Inventory Management

Inventory Management and Control

Image courtesy: http://www.keepcalm-o-matic.co.uk/p/in-god-we-trust-all-others-to-pay-cash/ Working Capital ManagementWhy Inventory Management?Conflicting views w.r.t. appropriate inventory level:Finance: less costsProduction: higher stock of raw materialsMarketing: higher stock of finished productsPurchasing/Stores: minimum no. of ordersOur job: to reconcile themEffective cash managementMinimum costs high inventory turnover optimal level of stock no effect on production and sales demand Twin ObjectivesTo minimize investment in inventory, andTo meet demand for the product(s)Efficient organization of production and sales operationsHow: CBACosts-Benefits Analysis: Trade-offSmaller the inventory, lower the costs;Higher the inventory, smoother the operations.

CostsBenefitsOrdering/acquisition costsCarrying costsArising due to inventory storageOpportunity costs of funds

Uninterrupted and independent operation:PurchasingProductionSelling

Long-term vs. Short-termLong-term goal:Purchase and production processes should depend on sales.

Short-term goal:The processes should be independent, almost!

Examples:Seasonal production vs. level production issue in Toy World, Inc.Oswal Knitwears: Production and sales of woolen clothes; highly seasonal.Issues in Inventory ManagementsDetermination of control requiredClassification problem: ABC SystemThe order quantity problemEconomic Order Quantity (EOQ),The order point problemRe-order level,Safety stocksInventory Control: ABC SystemInventory divided into three categoriesBased on rupee investment in eachCaution: An inexpensive item may be critical for production process.

ABCThe costliest itemsSlowest turningHighest controlMost sophisticated techniquesLeast wastageModerate investmentsManageable controlLittle wastage affordableThe least expensive itemsLarge no. of itemsMinimum attention

ABC System

Illustrative Example 1: ABC AnalysisMooca Furniture has 7 different items in its inventory as follows (average number of each items with their respective unit costs). The firm wishes to implement ABC system of inventory management.

ItemAvg. No. of UnitsAvg. Cost/Unit (Rs.)120,00060.80210,000102.40332,00011.00428,00010.28560,0003.40630,0003.00720,0001.30ABC AnalysisItemUnits% of totalUnit costTotal cost (Rs.)% of total(1)(2)(3)(4)(2) X (4) = (5)(6)120,0001060.8012,16,00038.00210,0005102.4010,24,00032.00332,0001611.003,52,00011.00428,0001410.282,88,0009.00560,000303.402,04,0006.38630,000153.0090,0002.80720,000101.3026,0000.82Total2,00,00010032,00,000100.00153055702010EOQ: How Much to Order?The optimal order quantity for a particular item of inventory, given its forecast usage, ordering cost, and carrying cost.Ordering costs: requisitioning, order placing, transportation, receiving, inspecting and storing, administration (constant).Carrying costs: warehousing, handling, clerical and staff, insurance, depreciation and obsolescence (varying).Ordering can mean either the purchase of the item or its production.

EOQWhere,O: ordering costs per order,S: total usage (in units) of an item of inventoryC: carrying costs per unit

EOQ: DerivationIf usage of an inventory item is at a steady rate over a period of time and there is no safety stock, average inventory (in units) can be expressed as:Average inventory = Q/2 Total inventory costs are the sum of the total carrying costs plus total ordering costs:Total inventory cost (T ) = C(Q/2) + O(S/Q) Taking the first derivative of above equation with respect to Q and setting the result equal to zero, we obtain: dT/dQ = (C/2) O(S/Q2) = 0 Now, solving for Q, we get O(S/Q2) = C/2Q = 2(O)(S)/C = Q*EOQ: AssumptionsAnnual consumption of an item known with certainty,The rate of usage of an inventory steady over time,The order placed to replenish the stocks received at exactly that point in time when inventory = 0.Ordering and carrying costs constant.EOQ

Illustrative Example 2: EOQThe usage of an inventory item is 2,000 during a 100-day planning period, ordering costs are $100 per order, and carrying costs are $10 per unit per 100 days.The EOQ amount, then, is: ??EOQ = 200 unitsWith an order quantity of 200 units, the firm would order (2,000/200) = 10 times during the period under consideration or, in other words, every 10 days.

