INVENTORY MANAGEMENT

HYDERALI C.K Click to edit Master subtitle style 106004

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INTRODUCTION

Significant part of the current asset Large amount of inventory leads to considerable lapse of fund Imperative to manage to avoid unnecessary investment

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Cont..

Inventory Control measure and regulate to predetermine -size for order or production, -safety stock - minimum level of order - maximum level of order

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Nature of inventories

Raw material Work in process Finished goods

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NEED TO HOLD INVENTORIES

Transaction motive(smooth production) Precautionary motive(demand) Production motive (price)

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PRODUCTION CYCLE

Time span between introduction raw material to the conversion into the finished product

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OBJECTIVE OF INVENTORY MANAGEMENT

To meet unforeseen future demand due to variation in forecast figures and actual figures. To meet the customer requirement timely, effectively, efficiently and smoothly To smoothen the production process. To facilitate intermittent production of several products on the same 4/14/12 facility.

Cont..

To gain economy of production or purchase in lots. To reduce loss due to changes in prices of inventory items. To meet the time lag for transportation of goods. To balance various costs of inventory such as order cost or set up cost and inventory carrying cost

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Cont..

To balance the stock out cost/opportunity cost due to loss of sales against the costs of inventory. To minimize losses due to deterioration, obsolescence, damage etc.

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Optimum level of inventory

It lies between two danger point,i.e between excessive and inadequate level

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Major danger in the overinvesment

Unnecessary tie-up of firms fund and loss of profit Excessive carrying cost Risk of liquidity

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Major danger in the inadequate level

Production hold-up Failure to meet delivery commitment

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Effective inventory management

Continues supply of raw material to facilitate production Maintain sufficient stock of raw materials in periods of short supply and anticipate price changes Maintain sufficient finished goods inventory for smooth sales operation, and efficient customer service
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Cont..

Minimise the carrying cost and time Control investment in inventories and keep it an optimum level

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Inventory management techniques

Aim to maximise the shareholder wealth For efficient inventory management, we have to answer

-how much should be ordered ? (ans;EOQ) -when should it be ordered ? (ans;reorder point)
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Economic order quantity

ordering materials whenever stock reaches the reorder point It tells how production to be schedule optimum level of inventory involves two types of cost 1.ordering cost 2.carrying cost
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Ordering cost

It is the entire cost to acquire the raw material(supplies). It include -Requisitioning -order placing -Transportation -Receiving, inspecting and storing -clerical and staff 4/14/12

Carrying cost

It is the cost incurred to maintain the given level of inventory It include -Warehousing -Handling -clerical and staff -Insurance -Deterioration and obsolescene 4/14/12

Ordering and carrying cost trade off

Optimum level of inventory referred to EOQ To determine EOQ-three approaches -Trial and error approach -Formula approach -Graphical approach

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Trial and error approach

Assumptions -known annual requirement -steady usage

-ordering and carrying cost to be constant through the entire period

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Example illustrating the trial and error approach

Estimated annual requirement, A =1200unit Purchasing cost per unit, P(Rs) =50 Ordering cost (per order),O(Rs) =37.50 Carrying cost per unit,c(Re) =1 4/14/12

Total cost in the various orders 200 150 120 Order size(Q) 1200 600 400 300 240
Average 600 inventory(Q/2) No.of orders (A/Q) Annual carrying Cost (Rs) (cQ/2) 1 600 300 200 150 120 100 75 60 2 3 4 150 5 120 6 100 8 75 10 60

100 50

12 50

300 200

Annual 37.5 ordering cost (Rs)(OA/Q) Total annual costs (Rs) 4/14/12

75

112.5 150

187.5 225

300

375

450

637.5 375 312.5 300

307.5 325

375

435

500

Inference from the TC table

Order Total cost 1.For single order(once in year) 637.5 2.12 order (once in a month) 500 3.4 order(once in every 3 month) 300
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i.e.the third option is the most

Order formula approach

It is more easier way compared to trial and error approach Assumption -carrying cost per unit constant -ordering cost per order fixed

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Cont

O=ordering cost per order A=Total annual requirement Q=order size Per unit carrying cost=c Number of order=A/Q TOC(Total order cost)=(A/Q)XO
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Cont..

