inventoryfundamentalpowerpoint-120826033332-phpapp02

7/27/2019 inventoryfundamentalpowerpoint-120826033332-phpapp02

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Supply Chain Management

InventoryFundamentals


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Inventory Fundamentals

Inventory = material + supply For sale

Input or supply to the production process Substantial part of total assets

20% to 60% of total assets on balance sheet

When used value is converted into cash

Improve cash flow and return on investment(ROI)


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Cost for carrying inventories

- Increase operation cost

- Decrease profit Inventory management is responsible for

- Planning inventory from raw material tocustomer

- Controlling inventory from raw material tocustomer


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1. Inventory results from production: finishedgoods

2. Inventory support production: raw materialwork in process (WIP), etc.

1 and 2 must be coordinatedInventory must be considered at each of the

planning level

- Production planning: over all - Master

production schedule: end items - Materialrequirement planning: components & rawmaterial


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Aggregate inventory management Deals with managing inventory according to their

classification

- Raw material

- Work in process (WIP- Finished good

Function of different inventories - not individual

item level Financially oriented - cost and benefits of

carrying different classifications of inventories


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Involves

1. Flow and kind of inventory needed

2. Supply and demand pattern 3.Functions that inventories perform 4.

Objective of inventory management 5.

Cost associated with inventory


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Item inventory management Item level, not aggregate

Management establishes decision ruleabout inventory item

Rules

- Which inventory items are most important

- How individual items are to be controlled -How much to order at one time - When to

place an order


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Factors affecting inventorymanagement decision

1. Types of inventory based on the flow ofmaterial

2. Supply and demand pattern 3.

Function performed by inventory 4.

Objective of inventory management 5.Inventory cost


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1. Inventory and flow of material: Raw material

Purchased item not processed yet Supplier material

Components Sub-assemblies

Work in process (WIP) Raw material has been processed but not

finished


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Supplier Supplier Supplier

Raw material/ Purchased part/Material

Work in process (WIP)

Finished goods

Warehouse Warehouse Warehouse

Customer Demand Customer Demand Customer Demand


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Inventory & flow of material-Continues

Finished goods

Ready to be sold as completed items Factory storage

Warehouse

Distribution centers

Distribution inventories

Finished goods in the distribution system


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MRO supplies used in production that

do not become part of the productssuch as hand tools, spare parts, die,drill bit, etc.

Maintenance

Repair

Operational


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Classification depends on production

environmentFor example tire

Tire is finished goods for tire manufacturer Tire is raw material for car manufacturer


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2. Supply and demand pattern

If supply meet demand - no inventory Demand must be predictable, stable andrelatively constant over a long time period -zero inventory

Produce goods on a line - flow basis -

matching production with demand - noinventory

Raw material Work center CustomerZero Zero


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2. Supply and demand pattern-continues Large demand to justify setting up flowsystem

Demand is instable - varies Lots or batch manufacturing

Workstations are organized by function Work flow from workstation to workstation in lot Inventory build up in

Raw material Work in process (WIP) Finished goods


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3. Functions performed by inventory :

Decouple supply and demand

Buffer between supply and demand Buffer between finished goods and

customer demand

Buffer between finished goods andcomponent availability


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3. Functions performed by inventory -continue

Requirement for an operation and theoutput from the preceding operation Parts and material to begin productionand supplies of material


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3. Functions performed by inventory -continue

Classification of inventory by function:a) Anticipation inventory:

Build up in anticipation of future demand

Example: before peak selling season, promotion

program, vacation, shut down, etc. To helplevel production

To reduce cost of changing production rate


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Classification of inventory by function -continues

b) Fluctuation inventory (Safety stock): Inventory is held to cover random,

unpredictable fluctuation in supply anddemand or in lead time

If demand or lead time is greater thanforecast, a stock out occurs

Safety stock is carried to protect stock out


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2. Fluctuation inventory (Safety stock): Prevent disruption in manufacturing or

deliveries to customer

Safety stock - buffer stock - reserve stock


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3. Lot size inventory:

Items purchased or manufacturing in quantitiesgreater the needed

Lot size inventory - cycle inventory

Portion of inventory that depletes gradually as

customer order received Replenish cyclically when suppliers order are

received


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4. Transportation inventory:Transportation inventory - Pipeline inventory

- movement inventory

Time needed to move goods from one

location to another location Example: supplier to manufacturer; plant

to distribution centers, etc.


