INVENTORY MANAGEMENT,LEAN AND FINANCE

John Carrico

What is inventory?

Inventory is anything that is purchased and held (stored) prior to use/need

product on-hand, current asset that has been acquired by cash (or payables) and is yet to be consumed

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Inventory Distribution Management

Physical inventory is the actual counting of supplies and comparing the amount on hand with the amount on the financial statement

Inventory can be counted two ways: Periodic counting

Done at regular intervals (usually 6 or 12 months)

Cycle counting Continuously selecting subgroups to count Typically 10% of stock per month May be critical or volatile items

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Inventory Distribution Management

Inventory control should: Provide monetary savings Improve service levels Improve internal operations Review supply utilization Reduce waste Fully utilize MMIS capabilities

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Inventory Distribution Management

Inventory Valuation Last in, First out (LIFO)

Cost is defined as the newest (most recently received) item is used to define product cost.

First in, First out (FIFO) Cost is defined as the oldest item in the inventory

(conservative, understates the inventory) Average costing inventory

Method where a weighted average cost is computed.

Your valuation methodology may be the source of your never being “right on” at inventory count time

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Types of Inventory

Official- On the Hospital financial books as an ASSET.

PerpetualAlways reflects actual on-hand quantity-computer

Periodic Periodically updated based on a count

Unofficial- Already expensed.

Consignment Housed in the facility, owned by the vendor, purchased when used. Is not included in inventory turn calculations.

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Inventory Ground Rules

Impact of Consignment on our performance Consignment stock is not counted as our inventory

and is not included in turns. The more items you consign, the higher your

expected level of performance (turns) of your owned inventory.

However, while you do not retain ownership of the product, you are still responsible for the loss or damage-how many of you have letters of understanding with your vendors?

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Managing Inventory

Why Manage Inventories?

Reduce Costs-carrying costs

Free Up Space

Have Supplies Available

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Managing Inventory

Controlling Inventory

Techniques you can use to monitor and reduce inventories

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Inventory Distribution Management

Successful Inventory Control is achieving balance between stock on-hand and organizational need

Basic components to assist inventory management are: Order quantity Lead time Safety stock

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“Normal” Departmental Inventory(% of total hospital supply inventory)

0% 10% 20% 30% 40% 50%

Lab

CCU

CS/SPD

Drugs/Meds

General Stores

OR

Note: All other individual departments are less than 5% of total supply inventory

Source: VCS Supply Chain Database

6.3%

9%

12.3%

15.8%

23.8%48%

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Inventory Control Techniques

Inventory Turnover Rate

Turnover = Total $ Issued

Average Inventory Value

(or ending value)

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Inventory Control Techniques

Balance Order and Inventory Costs

15 – 18 Turns

Higher

Cost

Lower

Less Order Frequency More

Order Cost

Inventory LevelsSweet Spot

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Inventory Management

Inventory Turn Calculation Worksheet

$20,000,000 State your annual purchases$2,500,000 State value of inventory

16% State percent carrying cost of inventory

Turns Owned Inventory

Annual Cost for Holding Inventory

Inventory Reduction - One Time Cash Flow

Holding Cost Savings

Days On Hand (DOH)

8 $2,500,000 $400,000 $0 $0 33

4 $5,000,000 $800,000 $0 $0 655 $4,000,000 $640,000 $0 $0 526 $3,333,333 $533,333 $0 $0 447 $2,857,143 $457,143 $0 $0 378 $2,500,000 $400,000 $0 $0 339 $2,222,222 $355,556 $277,778 $44,444 2910 $2,000,000 $320,000 $500,000 $80,000 2611 $1,818,182 $290,909 $681,818 $109,091 2412 $1,666,667 $266,667 $833,333 $133,333 2224 $833,333 $133,333 $1,666,667 $266,667 11

Yellow Squares indicate where you should key in your hosptial values

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Inventory Costs

Inventory Carrying Costs-what does it cost you to maintain your inventory?

