Project report on inventory management

University Of Central Punjab F 13

Production & Operation Management P age 1

Executive Summary Inventory is an itemized catalog or lists of i tangible goods or property, or the

intangible attributes or qualities. Here we discuss inventory management in this

report, which means the overseeing, and controlling of the ordering, storage and

use of components that a company will use in the production of items, it wil l sell

as well as the overseeing and controlling the quantities of finished goods

products.

In this report we discuss importance of inventory, importance of inventory

management , types of inventory, inventory costs , inventory turnover ratios and

different sizes of inventory levels just like reorder point, maximum quantity,

EOQ, EPQ etc.



Inventory Inventory is the physical stock of goods maintained in an organization for its smooth

running, in accounting language it may mean stock of finished goods only. In a

manufacturing concern, it may include raw materials, work-in-process etc. in the

form of material or supplies to be consumed in the production process or in the

rendering of services.

The raw materials, work-in-process goods and completely finished goods that are

considered the portion of a business's assets that is ready or will be ready for sale.

Inventory represents one of the most important assets that most businesses possess,

because the turnover of inventory represents one of the primary sources of revenue

generation and subsequent earnings for the company's shareholders/owners.

Importance of Inventory

Inventory represents one of the most important assets that most business possesses,

because the turnover of inventory represents one of the primary sources of revenue

generation and subsequent earnings for the company’s shareholders/owners.

Inventory Management Activities employed in maintaining the optimum number or amount of each inventory

item. The objective of inventory management is to provide uninterrupted production,

sales, and/or customer-service levels at the minimum cost. Since for many companies

inventory is the largest item in the current assets category, inventory problems can

and do contribute to losses or even business failures. Also called inventory control.

Possessing a high amount of inventory for long periods is not usually good for a

business because of inventory storage, obsolescence and spoilage costs. However,

possessing too little inventory isn't good either, because the business runs the risk of

losing out on potential sales and potential market share as well.

Inventory management forecasts and strategies, such as a just-in-time inventory

system, can help minimize inventory costs because goods are created or received as

inventory only when needed.

Importance of Inventory Management

Managing your inventory in a cost-efficient way helps you optimize your profits. This

begins with negotiating the lowest costs with your suppliers. Buying in volume or

committing to suppliers in long-term relationships can help with this. Managing

inventory once you have it is vital as well. If you order too much inventory, you have

to pay more money for employees to organize it and manage it. You have more

expenses for storage areas where you hold it. You also risk waste on expired or rotted

items. Having too little inventory can lead to stock-outs, which is bad for customer

service.



Nature of Inventories

Raw Material

A material or substance used in the primary production or manufacturing of a good.

Raw materials are often natural resources such as oil, iron and wood.

Work in Progress

Material that has entered the production process but is not yet a finished product.

Work in progress (WIP) therefore refers to all materials and partly finished products

that are at various stages of the production process. WIP excludes inventory of raw

materials at the start of the production cycle and finished products inventory at the

end of the production cycle.

Finished goods

Finished goods are goods that have completed the manufacturing process but have

not yet been sold or distributed to the end user.

How companies use their inventories?

Anticipated inventory

Inventory that results whenever quantity price discounts, shipping costs, setup costs,

or similar considerations make it more economical to purchase or produce in larger

lots than are needed for immediate purposes.

Fluctuation Inventory

Inventory that is carried as a cushion to protect against forecast error.

Lot-Size Inventory

Inventory that results whenever quantity price discounts, shipping costs, setup costs,

or similar considerations make it more economical to purchase or produce in larger

lots than are needed for immediate purposes.



Transportation inventory

Inventory in movement of location Transit between the manufacturing plant and the

distribution warehouse.

Speculative inventory

The term "speculative inventory" can mean different things, but in general, it refers to

inventory that a business obtains and holds in anticipation of future demand, rather

than to meet current demand. "Spec inventory" is most commonly a cost-saving

measure, though businesses also use it to get ahead of the market.

Maintenance, repair and operations

Maintenance, repair and operations (MRO) or maintenance, repair, and

overhaul involves fixing any sort of mechanical, plumbing or electrical device should

it become out of order or broken (known as repair, unscheduled, or casualty

maintenance). It also includes performing routine actions which keep the device in

working order (known as scheduled maintenance) or prevents trouble from arising

(preventive maintenance).

Objectives of Inventory Management

The objective of inventory management is to provide desired level of customer servive,

to allow cost-efficient operations, and to minimize the inventory investment.

Customer value

Delivering value to customers is important to managers, leaders, and entrepreneurs

alike. To be willing to pay, a customer must derive value from a market offer.

