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INVENTORY MANAGEMENTMODULE-4

• Determinations of inventory

• Control levels: ordering, reordering, danger level

• EOQ model.

• Pricing of raw material.

• Monitoring and control of inventories,

• ABC Analysis

What Is Inventory?

“…Those stocks or items used to support production,…supporting activities,…and customer service…”

—APICS Dictionary

MEANING OF INVENTORYMANAGEMENT

• Inventory management is concerned with keeping enough product on hand to avoid running out while at the same time maintaining a small enough inventory balance to allow for a reasonable return on investment.

• Excessive level of inventory, results in large inventory carrying cost.

An efficient system of inventory management will determine

(a) what to purchase

(b)how much to purchase

(c)from where to purchase

(d) where to store

Inventory and the Flow of Materials

Objects of inventory Mgmt.To ensure continuous supply of raw material, spares and finished goods.

To avoid both overstocking and under stocking of inventory.

To maintain investments in inventories at optimum level.

To keep material cost under control.

To eliminate duplication in ordering or replenishing stocks.

To minimize losses through wastage and damages .

To facilitates finishing of data

Inventory Positions in the Supply Chain

RawMaterials

WorksIn Process

FinishedGoods

Finished Goodsin Field

Need for Inventories Transaction motive: The transaction motive for holding inventory is to satisfy the

expected level of activities of the firm.

Precautionary motive: The precautionary motive is to provide a cushion in case the actual

level of activity is different than anticipated. Speculative motive: The speculative motive is to purchase larger quantity of materials

than normal in anticipation of making abnormal profits.

COST OF INVENTORIES• The determination of inventory cost is essentially an

income • measurement problem. • Relevant inventory costs which change with the level of

inventory are listed below:

Inventory Costs

– Item costs

– Carrying costs

– Ordering costs

– Stockout costs

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Item Cost - Direct material, direct labor, factory O/H, Transportation, Customs duties, Insurance

Carrying costs – 1. Cost of Capital – Interest paid on the money tied up

2. Storage costs - Space, personnel, and equipment3. Risk costs- Obsolescence, damage, pilferage, insurance

Ordering Costs - P O Paper cost / Follow-up, Visits, Calls Production Set-up, Inspection, Receiving etc.

Stock-out Costs Back-order costs, Lost sales costs, Lost customer costs

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CHARACTERISTICS OF INVENTORY SITUATIONS

1) Lead time: Obtaining inventory usually requires a time lag from the

initiation of the process until the inventory starts to arrive. This lead times may be few min.or months.

2) Sources & level of risk: Where there are substantial uncertainties & where the

costs of stockout are important . Strategies for addressing risk must be formulated.

3) Static versus dynamic problems: In static inventory problems, the goods have a

one-period life; there can be no carryover of goods from one period to next.

In dynamic inventory problems, the goods have value beyond the initial period; they do not lose their value completely overtime.

Zero Inventory?• Reducing amounts of raw materials and purchased

parts and subassemblies by having suppliers deliver them directly.

• Reducing the amount of works-in process by using just-in-time production.

• Reducing the amount of finished goods by shipping to markets as soon as possible.

ABC Analysis- Purpose• To determine the type & degree of control required for each type of inventories.

ABC system is a widely-used classification technique to identify various items of inventory for purpose of inventory control

The technique is based on the assumption that:A firm should not exercise the same degree of control on all items of inventory

It has classified inventory into: The most costly The slowest-turning Items that are less expensive.

VARIOUS TECHNIQUES TO CONTROL INVENTORY

A-B-C ANALYSIS: The materials are divided into three categories viz, A ,B &C

• CATEGORY-A: It involves the largest investment, Required most rigorous, intensive & sophisticated inventory control

• CATEGORY-B: Stand midway, Deserves less attention than A but more than C Controlled by employing less sophisticated techniques.

• CATEGORY-C:• Involves small investment• But the number of items is fairly large• Deserve Minimum attention

Inventory breakdown b/w no. of items & inventory value

Group No. of items (%) Inventory value (%)A 15 70

B 30 20

C 55 10

Total 100 100

ABC Analysis:

Nos. Of Suppliers

Purchase Value

Category

High Consumption

Items

40 10% 470 Cr 70% A

Medium Consumption

Items

80 20% 134 Cr 20% B

Low Consumption

Items

280 70% 68 Cr 10% C

Total Items 400 100% 672 Cr 100%

A B C analysis

0

100

100

A B C

%By value

% By units

5-10% 10-20% 70-80%

% in values

Steps involved in implementing the ABC Analysis Classify the items of inventories, determining the expected use in units & the

price per unit for each item

Determine the total value of each item by multiplying the expected units by its units price.

