Unit 3 - Inventory Management & Inventory Control

INVENTORY MANAGEMENT & INVENTORY CONTROL

BYALOK SINGH

What is Inventory?

• Stock of materials• Stored capacity

• Raw material• Work-in-progress• Maintenance/repair/

operating supply• Finished goods

Types of Inventory

Single-stage inventory system

Stock Sales operation

Suppliers Suppliers

Central depot

Distribution Local distribution

point

Sales operation

e.g. Local retail store e.g. Automotive parts distributor

(a) Two-stage inventory system

(b)

Input Stock

Stage 1

Suppliers

Multi-stage inventory system

(c)

Stage 2

Stage 3

WIP WIP Finished goods

stock

e.g. Television manufacturer

Inventory

Process stage

Demand Type

Number & Value Other

Raw Material / WIP/ Finished

Goods

Independent Dependent

A Items B Items C Items

Maintenance Dependent Operating

Inventory Classifications

Inventory Classification & Measures

Class A items - the

20% or so of high-

value items which

account for around

80% of the total

stock value

Class B items - the

next 30% or so of

medium-value

items which

account for around

10% of the total

stock value

Class C items -

the remaining 50%

or so of low-value

items which

account for around

the last 10% of the

total stock value

• Divides in-hand inventory into 3 classes– A class, B class, C class

• Basis is usually annual $ volume– $ volume = Annual

demand x Unit cost

• Policies based on ABC analysis– Develop class A suppliers

more– Give tighter physical

control of A items– Forecast A items more

carefully

ABC Analysis

Other Inventory Classification & Measures

VED – Vital, essential, desirable (criticality)

SDE – Scarce, difficult, easily (availability)

HML – High, medium, low (cost)

FNSD – Fast, normal, slow, dead (movement)

VED Analysis

• It is the Analysis for monitoring and control of stores and spares inventory by classifying them into 3 categories viz., Vital, Essential and Desirable. The mechanics of VED analysis are similar to those of ABC Analysis.

• The VED analysis is done to determine the criticality of an item and its effect on production and other services. It is specially used for classification of spare parts. If a part is vital it is given ‘V’ classification, if it is essential, then it is given ‘E’ classification and if it is not so essential, the part is given ‘D’ classification. For ‘V’ items, a large stock of inventory is generally maintained, while for ‘D’ items, minimum stock is enough.

SDE Analysis

S-D-E analysis is based on the problems of procurement namely:• Non-availability• Scarcity• Longer lead time• Geographical location of suppliers, and• Reliability of suppliers, etc.

Continue…S-D-E analysis classifies the items into three groups called “scarce”, “difficult”

and “easy”. The information so developed is then used to decide purchasing strategies.

• “Scare” classification comprise of items, which are in short supply, imported or canalized through government agencies. Such items are best to procure limited number of times a year in lieu of effort and expenditure involved in the procedure for import.

• “Difficult” classification includes those items, which are available indigenously but are not easy to procure. Also items, which come from long distance and for which reliable sources do not exist, fall into this category. Even the items, which are difficult to manufacture and only one or two manufacturers are available belong to this group. Suppliers of such items require several weeks of advance notice.

• “Easy” classification covers those items, which are readily available. Items produced to commercial standards, items where supply exceeds demand and others, which are locally available, fall into this group.

HML Analysis

• H-M-L analysis is similar to ABC analysis except for the difference that instead of “usage value”, “price” criterion is used. The items under this analysis are classified into three groups that are called “high”, “medium” and “low”. To classify, the items are listed in the descending order of their unit price. The management for deciding three categories then fixes the cut-off-lines. For example, the management may decide that all items of unit price above Rs. 1000/-will of ‘H’ category, those with unit price between Rs. 100/- to Rs.1000/- will be of ‘M’ category and those having unit price below Rs. 100/- will be of ‘L’ category.

Continue…

HML analysis helps to -

• Assess storage and security requirements

• To keep control over consumption at the departmental head level

• Determine the frequency of stock verification

• To evolve buying policies to control purchase

• To delegate authorities to different buyers to make petty cash purchase

FNSD Analysis

• Age of inventory indicates duration of inventory in organisation. It shows moving position of inventory during the year. If age of inventory is minimum it means, the turnover position of that particular item of inventory is satisfactory. If the age of any particular item of inventory, it indicates the slow moving of stock which may be due to lower demand for the product, inefficiency in shocking policy, excessive stocking etc. The excessive investment in stocks means, high investment is locked-up in inventory leads to lower profitability of the firm due to excess carrying costs. FNSD analysis divides the items into four categories in the descending order of their usage rate as follows:

• 'F' stands for fast moving items and stocks of such items are consumed in a short span of time. Stocks of fast moving items must be observed constantly and replenishment orders be placed in time to avoid stock-out situations.

