Prof.

Suhas Rane
[email protected]

Acknowledgement :
1. APICS literature, and 2. Book authored by Simchi-Levi & Kaminsky

Confusing Statements
Inventory is an asset
Inventory is a liability

Inventory takes Inventory blocks care of Rainy days working capital

Inventory is a double-edged sword Inventory is a WASTE

What exactly is INVENTORY ???

Contents
Introduction, Definition, Conflicting Interests Average Inventory, Inventory Related Costs, Inventory Turns EOQ , EBQ How much to order ? SS, ROP / ROQ What to control in Inventory Costs ? When to place Orders ? P & Q Methods of Ordering, MRP Selective Inventory Control methods : ABC, VED etc. Supply Contract terms, Risk Pooling Concept Numerical Problems

What Is Inventory?
APICS Dictionary : Those stocks or items used to support production,supporting activities, and customer service Inventory is the blocked working capital of an organization in the form of materials. Since blocked it should theoretically be zero, although it is impossible to do so.

Inventory and the Flow of Materials

Demand vs. Supply

INVENTORY CAPACITY

DEMAND

Opposing Views of Inventory

Why Do We Want to Hold Inventory?

Why Do We Not Want to Hold Inventory?

Inventory : CONFLICTING INTERESTS

OPERATIONS Viewpoint : STOCK MAINTAINED for OPERATIONAL CONVENIENCE Definition from FINANCE: MONEY LOCKED IN IDLE RESOURCES

AIM OF INV. Controller : TO PROVIDE OPERATIONAL CONVENIENCE WITH MINIMUM POSSIBLE INVESTMENT IN INVENTORY
HOW? : by EXERCISING A SELECTIVE INVENTORY CONTROL METHODs and APPLICATIONS OF INV. CONTROL TECHNIQUES (ABC, VED )

Accounting Systems
Accounting systems classify activities of a company into five types of accounts.
Assets Liabilities Owners equity Revenues Expenses Balance sheet accounts

Income statement accounts

Inventory Management
To establish decision rules about individual inventory items: Importance of inventory items How they are to be controlled

Two Fundamental Inventory Decisions

How much to order ? When to order ?

PUSH Approach to meet the demand

MRP
R.M M/C 1

Sales Forecast

Prod. Plan
M/C 2

Actual Sale
F.G

R.M Bin/ Store

WIP BIN

F.G BIN/ Warehouse

Traditional PUSH Approach

PULL Approaches to meet the demand

(JIT way)

R.M

M/C 1

M/C 2

M/C 2

F.G

Vendor

Our Factory

Customer

KANBAN SYSTEM

Why Do We Want to Hold Inventory ?

1. Unexpected changes in Customer demand 2. To improve customer service 3. Economy of scale (Production Lot Size , Transportation) 4. Lead times uncertainty 5. Hedging , Hoarding

Why We Do Not Want to Hold Inventory ?

To reduce certain costs, such as

- Carrying costs - Diluted return on investment

Inventory Mgmt : Trade-off Decision

Cost of Carrying Inventory
Cost of capital Storage area Depreciation Stores personnel Obsolescence / deterioration /wastages Insurance Transport/ handling

Cost of NOT Carrying Inventory

Back order cost Lost sales God will cost

Inventory
Inventory: a stock or store of goods
Independent Demand A Dependent Demand

B(4)

C(2)

D(2)

E(1)

D(3)

F(2)

Independent demand is uncertain. Dependent demand is certain.

12-16

Dependent & Independent Demand Inv. Systems

Dependent Demand Items whose demand depends on the demands for other items e.g. R M & Components demand depends on the demand for FG Independent Demand Demand for an item is independent of the demand for any other item in inventory e.g. F G inventory Demands are estimated from forecasts or customer orders Therefore the systems used to manage these inventories are different

Types of Inventory
Raw material Wip FF Goods Distribution inventory transit Spares M.R.O. Tools/Tooling Capital equipment

Why Average Inventory ?

