Inventory Management

INVENTORY MANAGEMENT
Definition of inventories, inventory analysis and inventory catalog. Inventory management in India. Classification of inventories, forces creating various hypes of inventories, safety stock. Cost associated with inventories. Types of selective inventory control and advantages of selective control. ABC analysis. EOQ. MRP. P & Q systems.
Definition of Inventory management

It is the sum of value of raw materials, fuels and lubricants, spare parts, maintenance consumables, semi processed and finished goods.
Inventories
1.Production Inventories 2.MRO Inventories 3.In-Process inventories 4.Finished goods inventories.
Inventory Analysis
Inventory planning and subsequent control of an inventory is accomplished on the basis of knowledge about each of the individual items and the finished products of which each is a part.
Inventory Catalogue
1.it serves as a medium of communication 2. an inventory catalogue accrues to the inventory control operation it self.
Functions of inventories.
It makes possible smooth and efficient operation of a manufacturing organization by decoupling individual segments of total operation. 1.Purchased part inventories 2.Inventories of parts and components 3.Finished goods inventories
Inventory Management in India
Inventory may be defined as sum of value of raw materials, fuels and lubricants, spare parts, maintenance consumables, semi possessed materials & finished goods at any given point of time. These resources are called idle resources since they are idle they are kept in the stores.
These resources are maintained for operational smoothness. The size of inventory depends on internal lead time, suppliers lead time, vendors relation and availability of raw materials. Finished goods inventory are maintained to ensure free flowing supply of goods to customers.
Two factors which affect inventories are:1. Accuracy & detail of final forecast.
2. Availability of storage space.
Norms for inventory

1. The department set up monetary limits for investment in inventories. 2. They have to allocate the investments to various items and ensure smooth operations of the company. 3. While setting the norms involvement of people making the norms is desirable. 4. Departments like finance, production are included.
Peculiarities in India
It operates in sellers market for purchase of goods. Indian industry tends to stress a lot on machine utilization. In India, inventory control technique do not run under free availability of goods
Classification of Inventories
Production Inventory MRO Inventory (Maintenance Repair Operating Supplies) In-process Inventory Finished Goods Inventory
Forces Creating Various Types of Inventory

Creating Forces
Uncertainties Batch / Lot Size Economics Time Transportation Time-processing Seasonality Varying activity rates
Type of Inventory
Safety Stocks Cycle Stocks In-transit Work in Process Seasonal Stocks Decoupling Stocks
Three Components of Inventory Management
Forecasting: How much do we need? when will we need it? Replenishment: How much should we order? When should we order? Inventory control: How much do we have on hand? How much do we have on order? How much have we sold?
Dependent and Independent Demand
Costs relevant for Inventory Decision