Opportunity Costs-Invested Capital-Cost of Money Cost of Space Handling Charges-labor expense Storage Costs Utilities/Insurance Data Processing Shrinkage

• Pilferage/theft• Obsolescence• Spoilage

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Inventory Control Techniques

Setting LevelsReorder pointsReorder quantitiesMin/MaxEconomic Order Quantity (EOQ)

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Inventory Distribution Management

Supply level calculations Maximum/minimum Economic order quantity

The greater the order quantity, larger the inventory.

The longer the lead time, the greater the inventory.

The higher the safety stock, the greater the inventory.

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Order Cycle

Period of time elapsed between determining need and receipt of goods. Usually expressed in days or weeks. Shows how many periods (days or weeks) of stock are generally on-hand and how often the item is being ordered.

•Lead Time

Period of time between placing an order and receipt of goods.

Terminology

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Safety Stock

A level or quantity of inventory on-hand to reduce the probability of a stock-out between time of order and time of receipt of stock (lead time). This is a level (usually less than the reorder point) that theoretically should never be needed or used. It is “insurance.” It increases the cost of inventory and that cost is weighed against the cost of a stock-out.

Terminology

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Economic Order QuantityDefined as a calculation of the most efficient maximum order quantities consider factors such as lead times, carrying costs, ordering costs and available space. A very basic EOQ formula follows:EOQ = square root of (2(F*S)/(C*P)F = fixed cost of placing and receiving an orderS = annual usageC = carrying costs as a percentage of average inventory valueP = purchase price per unit

Terminology

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Inventory Control Techniques

Maintain Accuracy Control access to your inventory Locator system/location checks Cycle counting First in First Out (FIFO) philosophy

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Inventory Distribution Management

Fill-Rate- percentage of items successfully supplied to end user

Total Annual Stocking Cost (TASC) TASC = Annual Ordering Costs (AOC) + Annual Carrying Costs (ACC)

AOC = (D/Q)xS ACC= (Q/2)xC

D = Average Annual Demand Q = Order Quantity S = Fixed Order Cost C = Carrying Cost per Unit

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Inventory Distribution Management

Economic Order Quantity (EOQ) D = Ave. Annual Demand S = Fixed Order Cost

C = Annual Carrying Cost Total Material Cost (TMC)

TMC = TASC + D(AC) TASC = (D/Q)xS + (Q/C)xC D = Average Annual Demand AC = Acquisition Cost

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Inventory Distribution Management

Safety Stock (SS)

Z = Service Factor R = Average Replenishment Time S = Average Daily Demand σr = Standard Deviation of Replenishment

σs = Standard Deviation of Daily Demand

Order Point (OP) OP = EDDLT + Safety Stock EDDLT = Expected Demand During Lead Time

EDDLT = R(S) R = Average Replenishment Time S = Average Daily Demand OP = R(S) +

Integrated Enterprise Excellence

Utilize “Lean Organization” and “Standardization” approaches focused on aggressively identifying and

eliminating waste while achieving 5Rs (Right Product, Right Place, Right Quantity, Right Time, Right Price).

Quality Service Cost

– Increased Patient Satisfaction– Greater Value for the Community– Improved Competitiveness– Increased Employee/Physician Satisfaction

Which results in

Driving Enhanced

Technology

Definition:A systematic approach to the identification

and elimination of waste and non-value

added activities through continuous

improvement in all products and services

Characteristics:

• Equipment used synchronously to demand

• Utilizes people to their fullest capacity• Simple, flexible, visible, & responsive• Requires constant change• Creates products/services with minimum

consumption of:

- Capital investment

- Floor space

- Materials

- Labor

- Time

- Distance

Lean Organization

Definition of Waste

•Anything that doesn’t add value to the

process

• Anything that doesn’t help create

conformance to the customer’s

specifications

• Anything your customer would be

unwilling to pay (or need) you to do

Understanding Waste

• Identification and elimination of waste is

the central focus of a lean system.

• It is dependent on the understanding

and involvement of all employees.

• Successful implementation requires all

employees be trained to identify and

eliminate waste from their

work areas.