400
Units in Stock 200 Q

4 Time (Weeks)

Weekly demand = 100 units;

Average inventory =

Order Qty. = 400 units/ month

Order quantity 400 = = 200 units 2 2

This means that: Though your Actual Stock keeps varying, from 400 (on 1st) to Zero (on 30th), on an average you are holding 200 Pcs any day for the ICC calculation purpose

Inventory Turns
A measure of how effectively inventory is being used

Annual cost of goods sold Inventory turns Average inventory in Rs.

e.g.Annual cost of goods sold = Rs. 10 L Average inventory = Rs. 1 L

1,000,000 Inventory turns 10 100,000

Inventory Analysis
2009-10 RM & Pkg Inventory WIP Inv. F G Inv. Stores & Spares Inv. Material Consumed Cost of Goods Mfr. Net Sale 49.19 14.65 10.26 5.65 Inv. % Inv days 2008-09 38.94 12.91 10 12.91 Inv. % Inv days

517 620 697

392 450 520

Stores & Spares Consumed

10.82

9.20

Inventory Analysis
2009-10 RM & Pkg Inventory WIP Inv. F G Inv. Stores & Spares Inv. Material Consumed Cost of Goods Mfr. Net Sale 49.19 14.65 10.26 5.65 Inv. % 9.4 % 2.3 % 1.5 % 52 % Inv days 28 days stock 7 days 4.4 days Sales 6 months 2008-09 38.94 12.91 10 12.91 Inv. % 10 % 2.9 % 1.9 % 140 % Inv days 30 days 8.6 days 5.8 days 16 Mths

517 620 697

392 450 520

Stores & Spares Consumed

10.82

9.20

Inventory Related Costs

Item (Material) costs Carrying costs Ordering costs Stock-out costs

Inventory Related Costs

Item Cost Direct material, direct labor, factory O/H, Transportation, Customs duties,

Carrying costs
1. Cost of Capital : Interest pd on tied up capital : 12-15 % 2. Storage costs : Space, personnel, and equipment 13% 3. Risk costs : Obsolescence, damage, pilferage 1 -3% 4. Insurance 2- 4% ICC or Holding Cost : 20 -35 %

Ordering Costs - P O Paper-Work cost / Follow-up, Visits, Calls

Set-up costs, Inspection, Receiving, Sorting, Dispatch etc. Portion of Sal & Wages, Exp. used for procurement process Ordering Cost per PO = Total Cost incurred / Total POs released

Stock-out Costs : Back-order costs, Lost sales costs, Lost customer costs

Economic Order Quantity

If you consume an item on regular basis, - At what rate you should procure it - How frequent? What periodicity ? - What quantity ? So that - you are incurring minimum a. Ordering Cost b. Inventory Carrying Cost.

EOQ
Whats that ? Why do we need it ?

Ex.1 : Ordering Problem, EOQ

An item is consumed @ 10,000 pieces per year. (M) The other details are - Unit Price: Re 1 (s) ICC = 30% per year Ordering Cost (Co) = Rs 60 per order. 1. Considering various possibilities of order quantities at a time

(e.g. 10000, 5000, 2000, 1000, 500),

work out - Ordering charges, Inv. Carrying Charges and Total Cost. 2. On a graph paper, plot graphs of Ordering charges, Inv. Carrying cost and Total cost against each other. 3. Find out EOQ from the graph. 4. Find EOQ from formulae and tally with No. 3 above.

