1. 06/08/09

2. Inventory Definition

A stock of items held to meet future demand

Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business .

06/08/09 3. Introduction

Constitute significant part of current assets

On an average approximately 60% of current assets in Public Limited Companies in India

A considerable amount of fund is required

Effective and efficient management is imperative to avoid unnecessary investment

Improper inventory management affects long term profitability and may fail ultimately

10 to 20% of inventory can be reduced without any adverse effect on production and sales by using simple inventory planning and control techniques

06/08/09 4. Types of Inventory 06/08/09 Work in process Work in process Work in process Finished goods Raw Materials Vendors Customer 5. Nature of Inventories

Raw Materials Basic inputs that are converted into finished product through the manufacturing process

Work-in-progress Semi-manufactured products need some more works before they become finished goods for sale

Finished Goods Completely manufactured products ready for sale

Supplies Office and plant cleaning materials not directly enter production but are necessary for production process and do not involve significant investment.

06/08/09 6. ReasonsTo HoldInventory

Meet variations in customer demand:

• Meet unexpected demand

• Smooth seasonal or cyclical demand

Pricing related:

• Temporary price discounts

• Hedge against price increases

• Take advantage of quantity discounts

Process & supply surprises

• Internal upsets in parts of or our own processes

• External delays in incoming goods

06/08/09 7. Objective of Inventory Management

To maintain a optimum size of inventory for efficient and smooth production and sales operations

To maintain a minimum investment in inventories to maximize the profitability

Effort should be made to place an order at theright timewithright sourceto acquire theright quantityat theright priceandright quality

06/08/09 8. An effective inventory management should

Ensure a continuous supply of raw materials to facilitate uninterrupted production

Maintain sufficient stocks 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

Minimize the carrying cost and time

Control investment in inventories and keep it at an optimum level

06/08/09 9. An optimum inventory level involves three types of costs

Ordering costs:-

Quotation or tendering

Requisitioning

Order placing

Transportation

Receiving, inspecting and storing

Quality control

Clerical and staff

Stock-out cost

Loss of sale

Failure to meet delivery commitments

Carrying costs:-

Warehousing or storage

Handling

Clerical and staff

Insurance

Interest

Deterioration,shrinkage,

evaporation and obsolescence

Taxes

Cost of capital

06/08/09 10. Dangers of Over investment

Unnecessary tie-up of firms fund and loss of profit involves opportunity cost

Excessive carrying cost

Risk of liquidity- difficult to convert into cash

Physical deterioration of inventories while in storage due to mishandling and improper storage facilities

06/08/09 11. Dangers of under-investment

Production hold-ups loss of labor hours

Failure to meet delivery commitments

Customers may shift to competitors which will amount to a permanent loss to the firm

May affect the goodwill and image of the firm

06/08/09 12. Functions of Inventory Management 06/08/09

• -Track inventory

• How much to order

• When to order

13. Classification of inventory

ABC Classification

HML Classification

XYZ Classification

VED Classification

FSN Classification

SDF Classification

GOLF Classification

SOS Classification

14. ABC Classification

In most of the cases 10 to 20 % of the inventory account for 70 to 80% of the annual activity.

A typical manufacturing operation shows that the top 15% of the line items, in terms of annual rupees usage, represent 80% of total annual rupees usage.

Next 15% of items reflect 15% of annual rupees

Next 70% accounts only for 5% usage

A B C 15. XYZ Classification

On the basis of value of inventory stored

Whereas ABC was on the basis of value of consumption to value.

X High Value

Y Medium value

Z Least value

Aimed to identify items which are extensively stocked.

16. HML Classification

On the basis of unit value of item

There is 1000 unit of Q @ Rs. 10 and 10,000 units of W @ Rs. 5.

Aimed to control the purchase of raw materials.

H High, M- Medium, L - Low

17. VED Classification

Mainly for spare parts because their consumption pattern is different from raw materials.

Raw materials on market demand

Spare parts on performance of plant and machinery.

V Vital, E Essential, D Desirable

Therefore V items has to be stocked moreand D Items has to be less stocked 18. FSN Classification

According to the consumption pattern

To combat obsolete items

F Fast moving

S Slow moving

N Non Moving

19. SDF & GOLF Classification

Based on source of procurement

S Scarce, D- Difficult, E- Easy.

GOLF

G Government, O Ordinary, L Local, F Foreign.

20. SOS Classification

Raw materials especially for agriculture units

S Seasonal

OS Off seasonal

21. Deciding on the inventory model

Assume an analyst applies an inventory model that does not allow for spoilage to a grocery chains ordering policy for lettuce and formulates the strategy of ordering lettuce in large amounts every 14 days. A little thought will show that this is obliviously foolish. This strategy implies that lettuce will be spoiled. However it is not a failure of inventory, it is a failure to apply the correct model.