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4. Transportation inventory:I = t x A/ 365; I = average amount; A=annual

demand; t = transit time, days

I Cost; I t;

Reduce transit time to reduce inventoryand hence cost


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4. Transportation inventory:Example: Delivery of goods from a supplier is

in transit for ten days. If the annualdemand is 5200 units, what is the average

annual inventory in transit?I = 10 x 5200 / 365 = 142.5 units


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5. Hedge inventory: Commodities- Mineral

- Oil

- Grain Buy and wait to sell when price rises Buy at low cost, wait, sell on high price


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6. MROs inventory:

Maintenance, repair and operation / over haul Support general operation and

maintenance

- Spare parts -

Consumables -

Stationer


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3. Objective of inventory management:

A. Maximum customer service

B. Low cost plant operation C. Minimuminventory investment Maximum customer

service: Ability to satisfy customer

needs Availability of items when

needed and a measure of inventorymanagement effectiveness


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3. Objective of inventory management-continues

Maximum customer service: Customers: who they are!

Purchaser

Distributor Other plants

Workstations


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3. Objective of inventory management-continues

Maximum customer service:

Measurements of customer service % of order shipped on schedule % of line item shipped on schedule Order days out of stock

Inventory help to maximize customer service

by protecting against uncertainties Carry extra inventories to meet uncertain

demand


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3. Objective of inventorymanagement:- continues

Low cost plant operations (4 ways)I.Allow operation with different rates ofproduction to operate separately andmore economically

II. Allow level production of seasonalitems - inventories build up in non-peak sale season


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3. Objective of inventory management:-continues

Low cost plant operations (4 ways) II.Allowlevel production of seasonal items -inventories build up in non-peak sale season,How?

Reduced overtimeReduced training cost Reducedtraining cost Lower capacity requirement Reduced

subcontracting cost


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Low cost plant operations (4 ways)

III. Allow longer production run Lower setup cost

Setup cost is fixed: one unit or 1000 units

Increase in capacity

less setup More run time

Bottleneck operation


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3. Objective of inventorymanagement:- continues

Low cost plant operations (4 ways) IV.Allow to purchase in larger quantities

Lower ordering cost

Quantity discount


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Inventories cost money, they must be balanced

withI. Customer service: Low inventory - high stock out Lowerlevel of customer service II.Cost inchanging production level Excess equipment Overtime Hiring and layoff training


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Inventories cost money, they must be balanced

withIII. Cost of placing order

Each order placed cost

IV. Transportation cost Small quantity cost more per unit

Therefore, carry inventory if it cost lessthan not to carry


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Inventory costs:1. Item cost

landed price purchase cost

cost to get it in plant transportation custom duties insurance

2. Carrying cost

3. Ordering cost4. Stock out cost5. Capacity associated costs


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2. Carrying cost Cost of carrying volume of inventory Capital cost

Storage cost Space Labor equipment

Risk cost Obsolescence: model change, out dated Damage: in handling Pilferage: lost, misplace, stray, stolen

3. Ordering cost4. Stock out cost5. Capacity associated costs


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Inventory costs:1. Item cost2. Carrying cost

3. Ordering cost Associated with placing an order with a factory or supplier Independent of quantity order Depends on number of orders placed in a year Production control cost

* Setup time *Production loss* Tear down at the end of run

Lost capacity cost* Incurred when an order is placed* Order preparation * Expediting* Follow-up * Receiving* Authorizing payment * Receiving and paying invoice


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2. Carrying cost

3. Ordering cost: ExampleA company carry an average annual

inventory of $2,000,000. If they estimatethe cost of capital is 10%. Storage costs

are 7% and risk costs are 6%. Whatdoes it cost per year to carry thisinventory?