Ordering Problem
Annual Demand = M = 10,000 pieces Unit Rate = s = Re 1 ICC = 30% per year = Ordering Cost (Co) = Rs 60 per order. Order Quantity No of Orders Ordering per Yr. Charges Average Inventory 0.30

Carrying Total Cost Cost (ICC)

500 1000 2000

4000
5000 10000

Ordering Problem
Annual Demand = M = 10,000 pieces Unit Rate = s = Re 1 ICC = 30% per year = Ordering Cost (Co) = Rs 60 per order. Order Quantity No of Orders Ordering per Yr. Charges Average Inventory 0.30

Carrying Total Cost Cost (ICC)

500 1000 2000

20 10 5

1200 600 300

250 500 1000

75 150 300

1275 750 600

4000
5000 10000

2.5
2 1

150
120 60

2000
2500 5000

600
750 1500

750
870 1560

Ord. Qty.

No of Ordrg POs per Charg Yr. es

Av. Inv

Carryi ng Cost (ICC) E= D X 0.3

Total Cost

B= C=B X 10000/A 600

D= (A+0)/ 2

F=C +E

500
1000 2000 4000 5000 10 K

20
10 5 2.5 2 1

1200
600 300 150 120 60

250
500 1000 2000 2500 5000

75
150 300 600 750 1500

1275
750 600 750 870 1560

Minimum Total Cost

The total cost curve reaches its minimum where the carrying and ordering costs are equal. Q 2
Total cost

=
Annual carrying cost Q 2 H

D Q

S
+ Annual ordering cost D Q O

=
TC =

12-31

EOQ Formula
EOQ =
Where
A S i C = = = = Annual usage in units no. Ordering cost in Rs. / order Annual inventory carrying cost as a decimal Unit cost (Rs./ pc)

2AS iC

Or

Cost of Not Operating Scientifically

Problem
Solution
A Co. placed 6 orders/ yr. each of Presently with 6 orders : 200 units. OC = 6 x 600 = 3600; Given Ordg Cost = Rs 600 / ord. ICC = 200/2 X 40 X .4 = 1600 Unit Cost = Rs 40, Mat Cost = 1200 X 40 = 48000 Thus, Total Cost = 53200 Holding Cost = 40% of Unit cost . Ideally EOQ = 300 X 4 ord/ yr 1. Find out loss to the Co. in not Hence OC = 600 X 4 = 2400; operating scientific inventory policy. ICC = 300/2 X 40 X .4 = 2400; Mat Cost = 48000 ; 2. What is your recommendation for EOQ & No of orders / yr ? Thus Ideal Total Cost = 52800 3. How much would they save/yr ? Loss = Rs 400

Sensitivity of EOQ Curve

EOQ curve is flat at bottom This means

Even if you alter the EOQ slightly ( + or -- ),

the difference in the total charges

will not be very high

EOQ Curve Sensitivity

E Variation +100 -50% -20% -10% O +10% +20% +50% in EOQ % Q

Increase in 25 % 2.5% 0.5% cost

0 0.4 % 1.6 % 8.0 % 25 %

How Much to Order at One Time ?

Management wants to Minimize sum of all costs involved Maximize customer service

Methods of deciding how much to order at one time: 1. Lot-for-lot 2. Fixed order quantity 3. EOQ

1. Lot-for-Lot
Only required amount is ordered No unused lot-size inventory is created This is used For dependent demand items For expensive components (A items) In a Just-in-Time (JIT) environment

2. Fixed-Order Quantity
Specific (pre-decided) Fixed Qty. is ordered each time

Quick and simple

On the basis of what seems reasonable Does not always produce the best results

3. Economic Order Quantity

A = 1,000 units S = $ 20 per order i = 20% = 0.2 C = $5 per unit Find EOQ = ???

Demand per year Ordering Cost ICC Unit Rate

2 x 1,000 units x $20 EOQ = = 200 units 0.2 x $5

What to control in Inventory Costs ?

E OQ = 2AS iC

A = Annual usage in Units / Nos.

S = Ordering Costs (Rs/ order)

i =
C =

Inventory Carrying Cost

Unit Cost (Rs/ Unit)

EOQ Assumptions Assumes that

Demand is relatively constant and known Order preparation costs and inventory carrying costs are constant ( all through period) and known

Replacement occurs all at once (instantaneous)

Whereas the market functions independently.

