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BITSPilaniPilani Campus

Manufacturing Organization

and Management

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BITSPilaniPilani Campus

Inventory Management and ControlLecture 15

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BITS Pilani, Pilani Campus

Control of material in manufacturing.

Control of the flow of material from a raw state to afinished product.

Most industries buy material, transport it to the plant,change the material into parts, assemble parts intofinished products, and sell and transport the product tothe customer.

The flow of material as they progress, with the aid of

inventories, through the production cycle can bediagrammed as shown in the following figure.

Introduction

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BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Flow of material through production cycle

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The ultimate objective of all manufacturing controls is torealize a profit through the operation of the business.

A more restricted objective of the control of material is tosatisfy the customer by meeting the schedule for deliveries.

Failure of deliver order on time is one principal cause of loss

of business and customers. Effective control of the material throughout the manufacturingcycle reduces the chance of this problem arising.

Material must wait for machines or materials handlingequipment to become available and must be ordered inadvance of production and stored in a warehouse or storagearea.

Japanese concept of just-in-timeproduction scheduling mayreduce manufacturingsdependence on inventories.

Objectives of Inventory Management

and Control

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Specific objectives of the inventory management andcontrol group are to maintain optimum inventorylevels and inventory turnover for operation of thebusiness at maximum profit

Through the control of inventories, it should be

ensured that the right material in the right quantity andof the right quality is made available at the right placeat the right time.

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In the same manner that we identify the variousfunctions in material management with the flow ofgoods, we can identify the different types of inventoriesor stocks of material maintained in a manufacturing

plant. All plants use the same general classification of

inventories, including raw material, purchased parts,work-in-progress, finished goods, and supplies.

Inventory Classifications

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A raw material inventory includes all items that, afterbeing received at the plant, require additional processingbefore becoming an identifiable part of the finishedproduct.

It is obvious that the finished product of one plant- suchas roll, bar, and sheet steel- may be the raw material ofthe next industrial purchaser.

Raw Material

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This classification of inventory is applied tocomponent parts of a product that need no additionalprocessing before being assembled into the finishedproduct.

In some cases this material may be classified as rawmaterial inventory. More times than not, however, aseparate classification is justified.

The TV picture tube that is the finished product of

one manufacturer becomes a purchased part to thetelevision set manufacturer.

Purchased Parts

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This classification of inventory is self-explanatory.

All material that leaves either raw material stores ofpurchased parts stores enters the work-in-processinventory until the product is completed and placed in

finished goods. Work-in-process is the inventory of material, the flow of

which is controlled by production control procedures tobe discussed in a later chapter.

Work-in-Process

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This classification applied to the quantities of finished goodsthat are held at the factory awaiting shipment.

It will include stocks held in warehouses owned and operatedby the manufacturer, or stock held on dealers floors onconsignment.

The value of the finished goods inventory is usually very highand a principal factor in the financial management of thecompany.

A typical example of this is the piston ring manufacturer, who,in addition to supplying the original car manufacturer, also

maintains large stocks of many different sizes of piston ringsin automotive supply houses for quick service to the autorepairman.

These stocks are on consignment; that is the piston ringmanufacturer does not receive any payment for the goods

until they have been sold by the distributor.

Finished Goods

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All the materials needed for the operation of the plantthat are not used as parts of the finished product areclassified as supplies.

In the chapter on cost accounting we have identified this

inventory classification as indirectmaterial. On the other hand, the material that becomes part of the

finished product is called direct material. Lubricatingoils, sweeping compound, light bulbs, and many other

items fall into the supply category.

Supplies

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The complex relationship between modern industry andits market presents a real problem in the size ofinventories that should be maintained.

Large inventories in the face of declining sales meanlower profits.

Small and inadequate inventories in the face of anincreasing market demand may result in the loss ofsales to competitorsand a decreased profit.

Recognition of these conditions should indicate that theoptimum inventory is not necessarily either the

minimum or the maximum level of inventory; nor is itoperation at a maximum inventory turnover.

Optimum Inventory

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A very common index of inventory control, inventoryturnover is the ratio of the value of the product shippedto the average investment in inventory for the sameperiod.

Inventory tu rnover =(value of product shipped)/(valueof average inventory)

Obviously, the higher this index, the lower the inventorylevels and the lower the cost of maintaining theinventories.

Also, it is obvious that a high index indicates a shortermanufacturing cycle with all the saving inherent therein.

Inventory Turnover

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Throughout this century management scientists havedevoted considerable effort to the mathematicalformulation of inventory models.

An elementary building block of this analysis has been

the so-called economic lot size mode. Through the years, it has been used to determine

manufacturing batch quantities for in-plant productionorders or purchase orders and also for determination of

optimuminventory levels.

Economic Lot Size Concept

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The anticipated rate of usage of the part must beconsidered together with the time required to produce areplacement lot.

Quantities should be established such that at all timesstock will be available to the assembly departments.

This principle is used by the materials control group indetermining inventory levels.

Rate of Usage

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Next in importance is the cost to acquire the item. In amanufacturing situation this would be a setup cost.