However, what is customer value? How does a supplier deliver customer value? The

definition above suggests that there are two aspects to customer value: desired value

and perceived value. Desired value refers to what customer’s desire in a product or

service. Perceived value is the benefit that a customer believes he or she received

from a product after it was purchased.

Provide desired customer service level:

Percentage of orders shipped on schedule.

Percentage of line items shipped on schedule.

Percentage of dollar volume shipped on schedule.

Idle time due to material and component shortages.

Provide for cost-efficient operations:

Buffer stock for smooth production flow.

Maintain a level work force.

Allowing longer production runs & quantity discounts.

Minimize inventory related investments:

Inventory turnover = Annual CGS/Avgas Inv ($).

Weeks (or days) of supply = Avg Inv ($)/Avg Wk Usage.

http://en.wikipedia.org/wiki/Machine

http://en.wikipedia.org/wiki/Plumbing

http://en.wikipedia.org/wiki/Electrical

http://en.wikipedia.org/wiki/Machine

http://en.wikipedia.org/wiki/Aircraft_maintenance

http://en.wikipedia.org/wiki/Preventive_maintenance



Percentage of Orders Shipped on Schedule

The percentage of orders shipped at the planned time.(Shipped means off the dock,

and in transit to its final destination).Note that the time to ship may be defined by the

customer, or it may be determined by the shipper in order to accommodate an On-

time Delivery. Good measure if orders have similar value. Does not capture value. If

one company represents 60% of your business but only 5% of your orders, 95% on

schedule could represent only 40% of value

Calculation

Number of order shipped on time / Total number of orders shipped

Percentage of Line Items Shipped on Schedule

Recognizes that not all orders are equal, but does not capture $ value of orders. More

expensive to measure. OK for finish. Goods. A 90% service level might mean shipping

225 items out of the total 250 line items totaled from 20 orders scheduled

Percentage of Dollar Volume Shipped on Schedule

Recognizes the differences in orders in terms of both line items and $ value

Cost such as scrap cost calibration cost and down time cost associated with

preparing the equipment for the next product being produced

Inventory Investment Measures Example:

The Coach Motor Home Company has annual cost of goods sold of $10,000,000. The

average inventory value at any point in time is $384,615. Calculate inventory

turnover and weeks/days of supply.

Minimum Inventory Investment Inventory as a company's goods on hand, which is often a significant current asset.

Inventory serves as a buffer between a company's sales of goods and its production or

purchase of goods. Companies strive to find the proper amount of inventory to avoid

lost sales, disruptions in production, high holding costs, etc.

Manufacturers usually have the following categories of inventories: raw materials,

work-in-process, finished goods, and manufacturing supplies. The amounts of these

categories are usually listed in the notes to its balance sheet.

Inventory Turnover

A company can measure its minimum inventory investment by its inventory turnover-

that is this, by the level of customer demand satisfied by the supply on hand. We

calculate the inventory turnover measure as:

If the cost of goods sold, at ABC Company is $10,000,000 and average inventory in

dollars is 384,615 then:

turnsinventory 26$384,615

0$10,000,00

valueinventory average

sold goods ofcost annualTurnover



Weeks/Days of Supply

A financial measure of a company's performance that gives investors an idea of how

long it takes a company to turn its inventory (including goods that are work in

progress, if applicable) into sales. Generally, the lower (shorter) the DSI the better,

but it is important to note that the average DSI varies from one industry to another.

Relevant Inventory Costs

Item Cost

Cost per item plus any other direct costs associated with getting the item to the plant .

Holding Costs

Holding cost is money spent to keep and maintain a stock of goods in storage.

Holding costs include rent for the required space; equipment, materials, and labor to

operate the space; insurance; security; interest on money invested in the inventory

and space, and other direct expenses. As inventory increases, so does the holding

cost?

Capital Cost

The higher of the cost of capital or the opportunity cost for the company.

Storage Cost

Storage cost includes the variable expenses for space, workers, and equipment related

to the volume of inventory.

Risk Cost

Risk cost includes obsolescence, damage or deterioration, theft, insurance, and taxes

associated with the volume of inventory held. These costs vary based on industry.

Ordering Cost

Fixed cost associated with either placing an order with a supplier or setup cost

incurred for in-house production. Ordering costs includes the cost of the clerical

work to paper, release, monitor, and receive order stand the physical handling of the

goods.

Shortage Costs (Penalty Cost)

The penalty cost is the cost per unit of not satisfying the order when it is received.

Shortage cost or stock-out cost is the total of all costs associated with shortage units.