Illustrative Example 3: EOQA firms inventory planning period is one year. Its inventory requirement for the period is 1,600 units. Assume that its acquisition costs are Rs. 50 per order. The carrying costs are expected to be Re. 1 per unit per year for an item.The firm can produce inventories in various lots as follows:1,600 units800 units400 units200 units100 unitsWhich of these order quantities is the EOQ?(1)(2)(3)(4)(5)(6)Size of order (units)1,600800400200100No. of orders124816Cost per order (Rs.)5050505050Total ordering costs (Rs.)50100200400800Carrying cost per unit (Rs.)11111Avg. inventory (Units)80040020010050Total carrying costs (Rs.)80040020010050Total costs (Rs)850500400500850Illustrative Example 4: EOQVostick Filter Company is a distributor of air filters to retail stores. It buys its filters from several manufacturers. Filters are ordered in lot sizes of 1,000, and each order costs $40 to place. Demand from retail stores is 20,000 filters per month, and carrying cost is $0.10 a filter per month. What is the optimal order quantity with respect to so many lot sizes (that is, what multiple of 1,000 units should be ordered)? What would be the optimal order quantity if the carrying cost were cut in half to $0.05 a filter per month? What would be the optimal order quantity if ordering costs were reduced to $10 per order?

Inference: Illus. Ex. 4The lower the carrying costs, the more important ordering costs become relatively, the larger the optimal order size;The lower the ordering size, the more important carrying costs become relatively, the smaller the optimal order size.Illustrative Example 5: EOQA college bookstore is attempting to determine the optimal order quantity for a popular book on psychology. The store sells 5,000 copies of this book a year at a retail price of $12.50, and the cost to the store is 20 percent less, which represents the discount from the publisher. The store figures that it costs $1 per year to carry a book in inventory and $100 to prepare an order for new books.Determine the total inventory costs associated with ordering 1, 2, 5, 10, and 20 times a year. Determine the economic order quantity.

Illustrative Example 6: EOQThe Hedge Corporation manufactures only one product: planks. The single raw material used in making planks is the dint. For each plank manufactured, 12 dints are required. Assume that the company manufactures 150,000 planks per year, that demand for planks is perfectly steady throughout the year, that it costs $200 each time dints are ordered, and that carrying costs are $8 per dint per year.Determine the economic order quantity of dints.What are total inventory costs for Hedge (total carrying costs plus total ordering costs)?How many times per year would inventory be ordered?Order Point: When to Order?In addition to knowing how much to order, the firm also needs to know when to order.The quantity to which inventory must fall in order to signal a reorder of the EOQ amount Earlier assumed that inventory can be ordered and received without delay.Time lapse between placement of a purchase order and receipt of the inventory, or in the time it takes to manufacture an item after an order is placed.This lead time must be considered.

Re-order Point: CertaintyOrder point (OP) = Lead time Daily usage

EOQ: 200 unitsOrder frequency: 10 daysLead time: 0 day (assumed)Daily usage: 20 unitsNow, revise the assumption that 5 day lead period is required before it runs out of stock:The Order Point = 5 days x 20 units = 100 unitsOrder PointUnits200Days1020EOQ1005Lead timeRe-order Point: UncertaintyReorder point = (Lead time x average usage) + safety stock

Other Inventory Control SystemJust-in-Time (JIT) SystemsOut-sourcingIT/ITeS firms providing inventory management servicesComputerized Inventory Control SystemSophisticated software, e.g. PosMaid, inFlow, BS1Help run lean operationsStrengthen vendor relationshipForecast with confidence Timely information and insightsInventory Management: AnalysisEstimation of incremental operating profitEstimation of incremental investment in inventoryEstimation of the incremental rate of return (IRR)Comparison of the incremental rate of return with the required rate of return (RRR)Optimum inventory:IRR = RRRInventory Management: ProcessExplicitly state the inventory policyCreate an inventory monitoring cellManagement group for controlling purchasesPeriodic meetings between purchase, materials planning and production executivesMonthly reviews of total inventory at plant/corporate levelDovetail inventory control to the total budgeting systemIdentify critical inventory items for closer scrutiny

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