If the part is purchased an ordering cost would beincurred.

For a cost such as this, the quantity purchased or made

is important the larger the quantity, the lower the per-piece cost.

Ordering Cost

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Another factor to be considered is the deterioration orobsolescence of a large stock of parts.

All these factors must be weighed by managementand an economic lot size determined that will result inthe acquisition of parts at an optimum cost per unit.

Deterioration or obsolescence

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The use of economic order quantity models has been in effect formany years, and the literature abounds with the many formulationsthat have been proposed.

One of the problems that arises in the use of mathematical model isthe fact that many factors have a bearing on optimum lot sizes, andone cannot weigh all of them in a simple formula.

Total cost = QI/2 + RS/Q

Qo=(2RS/I)Qo= economic lot size,

R= annual use of the item in units per year,S= cost each time a new lo is ordered (setup cost),

I= carrying cost per unit per year

Elementary lot size model

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Optimal Order Quantity

Expected Number of Orders

Expected Time Between Orders Working Days / Year

Working Days / Year

= =

= =

= =

=

=

Q*D S

H

ND

Q*

TN

dD

ROP d L

2

D= Demand per year

S= Setup (order) cost per orderH= Holding (carrying) cost

d= Demand per day

L= Lead time in days

EOQ Model Equations

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Youre a buyer for SaveMart.

SaveMart needs 1000coffee makers per year.

The cost of each coffee maker is $78. Orderingcost is $100per order. Carrying cost is 40%of per

unit cost. Lead time is 5days. SaveMart is open

365days/yr.

What is the optimal order quantity& ROP (reorder

point)?

EOQ

Example

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SaveMart EOQ

H

SDEOQ

2

20.31$

100$10002 EOQ

D = 1000S = $100C = $ 78I = 40%

H = C x IH = $31.20 EOQ = 80 coffeemakers

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SaveMart ROP

ROP = demand over lead time= daily demand x lead time (days)= d x l

D = annual demand = 1000

Days / year = 365

Daily demand = 1000 / 365 = 2.74

Lead time = 5 days

ROP = 2.74 x 5 = 13.7 => 14

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Cost relationship in EOQ model

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The computer is the direction to go for assistance if its usecan be justified.

One can do much posting of numbers by hand for the rentalor purchase price of a computer, but there will be a point inalmost every companys operation when the inventory

problem can best be handled by computer, most often using adatabase management system.

Computer Assistance

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Sales personnel wish their company to stock largequantities of all items in the product line so they canmeet even the most unreasonable demands of theircustomers.

Typical production personnel wish to keep largequantities of parts on hand so there is never anydanger of a production line having to shut down forlack of parts.

Inventory Costs

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Many factors influence inventory management andcontrol. The principal effects of these factors arereflected most strongly in the levels of inventory and thedegree of control planned in the inventory controlsystem.

Type of ProductType of Manufacture

Volume

Factors Influencing Inventory

Management and Control

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If the materials used in the manufacture of the producthave a high unit value when purchased, a much closercontrol is usually in order.

Jewelers are much more careful with their stock ofdiamonds than they are with display cases full of low-

priced costume jewelry. This same principle holds inmanufacturing.

Type of Product

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The close relationship between the type of product and the type ofmanufacture makes an analysis of the effect on inventory controlssomewhat repetitious.

Continuous manufacture is common to the manufacture of standardproducts. However, some standard products are made in batches.Where continuous manufacture is employed, the rate of productionis the key factor.

Here, as a matter of fact inventory control is of major importanceand in reality controls the production of the product.

Type of Manufacture

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The volume of product to be made, as represented bythe rate of production, may have little effect on thecomplexity of the inventory problem.

Literally millions of brass bases for light bulbs aremanufactured each month involving the control of onlytwo principal items of raw inventory.

Volume

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The planning of the control of inventory can bedivided into two phases:

Inventory management

Inventory control.

Inventory management consists of:1. Determination of optimum inventory levels and procedures for their

review and adjustment

2. Determination of the degree of control that is required for the bestresults

3. Planning and design of the inventory control system

4. Planning of the inventory control organization.

Inventory Management

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We have already pointed out that the trend of sales must bewatched closely and inventories adjusted in advance of the changein rate of production as determined by actual sales.

But this is not the only factor that must be considered by inventorymanagement when determining inventory levels.

The planning for the actual production of the product may involveproblems of leveling production, that is producing at a constant rateeven though sales may fluctuate.

In slack times products are built to stock; the finished goodsinventory is increased to offset the demand anticipated when futuresales surpass the production rate of the plant.

The proper evaluation of this factor requires close cooperation withthe manufacturing function.

Optimum Inventory Levels

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Inventory management must decide just how muchcontrol is needed to accomplish the objective.

The least control as evidenced by systems, records,and personnel- that is required to perform the functionefficiently is the best control.

This problem of the degree of control can be approachedfrom the viewpoint of quantity, location and time.

Degree to Control

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Much publicity was given during the early 1980s to the Japanesestyle just-in-time inventory concepts.

The goal of JIT is simple enough; get the material to its nextprocessing point just at the time it is needed.

