Inventory Management. Inflow > Outflow Inflow < Outflow Inflow = Outflow INVENTORY The Law of the Bath Tub.

Inventory Management

Inflow > Outflow

Inflow < Outflow

Inflow = Outflow

INVENTORY

INVENTORY

INVENTORY

The Law of the Bath Tub

Arguments for Carrying Inventory

Balancing supply and demandBalancing supply and demand

Protection from uncertaintiesProtection from uncertainties

Buffer interfaceBuffer interface

Realizes economies of scale through reduction of fixed costs Realizes economies of scale through reduction of fixed costs

Allows quick response to customer demands

Allows quick response to customer demands

Keeps production line running Keeps production line running

Supports long production runsSupports long production runs

Disadvantages for Carrying Inventory

May become obsoleteMay become obsolete

Can be damaged or deteriorateCan be damaged or deteriorate

May be hazardous to storeMay be hazardous to store

May take up excessive W/H spaceMay take up excessive W/H space

Could be totally lost or hiddenCould be totally lost or hidden

Opportunity CostOpportunity Cost

Could be duplicated at different W/HCould be duplicated at different W/H

Cycle stockCycle stock

In-process or work-in-processIn-process or work-in-process

In-transit inventoryIn-transit inventory

Safety stock or Buffer inventorySafety stock or Buffer inventory

Seasonal stockSeasonal stock

Promotional stockPromotional stock

Speculative stockSpeculative stock

Dead stockDead stock

Consignment stock [held in customers W/H, but charged when is used]

Consignment stock [held in customers W/H, but charged when is used]

Types of Inventory


Symptoms of Poor Inventory Management[4]

1. An increase in backorders

2. More cancelled customer orders

3. Insufficient storage space

4. Unnecessary obsolete products


Financial Impact of Inventory [3]1. Inventory is often a company’s largest asset

2. Inventories can account for 20% of total assets

3. Inventory costs may run up to 40- 50% of the value of a product and ~ 40% of total integrated logistics costs


Definitions

• Inventory accuracy refers to how well the inventory records agree with physical count

• Cycle Counting is a physical inventory-taking technique in which inventory is counted on a frequent basis rather than once or twice a year


How to Measure Inventory

• The Dilemma: closely monitor and control inventories to keep them as low as possible while providing acceptable customer service.

• Average Aggregate Inventory Value:

how much of the company’s total assets are invested in inventory?

• Ford: 6.825 billion

• Sears: 4.039 billion

Formulas for Measuring Supply-Chain Performance

• One of the most commonly used measures in all of operations management is “Inventory Turnover”

• In situations where distribution inventory is dominant, “Weeks of Supply” is preferred and measures how many weeks’ worth of inventory is in the system at a particular time

valueinventory aggregate Average

sold goods ofCost turnoverInventory valueinventory aggregate Average

sold goods ofCost turnoverInventory

weeks52 sold goods ofCost

valueinventory aggregate Averagesupply of Weeks

weeks52

sold goods ofCost

valueinventory aggregate Averagesupply of Weeks

Inventory Measures - Examples

• Weeks of Supply– Ford: 3.51 weeks– Sears: 9.2 weeks

Inventory Measures - Examples

• Weeks of Supply– Ford: 3.51 weeks– Sears: 9.2 weeks

• Inventory Turnover (Turns)– Ford: 14.8 turns– Sears: 5.7 turns– GM: 8 turns– Toyota: 35 turns

Example of Measuring SC Performance

Suppose a company’s new annual report claims their costs of goods sold for the year is $160 million and their total average inventory (production materials + work-in-process) is worth $35 million. This company normally has an inventory turn ratio of 10. What is this year’s Inventory Turnover ratio? What does it mean?

Suppose a company’s new annual report claims their costs of goods sold for the year is $160 million and their total average inventory (production materials + work-in-process) is worth $35 million. This company normally has an inventory turn ratio of 10. What is this year’s Inventory Turnover ratio? What does it mean?



Example of Measuring Supply-Chain Performance (Continued)

= $160/$35 = 4.57

Since the company’s normal inventory turnover ration is 10, a drop to 4.57 means that the inventory is not turning over as quickly as it had in the past. Without knowing the industry average of turns for this company it is not possible to comment on how they are competitively doing in the industry, but they now have more inventory relative to their cost of goods sold than before.

= $160/$35 = 4.57

Since the company’s normal inventory turnover ration is 10, a drop to 4.57 means that the inventory is not turning over as quickly as it had in the past. Without knowing the industry average of turns for this company it is not possible to comment on how they are competitively doing in the industry, but they now have more inventory relative to their cost of goods sold than before.





Inventory Costs [7]1. Cost of placing an order2. Price discount costs for large orders or Extra costs for

small orders3. Stock-out costs4. Working capital costs (funding for the lag between

paying our suppliers and receiving payment from our customers)

5. Storage costs6. Obsolescence costs7. Production inefficient costs [hidden costs not realized

JIT]


Inventory Costs

• Two types: ordering and carrying


• Cost of placing the order

• Price discount costs


Ordering Costs [2]

1. Capital or opportunity cost2. Storage space cost3. Inventory service cost4. Inventory risk cost5. Insurance6. Storage and handling7. Depreciation8. Deterioration9. Taxes10. Interest

Inventory carrying cost varies between 10 – 20 %of the product cost.

