Inventoryfundamentalpowerpoint 120826033332 Phpapp02

Supply Chain Management
Inventory Fundamentals
Inventory = material + supply For sale
Input or supply to the production process Substantial part of total assets

20% to 60% of total assets on balance sheet When used value is converted into cash Improve cash flow and return on investment (ROI)
Cost for carrying inventories
- Increase operation cost - Decrease profit
Inventory management is responsible for

- Planning inventory from raw material to customer - Controlling inventory from raw material to customer
1. Inventory results from production: finished goods 2. Inventory support production: raw material work in process (WIP), etc. 1 and 2 must be coordinated Inventory must be considered at each of the planning level - Production planning: over all - Master production schedule: end items - Material requirement planning: components & raw material
Aggregate inventory management
Deals with managing inventory according to their classification
- Raw material - Work in process (WIP - Finished good
Function of different inventories - not individual item level Financially oriented - cost and benefits of carrying different classifications of inventories
Involves
1. Flow and kind of inventory needed 2. Supply and demand pattern 3. Functions that inventories perform 4. Objective of inventory management 5. Cost associated with inventory
Item inventory management
Item level, not aggregate Management establishes decision rule about inventory item Rules
- Which inventory items are most important - How individual items are to be controlled How much to order at one time - When to place an order
Factors affecting inventory management decision
1. Types of inventory based on the flow of material 2. Supply and demand pattern 3. Function performed by inventory 4. Objective of inventory management 5. Inventory cost
1. Inventory and flow of material:
Raw material
Purchased item not processed yet Supplier material Components Sub-assemblies
Work in process (WIP)

Raw material has been processed but not finished
Supplier Supplier Supplier
Raw material/ Purchased part/ Material
Work in process (WIP)
Finished goods
Warehouse
Warehouse
Warehouse
Customer Demand
Customer Demand
Customer Demand
Inventory & flow of material-Continues
Finished goods
Ready to be sold as completed items Factory storage Warehouse Distribution centers
Distribution inventories
Finished goods in the distribution system
MRO supplies used in production that do not become part of the products such as hand tools, spare parts, die, drill bit, etc.
Maintenance Repair Operational
Classification depends on production environment For example tire
Tire is finished goods for tire manufacturer Tire is raw material for car manufacturer
2. Supply and demand pattern
If supply meet demand - no inventory Demand must be predictable, stable and relatively constant over a long time period zero inventory
Produce goods on a line - flow basis matching production with demand - no inventory
Raw material
Zero
Work center
Zero
Customer
2. Supply and demand pattern-continues Large demand to justify setting up flow system
Demand is instable - varies Lots or batch manufacturing Workstations are organized by function Work flow from workstation to workstation in lot Inventory build up in
Raw material Work in process (WIP) Finished goods
3. Functions performed by inventory :
Decouple supply and demand Buffer between supply and demand Buffer between finished goods and customer demand
Buffer between finished goods and component availability
3. Functions performed by inventory continue
Requirement for an operation and the output from the preceding operation Parts and material to begin production and supplies of material
3. Functions performed by inventory continue
Classification of inventory by function: a) Anticipation inventory:
Build up in anticipation of future demand Example: before peak selling season, promotion program, vacation, shut down, etc. To help level production To reduce cost of changing production rate
Classification of inventory by function continues b) Fluctuation inventory (Safety stock):
Inventory is held to cover random, unpredictable fluctuation in supply and demand or in lead time If demand or lead time is greater than forecast, a stock out occurs Safety stock is carried to protect stock out
Classification of inventory by function continues 2. Fluctuation inventory (Safety stock):
Prevent disruption in manufacturing or deliveries to customer Safety stock - buffer stock - reserve stock
Classification of inventory by function continues 3. Lot size inventory:
Items purchased or manufacturing in quantities greater the needed Lot size inventory - cycle inventory Portion of inventory that depletes gradually as customer order received Replenish cyclically when suppliers order are received
Classification of inventory by function continues 4. Transportation inventory:
Transportation inventory - Pipeline inventory - movement inventory Time needed to move goods from one location to another location Example: supplier to manufacturer; plant to distribution centers, etc.
I = t x A/ 365; I = average amount; A=annual demand; t = transit time, days I Cost; I t;
Reduce transit time to reduce inventory and hence cost
Example: Delivery of goods from a supplier is in transit for ten days. If the annual demand is 5200 units, what is the average annual inventory in transit? I = 10 x 5200 / 365 = 142.5 units
Classification of inventory by function continues 5. Hedge inventory:
Commodities
- Mineral - Oil - Grain
Buy and wait to sell when price rises Buy at low cost, wait, sell on high price
Classification of inventory by function continues 6. MROs inventory: Maintenance, repair and operation / over haul Support general operation and maintenance
- Spare parts Consumables Stationer
3. Objective of inventory management:
A. Maximum customer service B. Low cost plant operation C. Minimum inventory investment Maximum customer service: Ability to satisfy customer needs Availability of items when needed and a measure of inventory management effectiveness
3. Objective of inventory managementcontinues
Maximum customer service: Customers: who they are!
Purchaser Distributor Other plants Workstations
3. Objective of inventory managementcontinues
Maximum customer service: Measurements of customer service
% of order shipped on schedule % of line item shipped on schedule Order days out of stock
Inventory help to maximize customer service by protecting against uncertainties Carry extra inventories to meet uncertain demand
3. Objective of inventory management:- continues
Low cost plant operations (4 ways) I.Allow operation with different rates of production to operate separately and more economically II. Allow level production of seasonal items - inventories build up in nonpeak sale season
3. Objective of inventory management:continues
Low cost plant operations (4 ways) II.Allow level production of seasonal items inventories build up in non-peak sale season, How?
Reduced overtimeReduced training cost Reduced training cost Lower capacity requirement Reduced subcontracting cost
Low cost plant operations (4 ways) III. Allow longer production run Lower setup cost
Setup cost is fixed: one unit or 1000 units
Increase in capacity
less setup More run time Bottleneck operation
3. Objective of inventory management:- continues
Low cost plant operations (4 ways) IV. Allow to purchase in larger quantities Lower ordering cost Quantity discount
Inventories cost money, they must be balanced with
I. Customer service:
Low inventory - high stock out Lower level of customer service II.Cost in
changing production level