Hence EOQ is hardly workable in practice. More practical in use is MRP systems

When to Place an Order ?

Late PO possibility of a stock-out Early PO extra inventory and cost The system is needed to trigger when to order

The Inventory Cycle

Q
Quantity on hand

Profile of Inventory Level Over Time

Usage rate

Reorder Level.

Receive order

Reorder Receive Time order

Reorder Receive Time order

Time

Re-Order Point

Lead time

Re-Order Point System (with SS)

Quantity

ROQ SS
LT

Re-Order Level = demand during lead time + safety stock

ROL = DDLT + SS
J. R. Tony Arnold, Introduction to Materials Management, Prentice-Hall.

Safety Stock
Purpose of SS to prevent a stock-out during L SS Qty. depends on
Demand Variability during the lead time Frequency of ordering Desired service level Length of the lead time
SS = Z x STD x L = (Safety factor ) x Std Devn. x Sq Rt. (Lead Time)

At 90 % Service Level, Z (90%) = 1.285, Z (92%) = 1.41, Z ( 95%) =1.65, Z ( 99%) = 2.33

Re-Order Point System (with SS)

Quantity

ROQ SS
LT

Re-Order Level = demand during lead time + safety stock

ROL

DDLT + SS

3 Methods of Ordering
1. Cyclical Ordering (Period Based)
Periodic Review System

P System

Inventory position is reviewed at a fixed interval say 25th of every month. 2. Fixed Order System (Quantity Based) Q System
Perpetual Inventory Record

Continuous review. Order : Pre-Fixed Qty., when the stock level drops to ROP

3. MRP System

Periodic Review System

Used where ? :
There are too many small items (low cost) and posting transactions is expensive Many different items are ordered from one source Ordering costs to be controlled

Perpetual Inventory Record

426254 Screw Part No. On Date Order Received 01 02 03 500 500 04 05 500 Issued Order quantity = 500 units Re-Order point = 100 units On Hand Allocated Available 500 500 400 500 100 400 500 100 100 0 100 600 600

400

3 Methods of Ordering ( Review )

Cyclical Ordering (Time Based) Periodic Review System Inventory position is reviewed at a fixed interval say 25th of every month. Fixed Order System (Quantity Based) Perpetual Inventory Record Continuous review. Fixed qty. placed, when the stock level drops to ROP point. Two Bin Three Bin

MRP System
BOM Prepared Master Production Schedule Individual Item Schedule Computerized- MRP I, MRP II

Economic Run Size or Economic Batch Quantity (EBQ)

Q0

2DS H

p p u

Where
12-51

p = Production Rate
u = Consumption Rate

Economic Production Quantity (EPQ)

Assumptions : Production done in batches or lots Capacity to produce > Usage or Demand rate Assumptions of EPQ are similar to EOQ except orders are received incrementally during production Annual demand is known Usage rate is constant & Usage occurs continually Production rate is constant Lead time does not vary
12-52

Inventory Classifications and Selective Inventory Control

Selective Inventory Control Techniques

Criteria
CONSUMPTION RATE CRITICALITY AVAILABILITY SEASONALITY CREDIT SITUATION WIP FOR LINE BALANCING LEAD TIME COST

Classifications
ABC XYZ VED FSN GOLF SDE JIT

Selective Inventory Control Methods

SI. Type of Control No.
1. A. B. C. (Always better control or Paretos Law)

Criteria
Value of consumption. (It has nothing to do with unit rate of the items)

Main use
To control R Ms, Comp. & WIPs

2. H. M. L. (High, Medium, Low)

To control Purchase Rates, Pilferage in Storage (This is opposite of ABC and does not take consumption into account Critically of the item)
Criticality Criteria To determine the stocking levels of Parts, from Production criticality view. Lead time Analysis and Review.

