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INVENTORY
MANAGEMENT
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Inventories are materials and supplies that a
business or institution carries either for sale or
provide inputs to the production process.
Inventories are stock of materials of any kind storedfor future use, mainly in the production process.
Inventory are the physical stocks of items that a
manufacturing or service organization keeps in handfor efficient running of its office or manufacturing
activity.
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Financially inventories are very important to
manufacturing companies.
On the balance sheet, they usually represent from
20% to 60 % of total assets.
As inventories are used, their value is converted into
cash, which improve cash flow and return oninvestment.
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There is a cost for carrying inventories, which
increases operating costs and decreases profits.
Hence good inventory management is essential.
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Type of Inventory needed
Inventories are classified as,
Raw Materials :- Purchased items which are not enteredthe production process
Work-in-process :- Raw materials that have entered themanufacturing process and are being worked on orwaiting to be worked on.
Finished goods :- They are ready to be sold ascompleted items. They may be held at factory or centralwarehouses or at various points in the distributionsystem.
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Distribution Inventories :- Finished goods located
in the distribution system.
Maintenance, repair and operational supplies(MROs) :- Items used in production that do not
become part of the product. It include hand tools,
spare parts, lubricants, cleaning supplies.
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Inventory Management
Inventory Management is responsible for planning
and controlling inventory from the raw material stage
to customer.
Inventory must be considered at each of the
planning level and is thus a part of production
planning, master production scheduling, Material
requirement planning.
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The basic objective of Inventory Management is to
be able to determine,
1. What to order
2. When to order
3. How much to order
4. And How much to carry in stock so as to gain
economy in purchasing, storing, manufacturing
and selling.
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Why does a firm carry Inventories?
1. To economize on buying / manufacturing cost.
2. To keep pace with changing market condition.
3. To satisfy demand during period of replenishment.
4. To take care of contingency (ie prevent stockout)
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5. To stabilize production
6. To prevent loss of sale
7. To satisfy other business constraints ie,
Suppliers condition of minimum quantity.
Government regulation Seasonal availability
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Symptoms of poor Inventory Management
Uneven Production with frequent layoffs and
overtime working.
Increase in inventory investment as
compared to increase in sales.
Partial utilization of machines due to frequent
shortage of materials.
Periodic backlog of orders or frequent failuresin delivery commitments.
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Inventory Management Techniques
ABC Analysis
HML Analysis
VED Analysis
SDE Analysis
GOLF Analysis
SOS Analysis
M-N-G Analysis
XYZ Analysis
Usage value (Consumption per period * price per unit )
(High Medium Low) Unit Price
(Vital-Essential-Desirable) Criticality of the item
(Scare-Difficulty-Easy) Procurement difficulties
(Govt.- Ordinary-Local-Foreign) Source ofProcurement
(Seasonal-OF-Seasonal) Seasonality
(Moving and Non-moving item)
Investment
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ABC Analysis
It tends to segregate all items or materials into three
categories: A,B & C on the basis of their annual
usage
Items called A hold a key to business
Other items are numerous in number but there
contribution is less significant.( Items B and C)
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A-Items : It is usually found that hardly 5-10% ofthe items account for 70-75% of the total money
spent on the materials.
These items require detailed and rigid control and
need to be stocked in smaller quantities.
These items should be procured frequently, the
quantity per occasion being small
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B-Items : These items are generally 10-15% of thetotal items and represent 10-15% of the total
expenditure on the materials.
C-Items : These are numerous, as many as 70-80% of the total items and inexpensive, 5-10% of
the total annual expenditure on materials.
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5. Calculate cumulative annual usage and expressthe same as cumulative usage percentage andcumulative item percentage
6. Graph cumulative usage percentage againstcumulative items percentage and segregate theitems into A, B, and C
7. Decide the policies of control for the threecategories.
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0 10 20 40 5030 60 8070 10090
10
20
30
40
50
60
70
80
90
100
A B C
X
Y
Graphical analysis ofABCClassification
Items
C
os
t
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Control of ABC Material
The Fix-Order-Interval system useful for high value
items i.e. Acategory of items requiring strict control
on stock level.
The Fix-Order-Quantity system is suitable forB-class
of items and low value items ordered infrequently in
large quantity
Two bin system is best suited forC-class of items.
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Inventory Cost
1. Item cost
2. Carrying Cost
3. Ordering cost
4. Stockout cost
5. Capacity associated cost
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Item cost It is the price paid for purchased item, which consist of
cost of item and any other direct costs associated ingetting the item into the plant.
This could include such as transportation, custom
duties, insurance.
The inclusive cost is often called as landed price.