Excess equipment Overtime Hiring and layoff training
Inventories cost money, they must be balanced with
III. Cost of placing order
Each order placed cost
IV. Transportation cost

Small quantity cost more per unit
Therefore, carry inventory if it cost less than not to carry
Inventory costs: 1. Item cost
landed price
purchase cost cost to get it in plant
transportation custom duties insurance
2. 3. 4. 5.
Carrying cost Ordering cost Stock out cost Capacity associated costs
Inventory costs:
1. Item cost
2.
Carrying cost Cost of carrying volume of inventory Capital cost Storage cost
Space Labor equipment
Risk cost
Obsolescence: model change, out dated Damage: in handling Pilferage: lost, misplace, stray, stolen
3. 4. 5.
Ordering cost Stock out cost Capacity associated costs
Inventory costs:
1. 2. Item cost Carrying cost
3. Ordering cost
Associated with placing an order with a factory or supplier Independent of quantity order Depends on number of orders placed in a year Production control cost * Setup time *Production loss * Tear down at the end of run Lost capacity cost * Incurred when an order is placed
* * * Order preparation Follow-up Authorizing payment * Expediting * Receiving * Receiving and paying invoice
Inventory costs:
1. 2. Item cost Carrying cost
3. Ordering cost: Example A company carry an average annual inventory of $2,000,000. If they estimate the cost of capital is 10%. Storage costs are 7% and risk costs are 6%. What does it cost per year to carry this inventory?
Example-continues
Total cost of carrying inventory = 10% + 7% + 6% Total cost of carrying inventory = 23% Total annual cost of carrying inventory = 23% x $2,000,000 Total annual cost of carrying inventory = 0.23 x $2,000,000 Total annual cost of carrying inventory = $460,000
Ordering cost: Example Given the following annual costs, calculate the average cost of placing one order. Production control salaries = $60, 000 Supplies and operating expenses for production control department = $15,000 Cost of setting up work centers for an order = $120 Order placed each year = 2000
Ordering cost: Example
Average cost = fixed cost/number of orders + variable cost
Average cost = ($60, 000 + $15,000 )/2000 + $120 Average cost = $37.50 + $120 = $157.50
Inventory costs:
1. 2. 3. Item cost Carrying cost Ordering cost
4. Stock out cost

If demand during the lead time exceeds forecast we expect a stock out
9 Back order cost 9 Lost sale 9 Lost customer
5. Capacity associated costs
Inventory costs:
1. 2. 3. 4. Item cost Carrying cost Ordering cost Stock out cost
5. Capacity associated costs