Theoretically, then, no inventory will be needed. JIT can be

implemented with manufacturing work-in-process or with materialpurchased from outside vendors.

The latter will require coordination with these vendors.

One truck transportation company obtains much of its business bycatering to companies that must deliver parts to other companiesjustin time.

The Toyota company in Japan has developed a schedulingdiscipline for internal control of in process material movement, calledkanban, which substantially reduces WIP inventories and hencereduces the associated costs.

Just-in-Time Concept

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The inventory control group puts the plans of inventorymanagement into operation.

These plans are seldom complete in every detail.

The day-to-day planning required to meet production

requirements the second phase of planning forinventory controlis the responsibility of this group.

Inventory Control

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Control of manufacturing inventories is basically aproblem of industrial communications. Earlier, we indicated that the complexity of these

systems is directly proportional to the number of items inthe inventories and to the number of transactions that

have to be recorded to keep abreast of the movement ofthe material. It should be emphasized here that a great many of the

inventory control systems in use in industry today arecomputer-oriented systems.

However, the initial part of the discussion in this sectionwill be concerned with basic concepts and dataassociated with inventory control procedures in general,without reference to capabilities of computer systems.

Inventory Control Systems

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The basic information normally carried on perpetual inventory recordsincludes:1. On order: This part of the record shows the quantity of material

ordered but not received. Now order are added in this column andreceipts subtracted.

2. Received: All receipts are posted here; there is no balance quantity

in this column.3. On hand: This balance figure represents the quantity of the item

that should be in the stock room. Receipts are added to this columnand issues subtracted.

4. Issued: A record of all quantities issued to the factory is entered inthis column.

5. Allocated: In this column are entered the quantities to be reservedfor later issue for specific order. Reserving of materials still in thisstock room will ensure their availability when they are needed onthe manufacturing floor.

6. Available: This is the quantity of material on hand that is stillavailable for assignment to future orders.

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There are four basic ways to price inventories foraccounting purposes:

1. First infirst out (FIFO): Under this procedure, all issuesare priced at the cost of the oldest lot until that lot is usedup. Then the price of the next oldest lot is used, and soon. In other words the first price into the inventory is thefirst price out of the inventory when issuing materials.

2. Last-in-first out (LIFO): under this procedure, all issuesare priced at the cost of the newest lot until that lot is

used up. Then the price of the next to newest lot is used,and so on. If, in the meantime, another lot comes in, theprice of this even newer lot is used when issuing materialuntil the entire quantity involved is issued, at which timethe price reverts to the next newest unused quantity.

Pricing Inventories

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3. Average value: Under this system, the values of issuesare computed by using the weighted average cost of thematerial in stock. As new material is received at slightlydifferent prices a new computation must be made as tothe weighted average cost of the total material on hand.

4. Standard costs: A standard cost is established for eachmaterial, and all disbursements are charged out at thisstandard value regardless of the price actually paid forthe material.

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The basic communication forms used in perpetualinventory control are:1. Purchase Requisition. This form is prepared by

inventory control when new quantities of material shouldbe ordered.

2. Shop order. This form is prepared by inventory controlwhen quantities of material need to be made by theshop for stock.

3. Receiving reports. These are the records of materialreceived by the stock room.

4. Stores requisition. This form authorizes the issuance ofany class of inventory material from a controlled storageto the shop. These requisition may be prepared by theproduction planner (as we well discuss underproduction control) or by foremen, supervisor, or other

authorized personnel.

Basic Communication Forms

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These are many commercial systems, such as Ditto, McCaskeyRegister, Remington Rand, International Business Machines, andothers too numerous to mention. Inventory records may be posted inledgers or on cards, with each entry made by hand.

Basic data of inventory transactions may be typed into a computerterminal and the many calculations or reports can be prepared by

computer; however the use of bar code and bar code scanners forpoint-of-transaction recording of data is fast becoming an acceptedway of collecting inventory data.

One can see this every day at grocery and department stores but itis also quite extensively used in industry. Bar codes, similar to thoseappearing on consumer goods, are seen in warehouses andproduction lines. Hand-held scanner/readers are interfaced with

personal computers and are quite flexible for inventory controlpurposes.

Inventory Control Records and Procedures

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We have discussed perpetual inventories at length. Again they areapplicable to what we have previously designated as high orintermediate value inventory items. It is still evident that suchprocedures as we have touched on briefly are costly. For thoseitems in which the cost of keeping such records cannot be justified,a bin control is usually adopted.

Bin Control

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Storerooms (or stock rooms) are areas in which material is held incontrolled storage. All material received in the area is counted andrecorded, none is issued without the proper stores requisition.Controlling materials in such a manner costs money in terms ofspace, personnel, and handling. These costs must be offset bybetter service to the factory and reduced loss of materials.

Storerooms

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A physical inventory is used to verify the balances shown on theperpetual inventory records and to obtain a correct count on allitems of inventory that may be on a bin control system. Physicalinventories may be taken in two different ways. Using the firstmethod, plans may be made for a complete shutdown ofmanufacturing activity.

Physical Inventories

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Thank You

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MM ZG511-L15