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Inventories

The document discusses inventory management processes including procurement cycle, inventory types, costs, appropriate inventory levels, ABC analysis, economic order quantity model, order points, safety stock, and just-in-time approach. It describes the eight steps in a typical procurement cycle and different inventory types such as raw materials, work-in-process, finished goods. It also explains how to determine optimal inventory levels and ordering quantities using EOQ model.

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66 views32 pages

Inventories

The document discusses inventory management processes including procurement cycle, inventory types, costs, appropriate inventory levels, ABC analysis, economic order quantity model, order points, safety stock, and just-in-time approach. It describes the eight steps in a typical procurement cycle and different inventory types such as raw materials, work-in-process, finished goods. It also explains how to determine optimal inventory levels and ordering quantities using EOQ model.

Uploaded by

dukegc
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Inventory Management

The procurement cycle may consist of eight processes:


Purchase Order Purchase Order

Procurement Cycle

8. Payment

1. Requirements determination 2. Source determination

7. Invoice verification

Purchase Order Purchase Order

6. Goods receipt and inventory management

3. Requisition assigned to a Vendor

5. Order follow-up

4. Order processing

Inventory Management
Typically, inventory accounts for about four to five percent of a firm's assets. In manufacturing firms, this could be 20 to 25% of the firms assets. Inventory sitting on your shelf earns nothing! In fact, it costs you 20 to 30% of the value of the inventory just to keep and maintain it. Therefore, the objective is to minimize the investment in inventory without sacrificing production requirements

Inventory Management and Control


Inventories form a link between production and sale of a product. Inventory types:
Raw-materials inventory Work-in-process inventory In-transit inventory Finished-goods inventory

Inventory Management and Control


Inventories provide flexibility for the firm in:
Purchasing Production scheduling Efficient servicing of customer demands

Inventory Costs
Carrying Costs
Warehouse rent, insurance, security costs, utility costs, maintenance costs, property taxes, move and re-arrange, obsolescence, and opportunity cost, i.e., using cash for profitable projects rather than being tied up in inventory.

Ordering costs
Clerical expense, telephone, Material Resource Planning (MRP) system, management time, receiving costs, etc.

Appropriate Level of Inventories


How does a firm determine the appropriate level of inventories?
Employ a cost-benefit analysis Compare the benefits of economies of production, purchasing, and product marketing against the cost of the additional investment in inventories.

Inventory Holding Costs


Reasonably Typical Profile

% of Category Inventory Value Housing (building) cost 6% Material handling costs 3% Labor cost 3% Inventory investment costs 11% Pilferage, scrap, & obsolescence 3% Total holding cost 26%

EOQ Model
Annual Cost

Order Quantity

EOQ Model
Annual Cost

Holding Cost

Order Quantity

Why Order Cost Decreases


Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.35) 1000 Orders (Postage $350)

Purchase Order Description Qty. Microwave 1000

Purchase Order Purchase Order Purchase Order Description Qty. Qty. Purchase Order Description Qty. Description Microwave Description Qty.11 Microwave 1 Microwave 1 Microwave

Order quantity

EOQ Model
Annual Cost

Holding Cost Order (Setup) Cost Order Quantity

EOQ Model
Annual Cost

Total Cost Curve


Holding Cost Order (Setup) Cost Order Quantity

EOQ Model
Annual Cost

Total Cost Curve


Holding Cost Order (Setup) Cost Order Quantity

Optimal Order Quantity (Q*)

ABC Method of Inventory Control


Cumulative Percentage of Inventory Value

ABC method of inventory control


Method which controls expensive inventory items more closely than less expensive items. Review A items most frequently Review B and C items less rigorously and/or less frequently.

100 90

C
70

B A
0 15 45 100 Cumulative Percentage of Items in Inventory

Inventory Mangement
In order to effectively manage the investment in inventory, two problems must be dealt with: how much to order and how often to order. The economic order quantity (EOQ) model attempts to determine the order size that will minimize total inventory costs.

16

How Much to Order?


The optimal quantity to order depends on:
Forecast usage Ordering cost Carrying cost
Ordering can mean either the purchase or production of the item.

The EOQ Model assumes the firm orders a fixed amount (Q) at equal intervals.
Inventory Level (units)

Order Quantity Q

Time

The EOQ Model


Inventory Level (units)

Average inventory =

Order Quantity 2

Order Quantity Q

Time

Total Inventory Costs

Total Carrying Costs

Total Ordering Costs

Total Inventory Costs Where: OQ S CC OC

OQ S ) CC + ( OQ) OC 2

= Order Size (order quantity) = Annual Sales Volume ( in units) = Carrying Cost per Unit = Ordering Cost per Order

Ordering Costs = ( S )OC OQ

Cost ($)

Ordering Costs, per unit

Ordering costs per unit go down as order size increases. Assumes ordering costs are relatively fixed.

Order Size (units)

Ordering Costs = ( S )OC OQ Carrying Costs = ( OQ ) CC 2


Cost ($)

Carrying Costs
Carrying costs increase as the size of the inventory increases.

Order Size (units)

Ordering Costs = ( S )OC OQ Carrying Costs = ( OQ ) CC 2 Total Costs = Carrying Costs + Order Costs Total Cost = OQ x CC + S x OC 2 OQ
The economic order quantity is the intersection of the X and Y points where total inventory cost is minimized

Cost ($)

Order Size (units)

Inventory Management
Determining Optimal Inventory The ordering quantity that minimizes the total costs of inventory.
OQ = 2 x S x OC CC

Inventory Management
Determining Optimal Inventory Economic Order Quantity (EOQ)
Example: Awesome Autos expects to sell 1,560 new automobiles in the next year. It currently costs $40 per order placed with the manufacturer. Carrying costs amount to $50 per auto. How many autos should they order each time they place an order?

OQ =

2 x S x OC CC

2(1560)40 50

= 49.96 50 cars

How Often Order?


Issues to consider:
Lead Time -- The length of time between the placement of an order for an inventory item and when the item is received in inventory. Order Point -- The quantity to which inventory must fall in order to signal that an order must be placed to replenish an item. Order Point (OP) = Lead time X Daily usage

Example of When to Order


Economic Order Quantity (Q*)
2000

UNITS

Order Point 200

Lead Time

18

20

DAYS

38

40

Example of When to Order


Mr. Aslam of ABC textile Mill has determined that it takes only 2 days to receive the order of fabric after the placement of the order. The Mill usage is 10,000 yards in 100 days.

When should Julie order more fabric?


Lead time = 2 days Daily usage = 10,000 yards / 100 days = 100 yards per day Order Point = 2 days x 100 yards per day = 200 yards

Safety Stock
Safety Stock -- Inventory stock held in reserve as a cushion against uncertain demand (or usage) and replenishment lead time.

Our previous example assumed certain demand and lead time. When demand and/or lead time are uncertain, then the order point is: Order Point = (Avg. lead time x Avg. daily usage) + Safety stock

Order Point with Safety Stock


2000

UNITS

Order Point 400 200

Safety Stock
0 18 20 38 40

DAYS

How Much Safety Stock?


What is the proper amount of safety stock?
Depends on the:
Amount of uncertainty in inventory demand Amount of uncertainty in the lead time Cost of running out of inventory Cost of carrying inventory

Just-in-Time
Just-in-Time -- An approach to inventory management and control in which inventories are acquired and inserted in production at the exact times they are needed.

Requirements of applying this approach:


A very accurate production and inventory information system Highly efficient purchasing Reliable suppliers Efficient inventory-handling system

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