - inventory levels for multiple stock items reviewed at same time - can be reordered together

higher carrying costs - not optimum, but more practical

P-SystemPeriodic Review Method

VALUATION OF INVENTORIES

1. FIRST IN FIRST OUT METHOD

6. MARKET PRICE

METHOD

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