INVENTORY MANAGEMENT

WHAT IS INVENTORY MANAGEMENT?

Inventory management involves the control of assets being produced for the purpose of sale in the normal course of the companys operation. The goal of inventory management is to minimize the total cost - indirect and direct that are associated with holding inventories.

INVENTORY
Stocks of manufactured products and the material that make up the product. Inventories represent the second largest asset category for manufacturing companies, next only to plant and equipment, therefore inventory management is necessary.

PURPOSE
AVOIDING LOST SALES

EFFICIENT PRODUCTION RUNS

GAINING QUANTITY DISCOUNTS

REDUCING RISK OF PRODUCTION SHORTAGES

REDUCING ORDER COSTS

ADVANTAGES OF INVENTORY MANAGEMENT

Helps reduce purchasing and inventory costs
Removes barrier between manufacturer and retailer

Gain visibility into inventory processes

Improve customer satisfaction

Current assets

Level of liquidity

Liquidity lags
creation lag

Circulation activity

Storage lag
Sale lag

THE INVENTORY CYCLE

Q
Quantity on hand Profile of Inventory Level Over Time

Usage rate

Reorder point

Receive order

Place order

Receive order

Place order

Receive order

Time

Lead time

TYPES OF INVENTORIES
1.Raw materials inventory 2.Stores and spares 3.Work in progress inventory 4.Finished goods inventory

COST ASSOCIATED WITH INVENTORIES

1.Material costs 2.Ordering costs 3.Carrying costs 4.Cost of funds tied up with inventory 5.Cost of running out of goods

TWO FUNDAMENTAL INVENTORY DECISIONS

How much to order of each material when orders are placed with either outside suppliers or production departments within organizations When to place the orders

INVENTORY MANAGEMENT TECHNIQUES

ECONOMIC ORDER QUANTITY

Optimal order size that will result in lowest total inventory cost

Assumptions of EOQ Model

Constant demand

Constant unit price

Constant carrying cost

Constant ordering cost

Instantaneous delivery

Independent orders

LIMITATIONS ( EOQ MODEL)

Only applicable to non-perishable products with staple demand. Assumes storage space is unlimited. Cost structures have changed, e.g. ordering costs reduced by e-commerce, stock is seen as a liability not asset. The assumption of a constant consumption and instantaneous replenishment are of doubtful validity.

LIMITATIONS ( EOQ MODEL) continued

The assumption of a known annual demand for inventories is open to question. A more difficult situation may occur when the number of orders to be placed may turn out to be a fraction.

Total Inventory Cost = Ordering Cost + Carrying Cost Total Ordering Cost = Number of orders x Cost per order = Rs. (U/Q) x F

U = Annual Usage Q = Quantity Ordered F = Fixed Cost

Total Carrying Cost = Average level of inventory x Price per unit x Carrying cost = Rs. (Q/2) x P x C

Q = Quantity Ordered P = Purchase price per unit C = Carrying cost

Total Inventory Cost = Rs. (U/Q) x F + (Q/2) x P x C

Costs

Total Cost

Carrying Cost

Ordering Cost

Q*

Order Quantity (Q)

EOQ = Q*
EOQ =

(2U x P)/PC

E = Optimum production quantity U = Annual Output P = Set up cost for each production run C = Carrying Cost

ABC Analysis

ABC Classification System

Classifying inventory according to some measure of importance and allocating control efforts accordingly.

A - very important B - mod. important C - least important

High Annual $ value of items Low

A B C
Few

Number of Items

Many

ABC The Breakup

A 10% to 20% account for 80% of value

B 15% to 25% account for 20% of value

A 5% to 10% account for 10% of value

FEATURES
A
Very close monitoring on consumption Phased Delivery Moderate Monitoring Monthly delivery

Loose control Once in 6 months delivery

LIMITATIONS (ABC ANALYSIS)

Detailed ABC systems are costly to operate and difficult to understand.
If the company is already using multiple absorption rates in each production centre, the potential for improved accuracy in product costs may be limited. The problems encountered by traditional methods remain like for example, many facilities costs ( rental, rates, insurance, heating and lighting) still needs to be apportioned to activities in the same way as traditional costing.

INVENTORY PLANNING AND MANAGEMENT

Inventories should be included in firms planning and budgeting process. The Production Side. Manufacturing Mix. Volume Purchases. Lead time. The Marketing Side. Sales Forecast Safety stock level

THREE SUBSYSTEMS OF THE INVENTORY-MANAGEMENT SYSTEM.

Economic -Order- Quantity Subsystem.
EOQ

Stock Level Subsystem.

Ending Inventory

Reorder-Point Subsystem.
Reorder Point

INVENTORY DATA BASE

Ensures movement of individual item and make decisions on replenishing the items. Classification and account of inventories. Demand for the items. Cost to the firm for each item. Ordering costs. Carrying costs.

PRICING OF INVENTORIES
First-In-First Out (FIFO) Last-In-First Out (LIFO) Weighted Average Cost Method. Standard Price Method. Replacement / Current Price Method.

DISADVANTAGES
Higher costs
Item cost (if purchased) Ordering (or setup) cost

Costs of forms, clerks wages etc. Building lease, insurance, taxes etc.

Holding (or carrying) cost

Difficult to control

IMPROVEMENTS IN INVENTORY MANAGEMENT

Review of classifications-ABC and FSN must be periodically reviewed. Improved classifications-better co-ordination among purchase, production, marketing and finance dept. Development of long term relationships-long term relationships with vendors would help in improving quality and delivery. Disposal of obsolete/surplus inventories-procedures for this should be simplified.