PRODUCTION AND OPERATIONS

MANAGEMENT

Chapter 23INVENTORY

MANAGEMENT

Meaning and Definition

The term inventory includes raw material, work-in-process, finished goods and stores and spares.

There are different kinds of inventories i.e production inventories, MRO inventories, in-process & finished goods inventory.

MRO inventories required for maintenance, repair and operating machinery.

Uses of Inventory

Inventory

•To satisfy the expected

customer demand (Anticipation

Inventory)

•To provide buffer between successive

operations (Decoupling Inventory

or Work-in-process Inventory)

•To protect against price increases and

to take advantage of

Quantity Discounts

•To satisfy periods of seasonal high demand (Seasonal Inventory)

•To avoid stock outs

(Safety Stock or Buffer

Stock)

•To minimize the total cost

by ordering the Economic

Order Quantity (Cycle

Stock)

•To act as a buffer between various elements of the

Supply-Chain (Suppliers-Producers-Distributors-Wholesalers-Retailers-Customers) (Pipeline or

Transit Stock)

Inventory Costs

Inventory costs includes ordering cost plus carrying costs.

1. Ordering Costs

2. Carrying Costs– Opportunity Costs

Opportunity cost is the loss of interest on money invested in inventory building and inventory control equipment.– Storage Space Costs

– Inventory Service Costs

– Handling-equipment Costs

– Inventory Risk Costs

3. Out-of-stock Costs

4. Capacity Costs

Inventory Management and Control

Inventory management involves administration, policies and procedures to reduce in inventory cost.

Factors Influencing Inventory Management and Control Type of Product Type of Manufacture Volume of Production Other factors

Benefits of Inventory Management and Control

1. Adequate supply of materials and stores

2. Low investment in inventories

3. Benefits of purchasing economies

4. No duplication in ordering

5. Better utilization of available stocks

6. Low loss of materials through carelessness or pilferage

7. Better cost accounting

8. Cost comparison

9. Disposal of obsolete items

10. Data for financial statements

Process of Inventory Management and Control

Step 1. Determination of optimum inventory levels and procedures of their review and adjustment.

Step 2. Determination of the degree of control that is required for the best results.

Step 3. Planning and design of the inventory control system.

Step 4. Planning of the inventory control organisation.

Fixed order quantity system or ‘Q’ system

• A fixed quantity of material is ordered whenever the stock on hand reaches the reorder point.

• The fixed quantity of material ordered each time is nothing but the economic order quantity (EOQ).

Operation of Fixed Order Quantity System

Total Annual Inventory Cost with EOQ Model

Total annual cost= annual ordering cost + annual holding costs

H

2DSQ and H;

2

QS

Q

DTCQ

Continuous (Q) Review System Example: A computer company has annual demand of 10,000. They want to determine EOQ for circuit boards which have an annual holding cost (H) of $6 per unit, and an ordering cost (S) of $75. They want to calculate TC and the reorder point (R) if the purchasing lead time is 5 days.

EOQ (Q)

Reorder Point (R)

Total Inventory Cost (TC)

units 500$6

$75*10,000*2

H

2DSQ

units 200days 5*days 250

10,000Time Leadx Demand DailyR

$3000$1500$1500$62

500$75

500

10,000TC

Advantages of ‘Q’ system

• Each material can be procured in the most economical quantity.

• Purchasing and inventory control personnel automatically devote attention to the items that are needed only when required.

• Positive control can easily be exerted to maintain total inventory investment at the desired level simply by manipulating the planned maximum and minimum value.

Disadvantages of ‘Q’ system• The orders are raised at regular interval which might not

be convenient for the supplier.

• In case the lead time is very high, say three months, and the ordering quantity happens to be material supplies for one month, there would be two or three pending orders with the supplier each time.

• The items can not be grouped and ordered at a time since the reorder points occur irregularly.

• EOQ may give you an order quantity which is much below the supplier minimum (for a good discount)

• Further, the system assumes stable usage and definite lead time.

Fixed-order Period System or ‘P’ system

• The stock position of each item of material is regularly reviewed.

• When the stock level of a given item is not sufficient to sustain the production operation until the next scheduled review, an order is placed replenishing the supply.

• The frequency of reviews varies from firm to firm.

Periodic Review System

Advantages of ‘P’ System

• The ordering and inventory costs are low. The ordering cost is considerably reduced though follow up work for each delivery may be necessary.

• The suppliers will also offer attractive discounts as sales are guaranteed.

• The system works well for materials which exhibit an irregular or seasonal usage and whose purchases must be planned in advance on the basis of sales estimates.

Disadvantages• It compels a periodic review of all items, this

in itself makes the system somewhat inefficient. – Usage patterns might change in between,

• Replenishment quantities (Q) vary

• Order quantities may not quality for quantity discounts

• On the average, inventory levels will be higher than Q systems-more stockroom space needed

Some more mathematics• (Max safety stock without taking any risk of

stock out) = (normal consumption rate) X (maximum extension of lead time).

• Safety stock with some risk of stock out = normal consumption rate X max extension of lead time X cumulative probability of that extension of lead time.

• Buffer stock = normal consumption rate X normal lead time

Distinction between ‘Q’ System and ‘P’ System

Inventory Control Techniques

1. Always better control (ABC) classification.2. High, medium and low (HML) classification.3. Vital, essential and desirable (VED)

classification.4. Scarce, difficult and easy to obtain (SDE).5. Fast moving, slow moving and non-moving

(FSN).6. Economic order quantity (EOQ).7. XYZ Analysis

ABC Classification• ABC classification is a method for determining

level of control and frequency of review of inventory items

• A Pareto analysis can be done to segment items into value categories depending on annual dollar volume

• A Items – typically 20% of the items accounting for 80% of the inventory value-use Q system

• B Items – typically an additional 30% of the items accounting for 15% of the inventory value-use Q or P

• C Items – Typically the remaining 50% of the items accounting for only 5% of the inventory value-use P.

The AAU Corp. is considering doing an ABC analysis on its entire inventory but has decided to test the technique on a small sample of 15 of its SKU’s. The annual usage and unit cost of each item is shown below

(A) First calculate the annual dollar volume for each item

B) List the items in descending order based on annual dollar volume. (C) Calculate the cumulative annual dollar volume as a percentage of total dollars. (D) Classify the items into groups

Graphical solution: the ABC classification of materials

• The A items (106 and 110) account for 60.5% of the value and 13.3% of the items

• The B items (115,105,111,and 104) account for 25% of the value and 26.7% of the items

• The C items make up the last 14.5% of the value and 60% of the items

• How might you control each item classification? Different ordering rules for each?