22. Different approaches

Certainty approach

Uncertain variables and risk are addressed separately

Uncertainty approach

Uncertain variables and risk are addressed simultaneously

Deterministic approach

Probabilistic approach

23. Basic EOQ Model

Assumption

Seasonal fluctuation in demand are ruled out

Zero lead time Time lapsed between purchase order and inventory usage

Cost of placing an order and receiving are same and independent of the units ordered

Annual cost of carrying the inventory is constant

Total inventory cost = Ordering cost + carrying cost

24. EOQ Three Approaches

Trial and Error method

Order-formula approach

Graphical approach

06/08/09 25. EOQ & Re-order point

EOQ gives answer to question How much to Order

Re-order point gives answer to question when to order

06/08/09 26. Trial & Error Method

Assumptions:-

Annual requirement (C)=1200 units

Carrying cost (I) = Rs.1

Ordering cost (O) =Rs.37.5

06/08/09 Order size Q1200 600 400 300 240 200 150 120 100 Average inventory Q/2600 300 200 150 120 100 75 60 50 No. of orders C/Q1 2 3 4 5 6 8 10 12 Annual carrying cost I* Q/2600 300 200 150 120 100 75 60 50 Annual ordering cost O*C/Q37.5 75 112.5 150 187.5 225 300 375 450 Total annual cost637.5 375 312.5 300 307.5 325 375 435 500 27. Order- Formula approach

1/2

EOQ =(2CO/I)

C = Annual demand

O = Ordering cost per order

I= Carrying cost per unit

1/2

EOQ =(2*1200*37.5/1)= 300 units

06/08/09 28. Q 0 T1 T2 T3 T4 Average inventory = Q/2 Time Inventorylevel order quantity Certainty case of the inventory cycle

Here the negative slope from Q to T1 represents the inventory being used up

T1, T2, T3, T4 represents the replenishment points

The inventory varies between 0 and Q

29. Graphical method to find EOQ CostinRS. Order quantity 0 Ordering cost = DS/Q Carrying cost = CQ/2 Total costEOQ 30. Extension of basic EOQ model

This model can be extended to include quantity discounts, were simple calculation for quantity discount is added.

Non zero lead time

Non zero lead time 31. Extension of basic EOQ model

Non zero lead time

If the lead time is n then procurement must be done prior to n days, i.e. T-n as shown in the figure

T1 - n T2 - n T3 - n T4 - n T1T2T3T4Time Q 0 Reorder point Placement of a order 32. Probabilistic inventory model

In practical inventory management assumption may not be strictly correct.

Demand may fluctuate over time due to seasonal, cyclical and random influences.

Lead time may also fluctuate because of transportation delay, strikes or natural disaster. For such reason most of the companies use safety stock.

33.

But in some cases even the safety stock becomes ineffective to combat stock out. Like:-

Probabilistic inventory modelcontd Reorder point Safety stock Placement oforder Lead time T1 T2 T3 T4 T5 T6 Stock out 34. A Review

So we have dealt with

EOQ model

Its extension

Probabilistic model

And now we will be dealing withspecial inventory models

35. Special inventory model

Non Instantaneous replenishment

Quantity Discount

One period decision

36. Non Instantaneous replenishment Special inventory model A B C D A B C Thus the inventory is replenished gradually than in lots Particularly in situation were manufacturers use continuesproduction process e.g. FACT makes Ammonium on a continual basis Capacity 10 units 37. Discount Quantities

If discount increases with the order quantity, then the price of inventory is no more constant

Special inventory model Hence a new approach is needed to find the best lot size Total cost Annual holding cost Annual ordering cost Annual cost of materials = + + 38. One period decisions

If a newspaper seller does not buy enough papers to resell on the street corner, sales opportunity is lost. If the seller buys too many, the overage cannot be sold because nobody wants yesterdays newspaper.

Special inventory model Applicable to fashion goods, seasonal goods anddue to change in technology Thenewsboyproblem 39. Inventory management under uncertainty

Option price model

Risk adjusted discount cash flow (DFC) Model

Dynamic inventory model

40. Option price model

Option is a contract that gives the holder a right to acquire or sell certain things at a predetermined price without any obligation.

Calculated by integrating the market information and inventory control.

41. Risk adjusted discount cash flow (DFC) Model

Inventory control problem is converted to capital budget problem

Suppose a television dealer decides to hold an additional inventory of 1000 television per month. The cost of holding inventory is spread overtime.

Inflows = no: of units probability present value

Beneficial for projects like oil drilling were thebenefit is acquired only after a long timebutonce oil is struck the additional expanse is covered. 42. Dynamic inventory model

Uncertain variables are identified

Probability associated with them is taken

Simulation techniques are applied

43. Emerging trends in inventory management

Entering into log term contract at a fixed price to reduce uncertainties

Just-in-time

Kanbans Japanese technique (Only produce when demand comes)

Internet based ordering system

Supply chain management

Vendor development

Investment in plant and machinery

44. Inventory control responsibility

Purchasing naturally has vest interest in inventories, even to the extend that in some companies the purchasing and stores functions are combined.

Production looks after the work in progress

Logistics plays a major role in inventory control

Inventories are economic importance to finance department

The fact that materials must be moved from one place to another is of importance to materials department

In effect the responsibility cannot be kepton one head since inventory managementis a integrated effort 45. THANK YOU