We use penalty cost in inventory planning. The penalty cost should not be something

you pay actually. It can be like a chance of profit you missed, which is called the

opportunity cost. However, there is a case when you should pay a penalty for the

shortage. This happens when you have an agreement with a customer to satisfy the

2weeks0/52$10,000,00

$384,615

COGS weekly average

valueinventory averageSupply of Weeks

days 100/260$10,000,00

$384,615Supply of Days



demand by a certain date with the right quantities, or you will pay a penalty for the

breach of contract.

Penalty cost includes loss of customer goodwill, back order handling, and lost sales

Shortage cost incurred due to two reasons.

Back Orders

Delaying delivery to the customers until the item becomes available.

Lost Sales

Occurs when the customer is not willing to wait for delivery.

Three Mathematical Models for Determining Order Quantity

Economic Order Quantity (EOQ or Q System)

A model used to find optimal order q. and RP (Reorder Point).

Part of continuous review system , which tracks on-hand inventory each time a withdrawal, is made

Economic Production Quantity (EPQ) A model that allows for incremental product delivery.

Quantity Discount Model Modifies the EOQ process to consider cases where quantity discounts are available.

Economic Order Quantity

EOQ Assumptions:

Demand is known & constant - no safety stock is required.

Lead-time is known & constant.

No quantity discounts are available.

Ordering (or setup) costs are constant.

All demand is satisfied (no shortages).

The order quantity arrives in a single shipment.

The EOQ model



Reorder Point (R)

Is the level of inventory , which triggers an action to replenish that particular

inventory stock? It is normally calculated as the forecast usage during the

replenishment lead-time plus safety stock.

Formula for reorder point:

R = dL

Where

R = reorder point

d = average daily demand

L = lead time

Example:

A computer company has annual demand of 10,000. They want to determine EOQ for circuit

boards, which have an annual holding cost (H) of $6 per unit, and an ordering cost (S) of

$75. They want to calculate TC and the reorder point (R) if the purchasing lead-time is 5

days.

Economic Order Quantity (EOQ)

The Economic Order Quantity (EOQ) is the number of units that a company should

add to inventory with each order to minimize the total costs of inventory—such as

holding costs, order costs, and shortage costs.

Formula for Economic Order Quantity:

Where

Q = optimal order quantity

D = annual demand

S = ordering or setup cost

H = holding cost

For the above example, we can calculate EOQ as under:

http://en.wikipedia.org/wiki/Inventory

http://en.wikipedia.org/wiki/Lead_time



Total Annual Inventory Cost with EOQ Model

Formula for Total Inventory Cost:

Total annual cost= annual ordering cost + annual holding costs

TC = (D/Q ×S) + (Q/2 × H)

Where

TC = total annual cost

D = annual demand

Q = quantity to be ordered

H = annual holding cost


For the above example, we can calculate EPQ as under

Economic Production Quantity (EPQ)

EPQ Assumptions

The EOQ model assumes inventory arrives instantaneously.

In many cases inventory arrives gradually.

The economic production quantity (EPQ) model assumes inventory is being

produced at a rate of p units per day.

There is a setup cost each time production begins

The EPQ model

Same assumptions as the EOQ except: inventory arrives in increments & is drawn down as

it arrives.



Economic Production Quantity (EPQ) Economic production quantity (EPQ) is the quantity of a product that should be

manufactured in a single batch to minimize the total cost that includes setup costs for

the machines and inventory holding costs. Formula for Economic Production Quantity:

Where

D = annual demand in unit

S = setup or ordering cost


d = average daily demand rate

p = daily production rate

Example:

Healthy Plants LTD. (HP) produces its premium plant food in 50 - pound bags.

Demand for the product is 100,000 ponds perweek.HP operates 50 weeks per year &

can produce 250,000 pounds per week. The setup cost is $200 and the annual holding

cost rate is $0.55 per bag. Currently, HP produces its premium plant food in batches

of 1,000,000 pounds.

S = 300

H = $3 per 50 pounds

D = 75000 = 75000*12/50 = 18000

p = 24000

E𝑃𝑄 = √2(18000)(300)

3(1−18000

24000)

E𝑃𝑄 = 3795

Total Annual Cost with EPQ Model

Formula for total cost:

Where


D = annual demand




𝐼𝑚𝑎𝑥 = 𝑚𝑎𝑥𝑖𝑚𝑢𝑚 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

H

2

IS

Q

DTC MAX

EPQ



For the above example, we can calculate total cost as under:

Total Cost = (949/2 3) + 18,000 × 300/ 3795

Total Cost = 1423.50 + 1422.92

Total Cost = $2846.42

Maximum Inventory Maximum level of inventory is maximum quantity of material, which have to keep in

store. We should not keep the stock more than maximum level because if we keep

more stock than maximum level it will increase the cost of capital because we do not

need the stock more than maximum level. Excess stock than maximum level will

increase the cost of storing.