When output level is changed, following cost may incur
i. Overtime ii. Hiring iii. Leveling production iv. Carrying inventory v. Training vi. Extra shift vii. Laying off
Quarter 1 Forecast demand Production Ending inventory Average inventory Inventory cost ($) 0 2,000 4,000 2,000 Quarter 2 3,000 4,000 3,000 Quarter 3 6,000 4,000 1,000 Quarter 4 5,000 4,000 0
Total 16,000 16,000 -
1,000
$ 3,000
2,500
$ 7,500
2,000
$ 6,000
500
$1,500
$18,000
1. Capacity associated costs: Example A company makes and sells a seasonal product. Based on a sales forecast of 2000, 3000, 6000 and 5000 per quarter, calculate a level production plan, quarterly ending inventory and average quarterly inventory. If inventory carrying costs are $3 per unit per quarter, what is the annual cost of carrying inventory? Opening and ending inventories are zero.
Financial statement and inventory: Balance sheet Assets = Liabilities + Owners equity Income statement Income = Revenue - Expenses Cash - flow analysis
- Cash requires To purchase raw material Pay for production cost Labor - overhead
Financial statement and inventory: Example: a) If the owners equity is $1,000 and liabilities are $800, what are the assets b) If the assets $1,000 and liabilities are $600, what is the owners equity? a) Assets = Liabilities + Owners equity Assets = $800 + $1,000 = $ 1,800) Owners equity = Assets - Liabilities Owners equity = $1,000 - $600 = $400
Financial statement and inventory: continues Cash in - cash out > 0; self-finance Income statement Cash in - cash out < 0; borrow Example: Given the following data, calculate the gross margin and the net income. How much would profit increase if, through better material management, material costs are reduced by $50,000?
Example: continues
Revenue Direct labor Direct material Factory overhead General and admin. Expenses $1,500,000 $300,000 $500,000 $400,000 $150,000
Notice, net income (profit) of 33%
Revenue Cost of goods sold Direct labor Direct material Factory overhead Gross margin General and admin. Expenses Net income (profit) $300,000 $500,000 $400,000
$1,500,000
Revenue Cost of goods sold Direct labor Direct material $300,000 $450,000 $400,000
$1,500,000
$1,200,000 $300,000 $150,000 $150,000
Factory overhead Gross margin General and admin. Expenses Net income (profit)
$1,150,000 $350,000 $150,000 $200,000 33%
Financial inventory performance measures: Inventory - money tied up
1. Total inventory investment 2. Inventory turn ratio 3. Days of supply
Financial inventory performance measures: continues
Inventory turn ratio = Annual cost of goods sold / average inventory in $ - Higher is better
If annual cost of goods sold is $1 million and average inventory is $500,000, then Inventory turn ratio = $1,000,000/$500,000 = 2
Inventory turn ratio - continues Example: a) What will be the inventory turn ratio if the annual cost of goods sold is $24 million a year and the average inventory is $6 million? Answer:
Inventory turn ratio = Annual cost of goods sold / average inventory in $ Inventory turn ratio = $24 million/$6 million = 4
Inventory turn ratio - continues Example: b) What would be the reduction in inventory if inventory turn ratio is increased to 12 times per year? Answer:
average inventory in $ = Annual cost of goods sold / Inventory turn ratio
average inventory = $24 million/ 12 =$2 million Reduction in inventory = $6 million - $ 2 million = $4 million
Inventory turn ratio - continues Example: c) If cost of carrying inventory is 25% of the average inventory, what will be the savings? Answer:
Reduction in inventory = $6 million - $ 2 million = $4 million Saving = $4 million x 25% = $4 million x 0.25 = $1 million
Financial inventory performance measures: continues
Days of supply = Inventory on hand / average daily usage - Lower is better Example: Inventory on hand is 9,000 units and annual usage is 48,000 units, there are 240 days per year average daily usage = 48,000/240 = 200 units Days of supply = 9000 / 200 = 45 days
Methods of evaluating inventory: (4)
1. FIFO
- In rising prices, replacement is at higher prices than assumed cost - Does not reflect current price - Replacement is understated in rising price Replacement is overstated in falling price
2. LIFO 3. Average cost 4. Standard cost
1. FIFO 2. LIFO
- In rising prices, replacement is at current prices Reflect current price - Replacement is current in rising price Replacement is current in falling price