Unit price of the materials

3. V. E. D. / VEIN (Vital, Essential & Desirable. Imp & Normal) 4. S. D. E. (Scarce, Difficult and Easy to obtain)

Purchasing problems in regard to availability

Selective Inventory Control Methods

SI. Type of Control No. 5. G. O. L. F. (Government, Open market, Local and Foreign Source) F. S. N. (Fast Moving, Slow Moving, Non Moving) S. O. S. (Seasonal and Off-Seasonal) Criteria Source of supply of Materials Main use to determine SS Levels

6.

Consumption pattern of the component. (Movement Analysis) Nature of supplies, and seasonality.

To design Stores Layout, To control obsolescence. Procurement and Holding Strategies for seasonal items like Agro. Products. To review High Value inventories and their uses at scheduled intervals.

7.

8.

X. Y. Z.

Inventory value of items in store, as on 31 March

ABC Analysis:

Nos. Of Items High Consumption Items Medium Consumption Items Low Consumption Items Total Items 40 10%

Purchase Value Category 470 Cr 70% A

80

20%

134 Cr

20%

280

70%

68 Cr

10%

400

100% 672 Cr 100%

A B C Graph
100

%By value

C 5-10% 10-20% 70-80%

0 % By units

100

ABC Steps:
1. For each item, find the issue/consumption value ( not purchase rate). 2. Sort this item in descending sequence.

3. Starting from top, compute running total of consumption value.

Normally, it shows: 5 - 10% of top items account for 70% of total consumption. 20% of consumption.

Next 15% to 20% items,

Remaining 70 - 80% items - only 10% of consumption

Actions to be taken
A items
1.

B items
Moderate value

C items
Low value

High consumption

2. Very strict control

3. Nil Safety Stock 4. Daily Deliveries 5. Multi-sources 6. Accurate forecasts 7. Central storage/ 8. Max. Cost control

Medium control
Low safety stocks Weekly/ Monthly Few sources Estimates Storage in each plant Minimum efforts

Loose control
High safety st. Bulk/ Quarterly Max.- 2 sources Guestimmates Site storage No efforts for.

VED Analysis
This method can be better suited for stocking critical item from production or maintenance view V Items of vital importance, E Items of essential importance, D Items of desirable importance. Vital - Indicating that production stops without V Item. Essential - Production (or Maintenance) can be saved, but by compromising some parameters as such efficiency, noise reduction etc. Desirable- Production can be managed without them Or M/c can run but factor of safety, industrial formalities cant be satisfied (e.g. - wearing ear protection aid) Factors to be reckoned for giving weightage during VED classification 1. Effect on Production : can it stop the work ? 2. Lead Time of Supply 3. Availability : Standard ready item or Customized design ? 4. Source of Supply : Local, Outstation, or Import

Ex. 6 - Buying with Discount

A toy shop buys from a toy manufacturer, and sells annually 5000 pcs. of a toy-car model. For a new model, the manufacturer has offered a bulk purchase discount scheme as given below.
Order Quantity 1-999 1000-1999 2000 and above Price per toy car5.00 4.80 4.60

The ordering cost is Rs. 49 per order. The inventory carrying

cost per year is estimated to be 20%.

Suggest what is the best order quantity to be selected by the shop-keeper, based on his over-all cost for the year.

Work-sheet
Price Rs. Ideal EOQ Nearest Possible EOQ Ordering Cost Inv. Carrying Cost Material Cost Total Cost for the whole year

Rs 5 each

700

700

(5000 / 700) x 49 = 350 (5000 / 1000) x 49 = 245 (5000 / 2000) x 49 = 122.50

700 x 0.5 x 5 5000 x 5 25700 x 2 % = 350 = 25000 1000 x 0.5 x 4.80 x 0.2 = .. 2000 x .5 x 4.6 x 0.2 = .. 5000 x 4.8 = . 5000 x 4.6 =23000

Rs 4.80 715 each

1000

Rs 4.60 730 each

2000

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