Inventory Management

Inventory management.
Inventory Stock of goods, commodities or other economic resources that are held by firms at a particular time for their future production requirements and for meeting future demands. Inventory Management It assists organizations in minimizing their inventory cost without compromising on their ability to respond quickly to customer demand.

Inventory for manufacturing sector

Manufacturing organizations , typically have inventories of raw materials, components, sub-assemblies, tools equipments, semifinished goods, finished goods etc.
E.g., Headlight assembly for cars at Maruti Udyog Ltd is supplied by Lucas-TVS Ltd

Inventory for service sector

In service organizations the inventory consists of various items to be used in various service operations.
E.g., In Banks there are inventories of different types of forms for various banking operations, brochures , pamphlets , currency notes and coins etc.

Inventory for service sector

In retailing warehouses & distribution centers have important place in overall operations
E.g., Wal- Mart tied up with Fingerhut Business services for the Internet based store Wal-Mart.com. Under this kind of arrangement, suppliers are paid only after an item is sold. As a result, the inventory is managed & controlled by suppliers & manufacturers.

Why We Want to Hold Inventories?

To avoid the stock out of an item which halts the production process. Balances supply and demand Provides protection from uncertainties in demand and order cycle Acts as a cushion between critical interfaces within the supply chain Can enhance customer service levels

Functions of Inventory
To To

meet anticipated demand smooth production requirements

To
To To To To To

decouple operations
protect against stock-outs take advantage of order cycles help hedge against price increases permit operations take advantage of quantity discounts

Types of Inventories
Production

Inventories

Raw materials, Parts & components

MRO

Inventories

Maintenance, repair & operating supplies which are consumed in the production but not become the part of the product
Work

in Progress-

Semi finished products

Goods-in-transit

to warehouses or customers Finished good Inventories

Types of Inventory

Objectives of Inventory Management

Smooth Production:
E.g., Sales of air conditioners is more during summers but an organization may not be capable of manufacturing entire units during summer. So it maintain constant production rate and finished goods inventory. It is used to cover the deficiency in manufacturing capacity during high demand period.

Provide for cost-efficient operations:

Buffer stock for smooth production flow Allowing longer production runs & quantity discounts

Protection against Business uncertainties:

E.g., A sudden and unexpected increase in demand can be met with finished goods inventory.

Provide desired customer service level or better service to customers

Customer service is customer requirements the ability to satisfy

Take advantage of Quantity Discount:

Each time a firm places an order ,it incurs an ordering cost. So to minimize ordering cost, firms try to reduce the numbers of orders , by ordering more quantity than is actually needed.

Role of Other Functional Departments in Inventory Management

Finance Department Salaries & wages of employees in the materials department Formulati on of annual budget for materials Information regarding payments to be made to suppliers Information regarding the ordering cost and carrying cost figures to be used in order size calculations

Demand forecast of finished goods so that raw materials can be procured accordingly
Marketing department

Information regarding changes made in the materials quality to enhance the quality of finished goods

Feedback regarding quality requirements of finished goods and thus the materials used

Materials Department Training of employees in the materials department regarding use of ERP and other software Information systems department

Recruitmen t of employees in the Materials Department

Performance appraisal of employees in the materials department

Human resources department

Installation of ERP or other software in the materials department

Training & development of employees in the materials department

Requirement of suitable software in the materials department

Independent and Dependent Demand Inventory

Independent demand Items demanded by external customers (Dinning Table) Dependent demand Items used to produce final products (table top, legs, hardware, paint, etc.)

Nature of Independent and Dependent Demand Inventory Management

Independent demand Uncertain / forecasted Continuous Review / Periodic Review Dependent demand Requirements / planned

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Inventory cost
Purchase cost: The cost of purchasing a unit of item is called purchase cost. Carrying cost: It is cost incurred when the inventories are stored in warehouses or stores. 1. Cost directly linked with materials

Obsolescence, Deterioration, Pilferage 2. Financial Costs Taxes, Insurance, Storage & Interest
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Ordering cost:
1. Cost of placing & order with a vendor of materials Preparing purchase order, Processing payments, Receiving & inspecting the material

2. Ordering from the plant

Machine set-up, Start-up scrap generated from getting a production run started

Stock out cost:

These are penalty cost associated with delays in meeting the demand or the firms inability to produce the product due to shortage of stock. The purpose of holding inventory is to avoid stock out cost.

Capacity Costs:
1. Overtime payments when capacity is too small 2. Lay-off & idle time when capacity is too large.