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• 'N' means normal moving items and such items are exhausted over a period of a war or so. The order levels and quantities for such items should be on the basis of a new estimate of future demand to minimize the risks of a surplus stock.

• 'S‘ indicates slow moving items, existing stock of which would last for two years or more at the current rate of usage but it is still expected to be used up. Slow moving stock must be reviewed very carefully before any replenishment orders are placed.

• 'D' stands for dead stock and for its existing stock no further demand can be foreseen. Dead stock figures in the inventory represents money spent that cannot be realized but it occupies useful space. Hence, once such items are identified, efforts must be made to find all alternative uses for it. Otherwise, it must be disposed off.

Inventory Costs

• Holding costs - associated with holding or “carrying” inventory over time

• Ordering costs - associated with costs of placing order and receiving goods

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

Obsolescence Insurance Extra staffing Interest Pilferage Damage Warehousing

Supplies Forms Order processing Clerical support

Clean-up costs Re-tooling costs Adjustment costs

• Fixed order-quantity models– Economic order quantity– Production order quantity– Quantity discount

• Probabilistic models

• Fixed order-period models

Inventory Models

Deriving an EOQ Model

• Develop an expression for setup or ordering costs

• Develop an expression for holding cost

• Set setup cost equal to holding cost

• Solve the resulting equation for the best order quantity

• Known and constant demand• Known and constant lead

time• Instantaneous receipt of

material• No quantity discounts• Only order (setup) cost and

holding cost• No stock outs

EOQ Assumptions

EOQ ModelHow Much to Order?

Order quantity

Ordering costs

Stock-holding costs

Total costs

EOQ

Co

sts

EOQ ModelWhen To Order?

Reorder Point (ROP)

Time

Inventory Level

AverageInventory

(Q*/2)

Lead Time

Optimal Order Quantity(Q*)

Optimal Order Quantity

Expected Number of Orders

Expected Time Between Orders Working Days / Year

Working Days / Year

= =× ×

= =

= =

=

= ×

Q*D S

H

ND

Q*

TN

dD

ROP d L

2

D = Demand per year

S = Setup (order) cost per order

H = Holding (carrying) cost

d = Demand per day

L = Lead time in days

EOQ Model Equations

Order quantity

Ordering costs

Stock-holding costs

Total costs

EOQ

Co

sts

• Answers how much to order and when to order

• Allows partial receipt of material– Other EOQ assumptions apply

• Suited for production environment– Material produced, used immediately– Provides production lot size

• Lower holding cost than EOQ model

Production Order Quantity Model

POQ Model Inventory LevelsInventory Level

TimeSupply Begins

Supply Ends

Production portion of cycle

Demand portion of cycle with no supply

D = Demand per year

S = Setup cost

H = Holding cost

d = Demand per day

p = Production per day

POQ Model Equations

Optimal Order Quantity

Setup Cost

Holding Cost

= =

-

= *

= *

=

Q

H*d

p

Q

D

QS

1

(

0.5 * H * Q -d

p1

)-d

p1

( )

2*D*S

( )Maximum inventory

level

POQ Model Inventory Levels

Time

Inventory Level

Production Portion of Cycle

Max. Inventory Q·(1- d/p)

Q

Supply Begins

Supply Ends

Inventory level with no demand

Demand portion of cycle with no supply

• Answers how much to order & when to order

• Allows quantity discounts– Reduced price when item is purchased in larger

quantities– Other EOQ assumptions apply

• Trade-off is between lower price & increased holding cost

Quantity Discount Model

Quantity Discount ModelHow Much to Order?

Lowest cost not in Lowest cost not in discount rangediscount range

Order Order QuantityQuantity

Total Total CostCost

Quantity which would Quantity which would be orderedbe ordered

TC for Discount 2

TC for Discount 2

Quantity to Quantity to earn earn

Discount 2Discount 2

Discount 2 Discount 2 PricePrice

Quantity to Quantity to earn earn

Discount 1Discount 1

TC for Discount 1

TC for Discount 1

Discount 1 Discount 1 PricePrice

TC forTC for

No Discount

No Discount

Initial PriceInitial Price

• Answer how much & when to order

• Allow demand to vary– Follows normal distribution– Other EOQ assumptions apply

• Consider service level & safety stock– Service level = 1 - Probability of stockout– Higher service level means more safety stock

Probabilistic Models

• Answers how much to order

• Orders placed at fixed intervals– Inventory brought up to target amount– Amount ordered varies

• No continuous inventory count– Possibility of stockout between intervals

• Useful when vendors visit routinely

Fixed Period Model

Time

Inventory Level Target maximum

Period PeriodPeriod

Fixed Period ModelWhen to Order?