Formula for Maximum Inventory:

𝐼𝑚𝑎𝑥 = 𝑄 (1 −𝑑

𝑝)

Where

d = average daily demand

p = daily production rate

For the above example, calculation of maximum inventory is as under:

𝐼𝑚𝑎𝑥 =3795(1 −18000

24000)

𝐼𝑚𝑎𝑥 =3795(1 − 0.75) = 949

𝐼𝑚𝑎𝑥 =949

Quantity Discount Model

Quantity Discount Model

Quantity discount model i a form of an economic order quantity (EOQ) model that

takes into account quantity discounts. Quantity discounts are price reductions

designed to induce large orders. If quantity discounts are offered, the buyer must

weigh the potential benefits of reduced purchase price and fewer orders against the



increase in carrying costs caused by higher average inventories. Hence, the buyer’s

goal in this case is to select the order quantity that will minimize total costs, where

total cost is the sum of carrying cost, ordering cost, and purchase cost.

Formula for quantity discount model:

Where


D = annual demand




C = unit price

Four Steps to Analyze Quantity Discount Models

1. Calculate Q* for lowest discount price

2. If Q* is too small to qualify for that price, adjust Q* upward

3. Calculate total cost for each Q*

4. Select the Q* with the lowest total cost

Example:

Rapid Grower, the supplier of plant for Greens in Problem 12, has offered the

following quantity discounts. If the nursery places orders of 50 bags or less, the cost

per bag is $20. For orders greater than 50 bags but less than 100 bags, the cost per

bag is $19. For orders of 100 bags or more, the cost is $18 per bag. Greens estimate

its holding cost to be 25 percent of the unit price. Determine the most cost effective

ordering policy for Greens.

Step 1

First, we calculate the EOQ at the lowest price offered. The annual holding cost is

25% of the unit cost is equal to $4.5.

𝐸𝑂𝑄 = √2𝐷𝑆

𝐻

𝐸𝑂𝑄 = √2(1560)(10)

4.5

𝐸𝑂𝑄 = 83 𝑏𝑎𝑔𝑠

Since the order quantity does not match the unit price used to calculate the EOQ, this

answer is infeasible. This means if we place an order for 83 bags, we are charged $19

per bag rather than $18 we used in calculating the EOQ.

Step 2

Since the first EOQ is infeasible, we calculate the EOQ for the next higher price.

Make sure to calculate the new annual holding cost, 25% of $19= 4.75.



𝐸𝑂𝑄 = √2𝐷𝑆

𝐻

EOQ= √2(1560)(10)

4.75

EOQ= 81𝐵𝑎𝑔𝑠 If we place an order for 81 bags, we will be charged $19 per bag, which is the price

we used to calculate the EOQ. Therefore, this is a feasible order quantity.

Step 3

Now we calculate the total annual cost for this policy.

TC = (D/Q ×S) + (Q/2 × H) + CD

TC = (1560/89 ×10) + (81/2 × 4.75) + (1560) (19)

TC = 192.59+ 192.38+ 29640

TC = $30024.97

Since the feasible solution was not at the lowest price, now we calculate the total cost

of any cheaper price, assuming that we order just enough to qualify for the cheaper

price. This means we need to order 100 bags to qualify for $18 price. The total cost of

this policy is

TC = (D/Q ×S) + (Q/2 × H) + CD

TC = (1560/100 ×10) + (100/2 × 4.5) + (1560) (18)

TC = 156+ 225+ 28080

TC = $28461

Step 4

Since the total annual cost of ordering 101 pairs at a time is less expensive, Greens

should order 100 bags each time.

Conclusion

From this report it is cleared that invtory is largest item in th ecurrent

assets category & inventory management is vital for smooth production &

operating activities within an organization.

References

http://www.clearlyinventory.com/inventory-basics

http://www.businessdictionary.com/definition/inventory-management.html

http://www.barcodesinc.com/articles/what-is-inventory-management.htm

http://smallbusiness.chron.com/top-ten-ways-manage-inventory-11099.html

http://www.tradegecko.com/

http://www.clearlyinventory.com/inventory-basics

http://www.businessdictionary.com/definition/inventory-management.html

http://www.barcodesinc.com/articles/what-is-inventory-management.htm

http://smallbusiness.chron.com/top-ten-ways-manage-inventory-11099.html

http://www.tradegecko.com/



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Project report on inventory management