Average inventory

=Q/2

TCC(Total carrying cost)=(Q/2)Xc TC(Total cost) =TOC+TCC TC =(A/Q)XO + (Q/2)Xc

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Inference from the equation

For larger quantity order =carrying cost increases

=ordering cost decreases

For lower quantity order=carrying cost decreases

=ordering cost 4/14/12 increase

Cont.

EOQ should lie between larger & lower quantity order So EOQ = differentiate TC and equate to zero TC =(A/Q)XO + (Q/2)Xc EOQ=-(AO)/Q^2+c/2=0 c/2=(AO)/Q^2 EOQ=Q=((2AO)/c)^.5
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In the earlier problem

A=1200 O=37.5 c=1 EOQ=((2AO)/c)^.5 =((2X1200X37.5)/1)^.5 =300

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Graphical method

Vertical axis

=costs -carrying cost

(TCC) -ordering cost (TOC) -Total cost (TC)

Horizontal axis =order size (Q)

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Cont
Cost (Rs.) Tc (Total Cost) Carrying Cost (Q/2)H

EOQ Order Quantity Size (Q)

DS/Q (Ordering Cost)

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Cont

Carrying cost increases with increase order size, because of large have to be maintained Ordering cost decline with increase in order size, because larger order size means lesser no of order Total cost has the behaviour of both ordering cost and carrying cost
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EOQ=deviating point of TC

Quantity discount

Supplier offer discount for large order size (above EOQ) Net return=discount savings additional carrying cost If return +ve = can avail the discount offer If return ve= order size should be EOQ level

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Example

d=discount rate (.005) Discount on savings=dXPXA=(.005X50X1200)

=300

Savings on the ordering cost=(OA/Q)(OA/q) Here Q=EOQ & q=discount quantity(400) 4/14/12

Cont.

Additional carrying cost=(cq/2)(cQ/2) =c/2(q-Q) =1/2(400-

300) =50

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Cont

Net return=[dPA+ savings on additional discount]

carrying cost =(300+37.5)-50 =287.5

Here net return is +ve= firm should order 400

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Important Terms

Minimum Level It is the minimum stock to be maintained for smooth production. Maximum Level It is the level of stock, beyond which a firm should not maintain the stock. Reorder Level The stock level at which an order should be placed. Safety Stock Stock for usage at 4/14/12 normal rate during the extension of

Case study of inventory control (ABC)

Several types of inventories are there in ABC Classify the inventories into -High value -Least value =A =C

-reasonable attention=B(A&C)

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Cont.

ABC analysis concentrate on important items

=Control by important exception(CIE)

Classified in the importance of their relative value=Proportion Value Analysis(PVA) 4/14/12

Classify ,determine expected use & price of the inventories Determine total value of item(expected unitXunit price) Rank the items (according to total value) Compute the ratios (no.of unit/total unit) & (each value of item/total 4/14/12 value of all item)

Step involved in implementing the ABC analysis

ABC analysis table

Item Units % of Total 10 5 16 14 30 15 10 100 45 15 Cumula- Unit Total cost % of tive % price Rs Rs Total 30.40 51.20 5.50 5.14 1.70 1.50 0.65 304000 256000 88000 72000 51000 22500 6500 38.00 32.00 11.00 9.00 6.38 2.81 0.81 100 90 70 Cumulative % 1 2 3 4 5 6 7 10000 5000 16000 14000 30000 15000 10000

Total 100000 4/14/12

800000

Inference

Assumption =1&2 ,3,4&5,6&7 fall in the same category 1&2=item 6&7 A 3,4&5=item B =item C

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Thank you

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