Rank the items in accordance with the total value, giving 1st rank to the highest total value & so on.

Compute the ratios (%) of no. of units of each item to total units of all items & the ratio of total value of each item to total value of all items

Combine items on the basis of their relative value to form three categories – A, B & C

A items B items C items

1. High consumption Moderate value Low value

2. Very strict control Medium control Loose control

3. Nil Safety Stock Low safety stocks High safety st.

4. Daily Deliveries Weekly/ Monthly Bulk/ Quarterly

5. Multi-sources Few sources Max.- 2 sources

6. Accurate forecasts Estimates Guestimmates

7. Central storage/ Storage in each plant Site storage

8. Max. Cost control Minimum efforts No efforts for.

Economic Order Quantity (EOQ)/Economic Lot Size (ELS)

• EOQ refers to that level of inventory at which the total cost of inventory is minimum.

• The total inventory cost comprising of ordering & carrying costs.

ASSUMPTION

Demand for the product is constant & uniform throughout the period Lead time (time from ordering to receipt) is constant.

Price per unit of product is constant. Inventory holding cost is based on average inventory.

Ordering costs are constant, and All demand for the product will be satisfied (no back orders are allowed)

Determination of Optimum inventory Level

Determination involves 2 types of costs:

Ordering costs: this cost includes: Requisitioning Purchase ordering Transporting Receiving Inspecting & storing. ordering cost increases with proportion the no. of orders placed.

Carrying Costs: incurred for maintaining a given level of inventory. It includes: Storage insurance Taxes Deterioration & obsolescence. Clerical & staff

OrderingCosts

EOQ: Carrying cost increases as the order size increases, because, on an average, a larger inventory level will be maintained, & Ordering costs decline with increase in order size because a larger order size means less number of orders.

Total costs decline in the fist instance, but they start rising when the decrease in average ordering cost is more than offset by the increase in carrying costs.

Order size Q

Minimum total cost

2AOc

Carrying cost

Q*

cost

2xquantity required x ordering cost

Carrying cost

LIMITATIONS OF EOQ

Constant usage: unpredictably usage does not allow to predict -no formula will work well

Faulty Basic Information: Ordering & Carrying cost vary from commodity to commodity & with the co’s., opportunity cost of capital.

Costly Calculations: • Cost estimating• Cost of possession & acquisition &• Calculating EOQ exceeds the savings made by buying that quantity.

Order Point Problem

At what level of inventory should the order be placed?

If the inventory level is too high it will unnecessary blocks the capital, & If the level is too low, it will disturb production by frequent stock out & Also involves high ordering cost.

So, co., needs to maintain optimum inventory level, i.e., where there is no stock out & the costs re minimum.

Different stock levels are:

1. Minimum level2. Reorder level3. Maximum level4. Average stock level &5. Dangers level

Formulas

1. Minimum Level: Minimum stock required for smooth flow of production. Determinants:

Lead time/procurement time : It is the no. of days required to receive the inventory from the date of placing order.

Average quantity of raw materials consumed daily. Requirement of materials for normal or regular production or special order

production. Minimum Stock Level= Re-order level – [Average Usage x Average delivery time]

2. Reorder Level: the level of inventory at which an order should be placed for replenishing the current stock of inventory. (it lies b/w min. & max. stock level)

Reorder Point = Lead time (in days) x Average Daily usage.

Safety stock: To avoid stock out firm maintain safety stock.Re-order point = (Lead time (in days) X Averge usage ) + Safety stock

3. Maximum Stock Level: its that level of stock beyond which a firm should not maintain the stock ( otherwise it will be overstocking)

Maximum Stock Level = Reorder Level + Reorder Quantity – ( Minimum Usage x

Minimum Deliver Time)

4. Average Stock Level= Minimum level + [Reorder Quantity / 2]

5. Danger Stock Level: if the materials fall beyond the danger level it will disturb production.

Danger Level= Average Usage x minimum Deliver Time (or emergency purchase)