For an item manufactured in house the cost includes
direct material, labour and factory overhead which can
usually be obtained from either purchasing or
accounting.
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CarryingCost
It include all expenses incurred by the firmbecause of volume of inventory carried.
As inventory increases this cost increase.
They are broken down into threecategories,
1. Capital cost
2. Storage cost3. Risk cost
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Ordering cost
Cost associated with placing an order either with the
factory or a supplier.
The cost of placing an order does not depend upon
the quantity order.
Annual cost of ordering depends upon the numberof orders placed in a year.
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Stockout cost
If demand during the lead time exceeds forecast wecan expect a Stockout.
A Stockout can potentially be expensive because of
back order cost, lost sales, and possibly lostcustomer.
It can be reduced by carrying extra inventory to
protect against those times when the demand duringlead time is greater than forecast.
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Capacityassociated cost
When output levels required to change, there maybe cost of overtime, hiring, training, extra shift.
These cost can be avoided by leveling production byproducing items in slack periods for sale in peakperiods.
However, this builds inventory in the slack period.
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ECONOMICORDERQUANTITY
(EOQ)
One of the important decisions in stock system is
that of determining the ordering / manufacturing
quantities of different items.
Investment in inventories largely depends upon the
quantities in which they are ordered/manufactured.
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Ordering/manufacturing large lots infrequentlyreduces administrative work but makes investmentin stocks large.
Ordering/manufacturing small lots frequently keepinvestment low but increase administrative work.
The economic lot size for an order or the economicorder quantity depends upon two types of costs :
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a). Inventory procurement costs, which
consist ofexpenditure connected with :
Receiving quotations
Processing purchase requisition
Following up and expediting purchase order
Receiving material and then inspecting it
Processing vendors invoice.
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b).Carrying costs, which vary with
quantity ordered, base on average
inventory and consist of :
Interest on capital investment
Cost of storage facility, up-keep of material
(preservation), record keeping, etc
Cost involving deterioration and obsolescence Cost of insurance, property tax, etc.
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Economic Order QuantityModel
Assumptions :
The demand of the item occurs uniformly over the
period at the known rate
The replenishment of stock is instantaneous.
The price per unit is fixed & is independent of order
size.
The cost to place the order & process the delivery is
fixed & does not vary with the lot size.
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The inventory carrying charges vary directly &
linearly with the size of the inventory & are
expressed as a percentage of average inventory
investment.
The item can be procured free from restrictions of
any kind.
The item has fairly long shelf life, there being no fear
of deterioration or spoilage
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Derivation of EOQ Formula :
Annual consumption of the item (units): S
Unit Price : Cu
OrderQuantity ( Units) : q Procurement cost per order ( Rs.) : Cp
Inventory carrying cost expresses as a
Percentage of Average inventory investment : i
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1. Annual procurement cost =[ No. of ordersper year ] * [ Procurement cost per order
APC = S/q * Cp ------ (1)
2.Annual inventory carrying cost =[Averageinventory investment ] * [Inventory carrying cost ]
= [ OrderQty. x Price per unit ] * i
ACC = q/2 * Cu * i ------ (2)
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3. Annual Total Cost ( ATC )
= S/q * Cp + q/2 * Cu* i ------(3)
To get , EOQ, differentiate ATC with respect to q
d( ATC) =-S.Cp + Cu.i = 0
dq q02 2
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q02 = 2. S.Cp
Cu.i
q0 = 2. S.Cp
Cu.i
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Economic
OrderQuantity
=
2 X [ Annual consumption (units)]
X [Procurement Cost / Order]
Price per unit X Inventory Carrying Cost
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Investment in inventories to a large extent dependson the quantities in which the items are ordered for
replenishment.
Ordering bigger lots reduces procurement cost butincreases investment in stocks.
Ordering small lots keeps investment in inventories
low but increases procurement cost
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The two costs Procurement cost and Inventory
carrying cost are diametrically opposite to each
other.
When these costs have been properly balanced, the
total cost is minimum and the resultant quantity is
called Economic OrderQuantity.
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LOT SIZE
C
o
s
t
50 100 150 200 250 300 400350
100
200
300
400
500
Carrying Cost
Ordering Cost
Total Cost
EOQ
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EOQ ?
Suppliers minimum order quantity condition
Lead time
Government regulation
Seasonal availability
Packing size
Space restriction
Risk of obsolesce and deterioration
Price discounts
Unstable market conditions
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Service levels and safety stocks
The replenishment action is taken at the right
time
There is no increase in demand during the
lead time
There is no delay in getting the supplies
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Replenishment Systems
1. Fixed order quantity system
2. Fixed order interval system