Waste exists in all work . . . . and at all levels in the organization

8 Types of Waste

Transportation Inventory Movement Waiting Over Production Over Processing Defects People skills/potential

LeanOrganization

SmallLots

PullSystems

LevelScheduling

SupplierDevelopment

Lead TimeReduction

ErrorProofing

PlannedMaintenance

WorkplaceOrganization &Visual Controls

Employee / ProcessControl

Containerization/packaging

QuickSet-up

Plant, Machine& Office Layout

Transportation/Logistics

Reduction of

Variation

MachineProcess

Capability

StandardizedOperations

Lean Tool Box

A Four Step Focus

• Step One - Understand what waste is

• Step Two - Use appropriate waste elimination tool to eliminate specific waste(s) identified

• Step Three - Brainstorm to develop a vision so asto create a plan

• Step Four - Aggressive implementation of plans. Do it now!!!!

Lean Organization

Finance

3 Financial Statements Income Statement Cash Flow Statement Balance Sheet

Income Statement

Displays revenues and expenses Clearly states net profit or loss Also called “statement of revenue and

expense”

Sample Income Statement

Sales Revenue   $1,000,000 Cost of Goods Sold    Direct Material ($150,000)  

  Direct Labor ($100,000)  

  Overhead ($150,000)  

Total Cost of Goods Sold ($400,000) Gross Profit $600,000 Operating Expense    Office Supplies ($50,000)    Salaries ($225,000)    Utilities ($25,000)  

Total Operating Expense ($300,000) Net Income   $300,000

Balance Sheet

Summarizes assets, liabilities, and shareholder equity or net assets (non-profit)

Assets = Liabilities + Shareholder Equity Both sides of equation must “balance”

out http://www.investopedia.com/video/play/introduction-balance-sheet#axzz

1cjqs0ph6

                 

 Balance Sheet

 

  11/11/2011            

  ASSETS     LIABILITIES    

  Current Assets     Current Liabilities    

  Cash $62,950   Accounts payable $22,420  

  Accounts receivable 60,880   Short-term notes 1,800  

    (less doubtful accounts)     Current portion of long-term notes 6,000  

  Inventory 62,150   Interest payable    

  Temporary investment     Taxes payable    

  Prepaid expenses 2,650   Accrued payroll 1,140  

    Total Current Assets $188,630     Total Current Liabilities $31,360  

  Fixed Assets     Long-term Liabilities    

  Long-term investments     Mortgage $30,000  

  Land     Other long-term liabilities    

  Buildings       Total Long-Term Liabilities $30,000  

    (less accumulated depreciation)            

  Plant and equipment 150,000          

    (less accumulated depreciation) (56,870)  Shareholders' Equity    

  Furniture and fixtures 15,570   Capital stock $110,000  

    (less accumulated depreciation) (4,720)  Retained earnings 121,250  

    Total Net Fixed Assets $103,980     Total Shareholders' Equity $231,250  

                 

                 

  TOTAL ASSETS $292,610   TOTAL LIABILITIES & EQUITY $292,610  

                 

Cash Flow Statement

Records all cash movement Inflows from operations and investments Outflows for business expenses and

investments http://www.investopedia.com/video/play/what-is-cash-flow#axzz1cj

qs0ph6

         

Cash Flow Statement  

  Beginning Cash Position $6,000,000  

         

  Cash Flow from Operating Activities    

  Net Income $8,000,000  

    Depreciation Expense $4,000,000  

    Net Change in Accounts Receivable ($2,000,000)  

    Net Change in Account Payable $1,000,000  

    Total Adjustments to Operating Income $3,000,000  

  Net Cash Flow Provided by Operating Activities $11,000,000  

         

  Cash Flows from Investing Activities    

    Purchase of New Computers ($1,500,000)  

    Purchase of Assembly Line Machines ($2,000,000)  

    Decommissioning Fund Contributions ($500,000)  

  Net Cash Used in Investing Activities ($4,000,000)  

  Net Cash Flows from Financing Activities    

    Increase in Short Term Debt $500,000  

    Redemption of Long Term Debt ($3,000,000)  

    Issuance of Common Stock $250,000  

    Cash Dividends on Common Stock ($2,000,000)  

  Net Cash Provided by (Used in) Financing Activities ($4,250,000)  

         

  Net Increase / Decrease in Cash and Cash Equivalents $2,750,000  

         

  Cash and Cash Equivalents at the End of the Period $8,750,000