3. Average cost 4. Standard cost
1. FIFO 2. LIFO 3. Average cost
- An average of all the prices paid for the article Reflect average price - Replacement is average in rising price Replacement is average in falling price
4. Standard cost
1. FIFO 2. LIFO 3. Average cost 4. Standard cost
- Cost is determined before production begins Cost = direct material + direct labor + overhead Any difference between the standard cost and actual cost is stated as variance
ABC Inventory Control: Controlling individual items
- What is the importance of inventory item? How are they to be controlled? - How much should be ordered at one time? When should an order be placed?
ABC inventory classification system
- Importance of an SKU - inventory item
$ value scarcity
- Level of control Pareto principle - 80-20 rule 1. A - 20% of items; 80% of $ value 2. B - 30% of items; 15% of $ value 3. C - 50% of items; 5% of $ value
Steps in making an ABC analysis: (3)
1. Establish item characteristics
- $ value - scarcity
2. Classify items into groups
3. Apply a degree of control in proportion to importance
Procedure for classifying by annual $ values: (5 steps)
1. Determine annual usage 2. Multiply annual usage by its cost; total annual $ usage 3. List items according to their annual $ usage 4. Calculate the cumulative annual $ usage and cumulative percentage of the items 5. Examine the annual usage distribution and group the items into A, B and C groups based on annual percentage usage
ABC Analysis: Example A company manufactures a line of ten items. Their usage and unit costs are shown in the following table along with the annual usage. a. Calculate the annual usage of each items b. List the items according to their annual $ usage c. Calculate the cumulative annual dollar usage and the cumulative percent of items d. Group items into A, B and C classification
Example - continues (table)
Part Number 1 2 3 Unit usage 1,100 600 100 Unit cost $ 2 40 4
4
5 6 7 8 9 10 Total
1,300
100 10 100 1,500 200 500 5,510
1
60 25 2 2 2 1
Example - continues (Answer a))
Part Number 1 2 3 Unit usage 1,100 600 100 Unit cost $ 2 40 4 Annual $ usage $2,200 $24,000 $400
4
5 6 7 8 9 10 Total
1,300
100 10 100 1,500 200 500 5,510
1
60 25 2 2 2 1
$1,300
$6,000 $250 $200 $3,000 $400 $500 $38,250
Example - continues (Answer b), c) and d))
Part Number 2 Unit usage 600 Unit cost $ 40 Annual $ usage $24,000 Cumulative $ usage $24,000 Cumulative % $ usage 62.75% Cumulativ e % items 10.0% Class A
5
8 1 4 10 3 9 6 7
100
1,500 1,100 1,300 500 100 200 10 100
60
2 2 1 1 4 2 25 2
$6,000
$3,000 $2,200 $1,300 $500 $400 $400 $250 $200
$30,000
$33,000 $35,200 $36,500 $37,000 $37,400 $37,800 $38,050 $38,250
78.43%
86.27% 92.03% 95.42% 96.73% 97.78% 98.82% 99.48% 100.00%
20.0%
30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0%
A
B B B C C C C C
Control based on ABC classification: (2 rules)
1. Have plenty of low $ value items
- C items - 50% items - 5% cost - Keep safety stock Order annually
2. Use the money and control effort to reduce the inventory of high value items
- A items - 20% items - 80% cost - Deserve the tightest control Frequent review
Different Controls: A - items: High priority
- Tightest control - Complete accurate record Regular and frequent review Frequent review of demand - Close follow up and expediting to reduce lead time
B - items: Medium priority
- Normal control - Good record Regular attention Normal processing

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Supply Chain Management

Input or supply to the production process Substantial part of total assets

Inventory management is responsible for

Work in process (WIP)

Raw material/ Purchased part/ Material

Work in process (WIP)

Buffer between finished goods and component availability

Reduce transit time to reduce inventory and hence cost

changing production level

IV. Transportation cost

Therefore, carry inventory if it cost less than not to carry

Ordering cost Stock out cost Capacity associated costs

4. Stock out cost

5. Capacity associated costs

5. Capacity associated costs

Total 16,000 16,000 -

Notice, net income (profit) of 33%

$1,200,000 $300,000 $150,000 $150,000

$1,150,000 $350,000 $150,000 $200,000 33%

2. LIFO 3. Average cost 4. Standard cost

3. Average cost 4. Standard cost

2. Classify items into groups

3. Apply a degree of control in proportion to importance

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