INVENTORY MANAGEMENT

APARNA LAKSHMANAN S2,MBA Bhavan’s Royal Institute of Management

INVENTORY 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.

INTRODUCTION Constitute significant part of current assets. A considerable amount of fund is required On an average approximately 60% of current

assets in Public Limited Companies in India. 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.

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.

REASONS TO HOLD INVENTORY 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 quality discounts

Process &supply surprises Internal-upsets in parts of our own processes External –delays in incoming goods

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 the right time with right source to acquire the right quantity at the right price and right quality.

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.

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 costs:- Loss of sale Failure to meet delivery commitments.

Carrying costs:- Warehousing or storage Handling Clerical and staff Insurance Interest Taxes Cost of capital

DANGERS OF OVER INVESTMENT

Unnecessary tie-up of firm’s 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.

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.

FUNCTIONS OF INVENTORY MANAGEMENT

Track inventory How much to order When to order

CLASSIFICATION OF INVENTORY

ABC Classification HML Classification XYZ Classification VED Classification FSN Classification SDF Classification GOLF Classification SOS Classification

ABC CLASSIFICATION

In most of the cases 10 to 20% of the inventory account for70 to 80% of the annual activity.

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

B-15% of items select 15% of annual rupees C-70% accounts only 5% usage

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.

HML CLASSIFICATION On the basis of unit value of firm There is 1000 unit of q at Rs.10 and 10,000

units of w at Rs.5 Aimed to control the purchase of

rawmaterials H-high M-medium L-low

VED CLASSIFICATION Mainly for spare parts because their

consumption pattern is different from raw materials.

Spare parts on performance of plant and machinery.

V-vital E-essential D-desirable Therefore V items has to be stocked ore and

D items has to be less stocked.

FSN CLASSIFICATION

According to the consumption pattern To comat obsolete items F-Fast moving S-Slow moving N-Non moving

SDF &GOLF CLASSIFICATION SDF

Based on source of procurement S-scarce D-Difficult E-easy

GOLF G-Government O-Ordinary L-Local F-Foreign

SOS CLASSIFICATION

Raw materials especially for agriculture units S-Seasonal OS-Off seasonal

DECIDING ON THE INVENTORY MODEL

Assume an analyst applies an inventory model that does not allow for spoilage to a grocery chain’s 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 obviously 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.

DIFFERENT APPROACHES

Certainty approach Uncertain variables and risk are addressed

separately. Uncertainty approach

Uncertain variables and risk are addressed simultaneously

Deterministic approach Probabilistic approach

BASIC EOQ MODEL

Assumption Seasonal fluctuation in demand are ruked 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

EOQ- THREE APPROACHES

Trial and error method Order-formula approach Graphical approach

EOQ- RE-ORDER POINT

EOQ- Gives answer to question “How much to order”

Re-order point – gives answer to question “When to order”

ORDER FORMULA APPROACH

ECONOMIC ORDER QUANTITY,1/2

EOQ=(2CO/I) C=Annual demand O=ordering cost per order I=Carrying cost per unit

GRAPHICAL METHOD TO FIND EOQ

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

EXTENSION OF BASIC EOQ MODELNon –zero lead time

If the lead time is ‘n’ then procurement must be done prior to ‘n’ dayside T-n as shown in the figure

PROBABILISTIC INVENTORY MODEL

In practical inventory management assumptions 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.

SPECIAL INVENTORY MODEL

Non – instantaneous replenishment

Quantity Discount

One – period decision

NON – INSTANTANEOUS REPLENISHMENT

Particularly in situation were manufactures use continues production process

Eg; FACT makes Ammonium on a continual basis.

DISCOUNT QUANTITIES

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

Hence a new approach is needed to find the best lot size

Total cost = Annual holding cost +Annual ordering cost+ Annual cost of materials

ONE PERIOD DECISIONS

Applicable to fashion goods, seasonal goods and due to change in technology

INVENTORY MANAGEMENT UNDER UNCERTAINITY

Option price model Risk adjusted discount cash flow (DFC)

model. Dynamic inventory model.

EMERGING TRENDS IN INVENTORY MANAGEMENT

Entering into long term contract at a fixed price to reduce uncertainties.

Just in time Kanbans- Japanese technique (only produce

when demand comes) Internet based ordering system Vendor development Investment in plant and machinery

INVENTORY CONTROL RESPONSIBILITY Purchasing naturally has vest interest in

inventories, even to the extend that in some companies the purchasing and stores functions.

In effect the responsibility cannot be kept on one head since inventory management is a integrated effort.

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.