Holding Costs : Capital costs, inventory service costs, storage space and risk costs. Shortage Costs: Penalty for not having inventory available when required. Acquisition Costs: Cost to order and acquire inventory. Control System Costs: Cost of administrating systems needed to manage inventory levels.
COSTS ASSOCIATED WITH INVENTORIES
CARRYING COSTS
ACQUISITION COSTS
CARRYING COSTS
Carrying material in inventory is expensive. The annual cost of carrying a production inventory averaged approximately 25% of the value of the inventory.
CARRYING COSTS
1 Opportunity cost of invested funds
2 Insurance costs 3 Property taxes
12 20 %
24% 13%
4 Storage costs
5 Obsolescence and deterioration
Total carrying costs
1-3%
4 10 %
20 40 %
A n n u a l c o s t s
CC
AC
0 Inventory level (or order/delivery quantity)
Relationship of inventory-related costs to inventory level (AC = acquisition costs; CC = carrying costs)
(carrying cost / year) = (average inventory value) x (inv. Carrying cost as a % of inv. value)
(carrying cost / year) = (average inventory in units) x (material unit cost) x (inv. Carrying cost as a % of inv. value)
CC =
QxCxI 2
Where CC = carrying cost/yr for the material in question Q = order or delivery quantity for the material, in units C = delivery unit cost of the material I = inventory carrying cost for the material, expressed as a % of the inventory value
Acquisition costs
1. A certain portion of wages and operating expenses of such departments as purchase and supply, production control, receiving etc. 2. The cost of supplies such as engineering drawings, envelopes, stationery, and forms of purchasing etc. 3. The cost of services such as computer time, telephone, fax etc.
It can be calculated as follows: (acquisition cost/year) = (no of orders placed/yr) x (acquisition cost per order)
AC = U/Q x A
Where, AC = acquisition cost /year for the material in question U = expected annual usage of the material Q = order or delivery quantity for the material A = acquisition cost/order or per delivery for the material.
Sr No. 1)
Type of Control ABC analysis
Criteria Annual Consumption value of the item
Application To control inventory of raw material & WIP inventory
2)
XYZ analysis
Inventory value of items in stores
To review the actual inventories their uses, etc. at scheduled intervals.
3)
VED analysis
Criticality of the item
To determine the stocking level of spare parts for
machines &
equipments. 4) FSN analysis Consumption pattern of the items To control obsolescence.
Sr No. 5)
Type of Control HML analysis
Criteria Unit price of the item
Application To control the purchases & to develop vendors.
6)
SDE analysis
Purchasing problem in regard to availability
Lead time analysis & purchasing
strategies.
7) SOS analysis Nature of supplies & seasonality Procurement & holding stratergy for seasonal term. 8) GOLF analysis Source of supply of material Procurement strategy.
Advantages of selective control system
Helps the material manager to exercise selective control and focus attention only on few vital items. Able to control inventories and thereby achieve management objectives. Results in proper inventory analysis & obsolete stocks are pinpointed. Results in reduced administrative costs & improve inventory turnover. Powerful approach in the direction of cost reduction as it is helps to control items with selective approach.
ABC Analysis
What is ABC analysis?
ABC analysis is a basic analytical management tool which enables top management to place the effort where the results will be greatest. The techniques tries to analyze the distribution of any characteristic by money value of importance in order to determine its priority.
ADVANTAGES OF ABC ANALYSIS

This approach helps the material manager to exercise selective control and focus his attention only on few items when he is confronted with lakhs of stores items. By concentrating on A class items, the material manager is able to control inventories and is able to show Visible results in a short span of life. By controlling the A items, and doing a proper inventory analysis, obsolete stocks are automatically pinpointed.
MECHANICS OF ABC ANALYSIS
The mechanics of classifying the items into A, B and C categories is described here:
1. 2. 3. 4. 5. CALCULATE SORT PREPARE A LIST COMPUTE A RUNNING TOTAL COMPUTE AND PRINT
C 100 u m 90 u l a 75 t i v e
%
v a l u e
0
A 10
B 30
C 100
Cumulative % number
Basic principles of ABC analysis are:

1. The analysis does not depend upon the unit cost of the items but only on its annual consumption value. 2. It does not depend on the importance of the item. 3. The limits of ABC categorization are not uniform but will depend upon the size of the undertaking, its inventory as well as the number of items controlled.
PURPOSE OF ABC ANALYSIS
A items: High consumption value

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Very strict control No safety stocks Frequent ordering or weekly deliveries Weekly control statements Maximum follow-up and expediting Rigorous value analysis As many sources as possible for each item Accurate forecasts in material planning Minimisation of waste, obsolete and surplus Individual postings Central purchasing and storage Maximum efforts to reduce lead time Must be handled by senior officers
B items: moderate value

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Moderate control Low safety stocks Once in three months Monthly control report Periodic follow-up Moderate value analysis Two or more reliable sources Estimates based on past data on present plans Quarterly control over surplus and obsolete items Small group postings Combination purchasing Moderate Can be handled by middle management
C items : low consumption value

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Loose control High safety stock Bulk ordering once in six months Quarterly control reports Follow-up and expediting in exceptional cases Minimum value analysis Two reliable sources for each other item Rough estimates for planning Annual review over surplus and obsolete material Group positioning Decentralized purchasing Minimum clerical efforts Can be fully delegated
Objectives of ABC analysis

Exhibit 1 Item no Annual consumption value (Rs) 60,000 4,000 No of orders 4 4 4 Value per order 15,000 1,000 Average inventory 7,500 500
1
2 3
1,000
Total inventory
250
125
Rs 8,125
Exhibit 2 Item no 1 2 3 Annual consumption value (Rs) 60,000 4,000 1,000 No of orders 8 3 1 Value per order 7500 133 1000 Average inventory 3750 667 500 Rs 4,917
Total inventory
Limitations of ABC analysis