Effective Inventory Management

A system to keep track of inventory A reliable forecast of demand Knowledge of lead times Reasonable estimates of

Holding costs Ordering costs Shortage costs

Inventory system
The series of activities involved in maintaining adequate levels of inventory is referred to as inventory cycle. When a company places an order ,it should be based upon the inventory system. Inventory system is of two types: 1. Fixed Order Quantity system 2. Fixed Order Period system.

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Fixed Order Quantity System (Q-System)

In this system inventory is continuously checked and new order is placed when the level of inventory reaches a certain point, called reorder point. The order quantity is always constant. Order is placed when the level of inventory reaches the reorder point. The quantity to be ordered is determined by demand and cost consideration.

Fixed Order Quantity System (Q-System)

Advantages1. Material produced in economical quantity 2.Proper attention giving to the items when they required 3.Control mechanism works properly by manipulating the planned maximum & minimum values. Disadvantages1. Irregularities of placing order may not suitable to suppliers. 2. Higher lead time can lead to have extreme stock. 3. The items cannot be grouped & ordered at a time. 4. Any changes in lead time ,a new order point & new order quantity should be fixed which is tedious.

Fixed Order Period System (P -system)

In this system, the order period is fixed but the order quantity varies with the requirement. The quantity ordered each time depends on the current inventory level or inventory in hand and future inventory requirements. Orders are placed at equal intervals of time.

Fixed Order Period System (P -system)

Advantages1. The ordering & Inventory cost is low
2. Attractive discounts for guaranteed sales. 3. The system works well for irregular & seasonal usage product .

Disadvantages1. It compels periodic review of all items. 2. Higher level of safety stocks
Both systems have their strengths & weaknesses. So, operations managers adopt a combination of both of these systems.

Inventory Control Techniques

Economic Order Quantity Model (EOQ) Always Better Control Classification (ABC) Vital, Essential Desirable Classification (VED) Scarce, Difficult & Easy to obtain (SDE) High Medium & Low Classifications (HML) Fast moving, Slow moving & Non-moving (FSN) Max-Min System

EOQ Model
Assumptions Price for unit of product is constant. Demand for the product is constant & uniform throughout the period. Lead time is constant. Ordering cost is constant. Holding cost is based on average Inventory. All demands for the product will be satisfied & no back orders are allowed. Reorder Point(RP)RP= Lead Time(LT) X Average Daily Demand(D)

Balancing Carrying against Ordering Costs

Higher

Lower

A n n u al C o st

Minimum Total Annual Stocking Costs Total Annual Stocking Costs Annual Carrying Costs Annual Ordering Costs Smaller EOQ Larger

Order Quantity

EOQ

Annual carrying cost = (average inventory level) x (carrying cost) = (Q/2)Cc Annual ordering cost = (average number of orders per year) x (ordering cost) = (D/Q) Co Annual Purchase Cost= Annual Demand (D) x Purchase Price/Unit (P) Total annual Inventory Cost (TC) = annual carrying cost + annual ordering cost + annual purchase cost= (Q/2)Cc + (D/Q) Co+ DxP
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EOQ Model Equations

Economic Order Quantity = Q* = D Co 2 Cc Number of Orders = N = D Q* = T = 1 N Where ; D = Demand per year Co = Ordering Cost Cc = Carrying Cost

Expected Time Between Orders

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Problem-1: EOQ Model

ABC industries estimates that it will sell 12,000 units of its product for the forthcoming year . The ordering cost is Rs100/- per order and carrying cost per unit per year is 20% of the purchase price per unit . The purchase price per unit is Rs50/- . Find : (i) Economic Order Quantity . (ii) No. of Orders / Year . (iii) Time between successive orders .

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Example: Basic EOQ

Economical Order Quantity (EOQ) D = 12,000 units/year . Cc = .20(50) = Rs10/unit/year . Co = Rs100/order . (a) Economic Order Quantity (EOQ)= Q= 490 units per order .

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Example: Basic EOQ

Number of Orders Per Year = D/Q = 12,000/490 = 24.49 orders/year Time Between Orders = Q/D = 490/12000 = 0.04 years . = 0.48 months .
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ABC Analysis ABC- Always better control

Items are classified on the basis of annual consumption value. Annual consumption value= annual requirement x per unit cost

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ABC Analysis
Inventory Item 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Annual use in 1000Rupees 3 40 2 10 5 400 7 9 8 300 1 50 15 20 90 8 7 11 9 5 1000 % of total Inventory usage 0.3 4 0.2 1 0.5 40 0.7 0.9 0.8 30 0.1 5 1.5 2 9 0.8 0.7 1.1 0.9 0.5 100

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