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Example-continues

Total cost of carrying inventory = 10% + 7% + 6%

Total cost of carrying inventory = 23% Total

annual cost of carrying inventory = 23% x

$2,000,000

Total annual cost of carrying inventory = 0.23 x

$2,000,000Total annual cost of carrying inventory = $460,000


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Ordering cost: Example

Given the following annual costs, calculatethe average cost of placing one order.Production control salaries = $60, 000Supplies and operating expenses forproduction control department = $15,000

Cost of setting up work centers for an order= $120

Order placed each year = 2000


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Ordering cost: ExampleAverage cost = fixed cost/number of orders + variable cost

Average cost = ($60, 000 + $15,000 )/2000 + $120Average cost = $37.50 + $120 = $157.50


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2. Carrying cost

3. Ordering cost

4. Stock out cost If demand during the lead time exceeds forecast we

expect a stock out9 Back order cost

9 Lost sale

9 Lost customer

5. Capacity associated costs


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2. Carrying cost

3. Ordering cost

4. Stock out cost

5. Capacity associated costs When output level is changed, following cost may

incuri. Overtime v. Training

ii. Hiring vi. Extra shift

iii. Leveling production vii. Laying off

iv. Carrying inventory


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Quarter Quarter Quarter Quarter1 2 3 4 Total

Forecast demand 2,000 3,000 6,000 5,000 16,000

Production 4,000 4,000 4,000 4,000 16,000

Ending inventory 0 2,000 3,000 1,000 0 -

Averageinventory 1,000 2,500 2,000 500 -

Inventory cost ($) $ 3,000 $ 7,500 $ 6,000 $1,500 $18,000


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1. Capacity associated costs: Example A companymakes and sells a seasonal product. Based on asales forecast of 2000, 3000, 6000 and 5000 per

quarter, calculate a level production plan, quarterlyending inventory and average quarterly inventory.

If inventory carrying costs are $3 per unit perquarter, what is the annual cost of carryinginventory? Opening and ending inventories arezero.


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Financial statement and inventory: Balance sheetAssets = Liabilities + Owners equity

Income statementIncome = Revenue - Expenses Cash - flow analysis

- Cash requires

To purchase raw material Pay for production cost -Labor

- overhead


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Financial statement and inventory:Example:a) If the owners equity is $1,000 and liabilities

are $800, what are the assetsb) If the assets $1,000 and liabilities are $600,

what is the owners equity?

a) Assets = Liabilities + Owners equityAssets = $800 + $1,000 = $ 1,800)

Owners equity = Assets - LiabilitiesOwners equity = $1,000 - $600 = $400


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Financial statement and inventory: continuesCash in - cash out > 0; self-finance

Income statement

Cash in - cash out < 0; borrowExample:

Given the following data, calculate the grossmargin and the net income.

How much would profit increase if, through bettermaterial management, material costs arereduced by $50,000?


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Example: continuesRevenue $1,500,000

Direct labor $300,000

Direct material $500,000 Notice, net incomeFactory overhead $400,000

General and admin. (profit) of 33%Expenses $150,000

Revenue $1,500,000 Revenue $1,500,000

Cost of goods sold Cost of goods sold

Direct labor $300,000 Direct labor $300,000

Direct material $500,000 Direct material $450,000

Factory overhead $400,000 $1,200,000 Factory overhead $400,000 $1,150,000

Gross margin $300,000 Gross margin $350,000

General and admin. General and admin.Expenses $150,000 Expenses $150,000

Net income (profit) $150,000 Net income (profit) $200,000

33%


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Financial inventory performance measures: Inventory - money tied up

1. Total inventory investment2. Inventory turn ratio

3. Days of supply


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Financial inventory performance measures:continues

Inventory turn ratio = Annual cost of goods sold/ average inventory in $

- Higher is better

If annual cost of goods sold is $1 million and

average inventory is $500,000, then Inventoryturn ratio = $1,000,000/$500,000 = 2


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Inventory turn ratio - continues

Example: a) What will be the inventory turn

ratio if the annual cost of goods sold is$24 million a year and the averageinventory is $6 million?

Answer:

Inventory turn ratio = Annual cost of goods sold / averageinventory in $

Inventory turn ratio = $24 million/$6 million = 4


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Example: b) What would be the reduction ininventory if inventory turn ratio is

increased to 12 times per year?Answer:

average inventory in $ = Annual cost of goods sold /

Inventory turn ratioaverage inventory = $24 million/ 12 =$2 million Reductionin inventory = $6 million - $ 2 million = $4 million


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Example: c) If cost of carrying inventory is25% of the average inventory, what willbe the savings?