ABC analysis is based on grading the items according to the importance of the performance of an item, that is V.E.D.Vital Essential and Desirable- analysis. Some times, through negligible in monetary value, may be vital for running the plant, and constant attention is needed.
Music 3D Analysis
Consumption Value Delivery Time Criticality
High Level Consumption
Low Level Consumption
Long Lead Time
HLC&LLT critical
HLC&LLT LLC&LLT LLC&LLT noncritical critical noncritical
Short Lead Time
HLC&SLT
critical
HLC&SLT LLC&SLT LLC&SLT

noncritical critical noncritical
ECONOMIC ORDERING QUANTITY(EOQ)

INTRODUCTION
EOQ can be defined as that quantity which should be ordered during the lead time so that it becomes economic to order and the inventory carrying cost becomes minimum. When ordering quantity is less than EOQ, ordering cost will increase. When ordering quantity is more than EOQ, inventory carrying cost will increase Thus, EOQ refers to the quantity in which the ordering cost is equal to the holding cost (Inventory carrying cost)
GRAPHICAL DERIVATION OF EOQ
TC
HERE:
EOQ = Economic ordering quantity
TC = Total Cost
COST ICC
ICC = Inventory Carrying Cost OC = Ordering Cost
OC O EOQ ORDER QUANTITY X
DERIVATION OF EOQ FORMULAE

Annual Ordering Cost A x Co Q = = Annual Inventory Carrying Cost 0 + Q x i x Cc 2
Solving for Q QxQ = 2 x A x Co i x Cc 2 x A x Co i x Cc
HERE : A = Annual Demand ; Co = Cost of ordering ; Q = EOQ ; i = Cost per unit ; Cc = Cost of carrying or ICC
PROBLEMS ON EOQ
1. Annual Demand = 20,000 units Ordering Cost = Rs. 100 ICC = 20 % Unit Price = Rs. 20 EOQ = 2 x A x Co I x Cc 2 x 20,000 x 100 20 x 0.20
A.
EOQ =
EOQ = 1,000 units
2.
In a leading biscuit manufacturing organization, the annual demand for corrugated boxes is 20,000. The cost of placing an order is Rs. 100 and the inventory carrying cost is 20 per cent. The price per box is Rs. 10. The supplier offers 1 per cent discount if 4,000 corrugated boxes or more are purchased and 3.5% discount if 10,000 units or more are purchased. What should be the ordering quantity and would you accept the discount?
EOQ = 2 x A x Co I x Cc 2 x 20,000 x 100 10 x 0.20
A.
EOQ =
EOQ = 1,414 units
Number of orders placed in the year = 20,000 1414 = 14.14 orders 1 ) 1% for 4,000 Savings - Inventory Carrying Cost (ICC) Savings = Discount + Cost of ordering Discount = 1 x 20,000 x 10 100 = Rs. 2,000 Cost of ordering = [14.14 (20,000/4,000)] x 100 = Rs. 914 Savings = Rs. (2,000 + 914) = Rs. 2,914 Inventory Carrying Cost (ICC) = ( 4,000- 1,414/2) x 10 x0.20 = Rs. 2,586 Rs. (2,914 - 2,586) = Rs. 328 Accept the offer
2) 3.5% for 10,000 Savings - Inventory Carrying Cost (ICC) Savings = Discount + Cost of ordering Discount = 3.5 x 20,000 x 10 100 = Rs. 8,000 Cost of ordering = [14.14 (20,000/10,000)] x 100 = Rs. 1214 Savings = Rs. (7,000 + 1214) = Rs. 8,214 Inventory Carrying Cost (ICC) = ( 10,000- 1,414/2) x 10 x0.20 = Rs. 8,586 Rs. (8,214 - 8,586) = - (Rs. 372) Reject the offer
LIMITATIONS OF EOQ
Not suitable when annual demand fluctuates widely.
Not suitable when cost per unit fluctuates widely.
Materials Requirement Planning (MRP)

MRP is a computer based control system that determines how much of each material, any inventory item with a unique part / number, should be purchased or produced in each time period to support the master production schedule (MPS) - ( Newman, 1994)
MRP is, by necessity, a computer based system which is designed to:
1. Release production and purchase orders. 2. Ensure availability of materials, components and products. 3. Maintain minimum levels.
Major objectives of MRP are:

1. Improve customer service. 2. Reduce inventory costs. 3. Enhancing operating efficiency.
Elements of MRP
Orders/ forecast of service parts
Inventory Transaction data
Inventory status file
Changes to plan Orders Planned order schedule
MRP system
Master Production schedule
Primary outputs
Planning reports Performance reports
Secondary outputs
Bill of Material file
MRP computer programme
Exception reports
inputs
outputs
P - SYSTEM
Fixed Order Period System Not Suitable for A Class Items Extremely Useful for B & C Class Items Desired Inventory Level = Buffer stock + Safety stock + Reserve stock
Q- SYSTEM
Fixed Order Quantity System Re-order point determined by Buffer stock, Reserve stock & Safety stock Suitable for A Class Items Requires continuous review of inventory
Buffer Stock:
average lead-time
Average demand during
Reserve Stock:
Variations in demand during average lead time are known as reserve stock depend on service level
Safety Stock:
Average demand obtained through multiplying average demand for maximum delay & probability of delay
Annual demand = 20,000 units; Standard deviation of demand per week = 50 units; Price per unit = Rs.10; Ordering cost = Rs.100; Inventory carrying cost = 20%; Average lead time = 4 weeks; Maximum delay =3 weeks; Probability of delay = 0.31; Service level = 95%(1.64)
Solution: Q System
Order quantity = EOQ

2*M*Co
s*Cc = 2 * 20,000 *100 10 * 0.20 = 1414 units

Re-order point = Buffer Stock + Reserve Stock + Safety Stock Buffer Stock = 20000 * 4 = 1540 units 52 Reserve Stock = 4*50*100 = 164 units
Safety Stock = 20,000 *3 *0.31 52 = 358 units Re-order point = 1540+164+358 = 2062 units Solution: P System Review period = EOQ *52 weeks M = 1414 * 52 weeks 20000 = 3.7 weeks
Buffer Stock = 20,000 * 8 = 3080 units 52 Reserve Stock = 8 *50 *1.64 = 230 units Safety Stock = 20,000 *3 * 0.31 = 358 units 52 Desired Inventory Level = 3080 + 230 + 358 = 3668 units

Inventory Management

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INVENTORY MANAGEMENT

Definition of Inventory management

Inventory Management in India

2. Availability of storage space.

Norms for inventory

Forces Creating Various Types of Inventory

Three Components of Inventory Management

Dependent and Independent Demand

Costs relevant for Inventory Decision

COSTS ASSOCIATED WITH INVENTORIES

Type of Control ABC analysis

Criteria Annual Consumption value of the item

Application To control inventory of raw material & WIP inventory

Inventory value of items in stores

To review the actual inventories their uses, etc. at scheduled intervals.

Criticality of the item

To determine the stocking level of spare parts for

Type of Control HML analysis

Criteria Unit price of the item

Application To control the purchases & to develop vendors.

Purchasing problem in regard to availability

Lead time analysis & purchasing

Advantages of selective control system

ADVANTAGES OF ABC ANALYSIS

MECHANICS OF ABC ANALYSIS

Basic principles of ABC analysis are:

PURPOSE OF ABC ANALYSIS

A items: High consumption value

B items: moderate value

C items : low consumption value

Objectives of ABC analysis

Limitations of ABC analysis

High Level Consumption

Low Level Consumption

Long Lead Time

HLC&LLT LLC&LLT LLC&LLT noncritical critical noncritical

Short Lead Time

HLC&SLT LLC&SLT LLC&SLT

ECONOMIC ORDERING QUANTITY(EOQ)

GRAPHICAL DERIVATION OF EOQ

ICC = Inventory Carrying Cost OC = Ordering Cost

OC O EOQ ORDER QUANTITY X

DERIVATION OF EOQ FORMULAE

Solving for Q QxQ = 2 x A x Co i x Cc 2 x A x Co i x Cc

EOQ = 1,000 units

EOQ = 1,414 units

Not suitable when annual demand fluctuates widely.

Not suitable when cost per unit fluctuates widely.

Materials Requirement Planning (MRP)

MRP is, by necessity, a computer based system which is designed to:

Major objectives of MRP are:

Orders/ forecast of service parts

Inventory Transaction data

Inventory status file

Changes to plan Orders Planned order schedule

Bill of Material file

MRP computer programme

Average demand during

Order quantity = EOQ

s*Cc = 2 * 20,000 *100 10 * 0.20 = 1414 units

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sCc = 2 20,000 100 10 0.20 = 1414 units