February 2008inventory management 1 INVENTORY MANAGEMENT And Independent Demand Dr. Margaret Farrell Arnold, Chapman & Clive (2008) Heizer Slack.

february 2008 inventory management 1

INVENTORY INVENTORY MANAGEMENTMANAGEMENT

And And Independent Independent

DemandDemand Dr. Margaret Farrell Dr. Margaret Farrell Arnold, Chapman & Clive (2008)Arnold, Chapman & Clive (2008)Heizer Heizer Slack et alSlack et al

february 2008 inventory management 2

Inventory Fundamentals Inventory Fundamentals (Arnold, (Arnold, Chapman & Clive (2008) introduction to materials Chapman & Clive (2008) introduction to materials

management, Pearson Education)management, Pearson Education)

• Inventories are materials & supplies that a business or institution carries either for sale or to provide inputs or supplies to the production process.

• All businesses and institutions require inventories

• Often they are a substantial part of total assets

• Financially, inventories are very nb to manufacturing companies – representing from 20% to 60% of total asset value on the balance sheet

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Inventory ManagementInventory Management• Convert inventory value into cash cash-

flow• Planning & controlling Inventory from raw

material to end customer• Inventory either results from production or

supports it they cannot be managed separately

• Inventory must be considered at each planning stage long, medium and short term

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Supplier

Supplier

Supplier

Carrier

Carrier

Carrier

Manuf.

SiteCarrier

Carrier

Carrier

Distrib.centre

Distrib.centre

Customer

Customer

Customer

Customer

Customer

Customer

Customer

Customer

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Types of InventoryTypes of InventoryThere are many types and

classifications of stock and inventory, for example:

• raw materials, WIP, finished goods, components and sub-assemblies, consumables or MRO items, tools and equipment, and resale items. Russell and Taylor include labour, and working capital.

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Reasons for Holding Reasons for Holding StockStock

There are many reasons for holding stock (see below), however it should be remembered that the average cost of holding stock is 25% of its value.

• anticipated demand or certainty inventories

• variations (demand & production) also known as decoupling inventories

• Buffer - WIP - between production processes

• Buffer or uncertainty inventories or safety stock

• Bulk purchases• future shortages• seasonal fluctuations --supply and

demand balancing

• seasonal fluctuations --supply and demand balancing

• production processes can flow smoothly

• as part of production or distribution

• deliberate investment policy • cycle inventories (lots vs

individual)

Alternative Reasons• obsolete stock• little or no inventory control• little or no stock records• Poor Internal planning and

Control• Sub optimal decision making

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Aims of Inventory Aims of Inventory management or management or

ProvisioningProvisioning

• is to provide both internal and external customers with the required service levels in terms of quantity and order fill.

• requires ascertaining both present and future requirements for all types of inventory in order to avoid overstocking, whilst also avoiding bottlenecks in production.

• The final aim is to keep costs to a minimum by use of techniques such as variety reduction, economic lot sizes and analysis of costs incurred in obtaining and carrying inventories.

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In summary the role of inventory management for individual items encompasses the principles, concepts and techniques for deciding;What to order / buy? How much to order / buy? When it is needed?When to order for purchase or production? and How and where to store it?

Decisions made in answer to each of the above questions should be consistent with decisions at other levels (integrated) and should support Organisational objectives by;•defining & attaining desired levels of customer service•achieving investment objectives

Balancing these conflicting objectives is the role of inventory management, of which purchasing is a key element.

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How much When to What stock control to re-order? re-order? system to use?

When demand and When demand and/orlead-time are known lead-time are notwith certainty known with certainty

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Control of Service Control of Service InventoriesInventories

Can be a critical component of profitabilityCan be a critical component of profitability

Losses may come from shrinkage or Losses may come from shrinkage or pilferagepilferage

Applicable techniques includeApplicable techniques include

1.1. Good personnel selection, training, and Good personnel selection, training, and disciplinediscipline

2.2. Tight control on incoming shipmentsTight control on incoming shipments

3.3. Effective control on all goods leaving facilityEffective control on all goods leaving facility

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Holding, Ordering, and Holding, Ordering, and Setup CostsSetup Costs

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

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

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

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Cost of Stock Cost of Stock The cost of stock can be broken down into four key The cost of stock can be broken down into four key

elements;elements;Costs of Holding Stock (Ch)• Interest on Capital• Storage and Store mgt• Handling• Audits etc.• Insurance and Security• Deterioration & Obsolesce• Pilferage and VerminProcurement / Obtaining

Stock (Co)• clerical / administrative &

purchasing• transport• local manufacturing costs

(local order, P&C...)

Stockout Costs• Loss of Contribution• Loss of future sales• Loss of goodwill• Costs of Production stoppages• Labour frustration• Cost of expediting Materials

Costs of Stock• Bulk Buying• Longer production Runs• Actual sales price• Profit

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Holding CostsHolding Costs

Category

Cost (and Range) as a Percent of

Inventory Value

Housing costs (including rent or depreciation, operating costs, taxes, insurance)

6% (3 - 10%)

Material handling costs (equipment lease or depreciation, power, operating cost)

3% (1 - 3.5%)

Labor cost 3% (3 - 5%)

Investment costs (borrowing costs, taxes, and insurance on inventory)

11% (6 - 24%)

Pilferage, space, and obsolescence 3% (2 - 5%)

Overall carrying cost 26%

Table 12.1Table 12.1

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Simple Methods of Stock ControlSimple Methods of Stock ControlDemand and Supply• Demand or usage level average, busy or slack for specified

periods of time i.e. average, min., or max.• Suppliers delivery period or lead time

average, max or min. time • Calculate the re-order level or the level of stock which will trigger

a fresh purchase:

Re-Order Level=maximum delivery period x maximum usage

– Allowing for occasional checks– suitable for stock items of comparatively low value– real time information not required

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Re- Order Quantity

= optimum quantity which minimises the combined costs of ordering and holding stock

(and purchase costs)

use mathematical models

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Reorder level & reorder Reorder level & reorder quantity examplequantity example

Component no. 697 has a usage level or demand of 30,000 units per annum.

The max. weekly usage is 800 units and a minimum of 400 units p.w.

The average lead time is 3weeks but it can vary in the range of 4weeks to a minimum of 2 weeks.

What is the re-order level and reorder quantity?

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SOLUTION

•avg. weekly usage = 600

•avg. usage over avg. LT = 600 x 3 = 1,800 units

•max usage over max. LT = 800 x 4 = 3,200 units

•Probable re-order level set by management would be 3,000 units.

Low value item => fix reorder quantity by deciding how many times you would like to place an order p.a.

i.e. say 6 times, say every two monthsReorder quantity = (30,000/6) = 5,000 units

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More simple inventory systemsMore simple inventory systems

• Visual approaches to control, – Kanban or the two bin approach, – The use of records.

• The ABC classification system.• Continuous Inventory systems

– Or Fixed Order Quantity system: order a constant amount, once inventory has fallen to the ROL. The order placed, is for a fixed amount, known as the economic order quantity (EOQ).

• Periodic Inventory Systems place a variable quantity order, after a fixed period of time.

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Inventory CostsInventory Costs• Item Cost

– Landed price

• Carrying Cost– Capital cost– Storage costs– Risk costs– See next slide

• Ordering Costs– Production control costs– Setup and teardown

costs– Lost capacity cost– Purchase order cost– See next slide

• Stockout costs• Capacity associated

costs