Carrying or Holding Costs [10]

Time

QO

n-ha

nd I

nven

tory

Time

Q

On-

hand

Inv

ento

ryMany orders, low inventory level

Few orders, high inventory level

While carrying costs increase,

ordering costs fall and vice versa

OBJECTIVES: To determine the best ordering policy, i.e.

1. To decide how much, and

2. when to order

Economic Order Quantity [EOQ] model

•One of the oldest and most commonly used in inventory control

•Based on a number of assumptions

HOW MUCH?


EOQ Assumptions

1. Continuous and known demand rate

2. Lead time/replenishment cycle is known and constant

3. Price to purchase is independent of the amount needed

4. Transportation costs remain constant

5. No stock outs (or shortages) are permitted

6. No inventory is in transit

7. The order quantity is received all at once


The Inventory Order Cycle

Steady &predictabledemand, D

0Time

Inve

nto

ry L

eve

l

Orderquantity,

Q


QD

Slope =Demand rate

Average inventory =

QD

Instantaneous deliveries at a rate of per periodQD

The Inventory Order Cycle

Steady &predictabledemand, D

0Time

Inve

nto

ry L

evel

Q

QD

Slope =Demand rate

Average inventory =

QD

• Average inventory = Q/D [2 shaded areas are equal]

• Time interval between deliveries = Q/D

• Frequency of deliveries, N = reciprocal of the time interval = 1 / [Q/D] = D/Q

Order Quantity, Order Quantity, QQ

Annual Annual cost ($)cost ($) Total CostTotal Cost

Carrying Cost =Carrying Cost =CCccQQ

22

Slope = 0Slope = 0

Minimum Minimum total costtotal cost

Optimal orderOptimal order QQoptopt

Ordering Cost =Ordering Cost =CCooDD

QQ

EOQ Cost Model

EOQ Cost Model

CO - cost of placing order D - annual demand

CC - annual carrying cost/unit Q - order quantity

Annual ordering cost = Annual carrying cost

= ordering cost x No of orders = holding cost/unit x average inventory

= COD/Q = CCQ/2

Total cost = COD/Q + CCQ/2

Co .D

Q

Cc .Q

QCoDCc

Q*CoDCc

TCCoDQ*

CcQ*

22 2

2

2min

TCCoD

QCcQ

TCQ

CoD

Q

Cc

CoD

Q

Cc

Q*CoDCc

2

2 2

02 2

2

EOQ Model Cost Curves

Slope = 0 Total Costcurve

Ordering Cost = CoD/Q

Order Quantity, Q

Annualcost ($)

Minimumtotal cost

Optimal order Q*

(EOQ)

Carrying Cost = CcQ/2

Total Costs = Carrying Cost + Ordering CostCt = CcQ/2 + CoD/Q

EOQ, Q = 2 D Co

Cc

QUESTIONThe annual demand for a product is 8,000 units. The ordering cost is € 30 per order. The cost of the item is € 10 and the carrying cost has been calculated at € 3 to carry out one item in stock for one year. Calculate:a.What is the EOQ?b.The numbers of orders to be placed annually, andc.The overall costs.

Example: Basic EOQ

ANSWER

D = 8,000 units

CO = € 30

CC = € 3

Q*CoDCc

2

2 (8,000) (30)3

400 units

Number of orders per year =D

Q* 8,000

40020 orders

Total Costs = Carrying Cost + Ordering Cost Holding Costs = Average quantity in stock x Cost of holding item for 1 year

= 400/2 x 3 = € 600 Ordering Costs = Cost of ordering x Number of orders

= 30 x 20 = € 600 therefore Total Costs = € 600 + € 600 = € 1,200.

Example: Basic EOQ

Zartex Co. produces fertilizer to sell to wholesalers. One raw material – calcium nitrate – is purchased from a nearby supplier at $22.50 per ton. Zartex estimates it will need 5,750,000 tons of calcium nitrate next year.The annual carrying cost for this material is 40% of the acquisition cost, and the ordering cost is $595. a) What is the most economical order quantity?b) How many orders will be placed per year?c) How much time will elapse between orders?

Example: Basic EOQ

• Economical Order Quantity (EOQ)

D = 5,750,000 tons/year

Cc = .40(22.50) = $9.00/ton/year

Co = $595/order

= 27,573.135 tons per order

Example: Basic EOQ

EOQ = 2(5,750,000)(595)/9.00

• Total Annual Stocking Cost (TSC)

TSC = (27,573.135/2)(9.00)

+ (5,750,000/27,573.135)(595)

= 124,079.11 + 124,079.11

= $248,158.22 Note: Total Carrying CostNote: Total Carrying Costequals Total Ordering Costequals Total Ordering Cost

Example: Basic EOQ

• Number of Orders Per Year= D/Q = 5,750,000/27,573.135 = 208.5 orders/year

• Time Between Orders= Q/D= 1/208.5= .004796 years/order= .004796(365 days/year) = 1.75

days/order

Note: This is the inverseNote: This is the inverse of the formula above.of the formula above.

Example: Basic EOQ

END

Inventory Management. Inflow > Outflow Inflow < Outflow Inflow = Outflow INVENTORY The Law of the Bath Tub.

Documents

inventory costs

outflow inventory

physical inventory

distribution inventory

inventory records

weeks worth of inventory

inventory balancing

financial impact of