Answer:

Reduction in inventory = $6 million - $ 2 million = $4 million

Saving = $4 million x 25% = $4 million x 0.25 = $1 million


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Financial inventory performance measures:continues

Days of supply = Inventory on hand / average

daily usage- Lower is better

Example: Inventory on hand is 9,000 units andannual usage is 48,000 units, there are 240

days per yearaverage daily usage = 48,000/240 = 200 unitsDays of supply = 9000 / 200 = 45 days

I F d l


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Methods of evaluating inventory: (4)1. FIFO

- In rising prices, replacement is at higher prices

than assumed cost- Does not reflect current price

- Replacement is understated in rising price -Replacement is overstated in falling price

2. LIFO

3. Average cost4. Standard cost

I t F d t l


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Methods of evaluating inventory: (4)

1. FIFO

2. LIFO

- In rising prices, replacement is at current prices -Reflect current price

- Replacement is current in rising price -Replacement is current in falling price

3. Average cost

4. Standard cost


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1. FIFO

2. LIFO

3. Average cost

- An average of all the prices paid for the article -Reflect average price

- Replacement is average in rising price -Replacement is average in falling price

4. Standard cost


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1. FIFO

2. LIFO

3. Average cost4. Standard cost

- Cost is determined before production begins -

Cost = direct material + direct labor + overhead -Any difference between the standard cost and

actual cost is stated as variance

I t F d t l


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ABC Inventory Control: Controlling individual items

- What is the importance of inventory item? -How are they to be controlled?

- How much should be ordered at one time? -When should an order be placed?


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ABC inventory classification system- Importance of an SKU - inventory item

$ value

scarcity- Level of control

Pareto principle - 80-20 rule

1. A - 20% of items; 80% of $ value

2. B - 30% of items; 15% of $ value3. C - 50% of items; 5% of $ value


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Steps in making an ABC analysis: (3)

1. Establish item characteristics

- $ value

- scarcity

2. Classify items into groups

3. Apply a degree of control in proportion toimportance


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Procedure for classifying by annual $ values:(5 steps)

1. Determine annual usage

2. Multiply annual usage by its cost; total annual $usage

3. List items according to their annual $ usage4. Calculate the cumulative annual $ usage and

cumulative percentage of the items

5. Examine the annual usage distribution and groupthe items into A, B and C groups based on annualpercentage usage

I F d l


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ABC Analysis: Example

A company manufactures a line of ten items. Theirusage and unit costs are shown in the following

table along with the annual usage.a. Calculate the annual usage of each itemsb. List the items according to their annual $ usage

c. Calculate the cumulative annual dollar usageand the cumulative percent of items

d. Group items into A, B and C classification


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Example - continues (table)Part Number Unit usage Unit cost $

1 1,100 2

2 600 40

3 100 4

4 1,300 1

5 100 60

6 10 25

7 100 2

8 1,500 2

9 200 2

10 500 1

Total 5,510


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Example - continues (Answer a))Part Number Unit usage Unit cost $ Annual $ usage

1 1,100 2 $2,200

2 600 40 $24,000

3 100 4 $4004 1,300 1 $1,300

5 100 60 $6,000

6 10 25 $250

7 100 2 $200

8 1,500 2 $3,000

9 200 2 $400

10 500 1 $500

Total 5,510 $38,250



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Example - continues (Answer b), c) and d))



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Part Unit Unit Annual $ Cumulative Cumulative CumulativClass

Number usage cost $ usage $ usage % $ usage e % items

2 600 40 $24,000 $24,000 62.75% 10.0% A

5 100 60 $6,000 $30,000 78.43% 20.0% A

8 1,500 2 $3,000 $33,000 86.27% 30.0% B

1 1,100 2 $2,200 $35,200 92.03% 40.0% B

4 1,300 1 $1,300 $36,500 95.42% 50.0% B

10 500 1 $500 $37,000 96.73% 60.0% C

3 100 4 $400 $37,400 97.78% 70.0% C

9 200 2 $400 $37,800 98.82% 80.0% C

6 10 25 $250 $38,050 99.48% 90.0% C

7 100 2 $200 $38,250 100.00% 100.0% C


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Control based on ABC classification: (2 rules)1. Have plenty of low $ value items

- C items- 50% items

- 5% cost- Keep safety stock -Order annually

2. Use the money and control effort to reduce theinventory of high value items

- A items

- 20% items- 80% cost

- Deserve the tightest control -Frequent review

I t F d t l


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Different Controls:

A - items: High priority

- Tightest control

- Complete accurate record -

Regular and frequent review -

Frequent review of demand

- Close follow up and expediting to reducelead time

I t F d t l


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B - items: Medium priority

- Normal control

- Good record -

Regular attention -

Normal processing

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