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Chapter 9- Inventory Fundamentals

Chapter 9- Inventory Fundamentals. IM417 Manufacturing Resources Analysis Southeast Missouri State University Compiled by Bart Weihl Spring 2001. Inventory Fundamentals. Inventory

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Chapter 9- Inventory Fundamentals

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  1. Chapter 9-Inventory Fundamentals IM417 Manufacturing Resources Analysis Southeast Missouri State University Compiled by Bart Weihl Spring 2001

  2. Inventory Fundamentals • Inventory • Materials and supplies that a business or institution carries either for sale or to provide inputs or supplies to the production process • Represents between 20 to 60% of assets • http:www/inventoryops.com

  3. Inventory Fundamentals • Aggregate Inventory Management • Managing inventories according to their classification rather than at the individual item level. • Generally involves: • Flow and kinds of inventory needed • Supply and demand patterns • Functions that inventories perform • Objectives of inventory management • Costs associated with inventories

  4. Inventory Fundamentals • Item Inventory Management • The organization must establish some decision rules about inventory items for overall direction. • Rules include: • 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

  5. Inventory Fundamentals • Inventory and the Flow of Material • Raw materials • Purchased items received which have not entered the production process • Work-in-process • Raw materials that have entered the manufacturing process and are being worked on or waiting to be worked on

  6. Inventory Fundamentals • Inventory and the Flow of Material • Finished Goods • Finished products of the production process that are ready to be sold as completed items. • Distribution inventories • Finished goods located in the distribution system • Maintenance, Repair, and Operational Supplies (MRO) • Items used in production that do not become part of the product

  7. Inventory Fundamentals • Supply and Demand Patterns • Demand for many products is not constant enough to set up a flow system • Many products are made in lots or batches • Work moves in lots from one workstation or process to another as determined by the routings

  8. Inventory Fundamentals • Function of Inventories • In batch manufacturing, the basic purpose of inventories is to decouple supply and demand • Inventory serves as a buffer between: • Supply and demand • Customer demand and finished goods • Operations • Suppliers and queues

  9. Inventory Fundamentals • Function of Inventories • Anticipation inventory • Inventory built up in anticipation of future demand • Fluctuation Inventory • Inventory held to cover random unpredictable fluctuations in supply and demand or lead time

  10. Inventory Fundamentals • Function of Inventories • Lot-size Inventory • Also called cycle stock • Items purchased or manufactured in quantities greater than immediately needed. • Allows the firm to take advantage of quantity discounts and to reduce shipping, clerical, and setup costs

  11. Inventory Fundamentals • Function of Inventories • Transportation Inventory • Also called pipeline or movement inventories • Inventory in transit because of the time to move goods from one location to another • MROs • Used to support general operations and maintenance, but do not become part of the product

  12. Example: Transportation Inventory Q: A company is using a carrier to deliver goods to a major customer. The annual demand is $5,000,000, and the average transit time is 8 days. Another carrier promises to deliver in 6 days. What is the reduction in transit inventory? A: Average annual inventory in transit (I) = tA/365 Where t = transit time in days (8 - 6 = 2 days) A = annual demand ($5,000,000) I = (2 X $5,000,000) / 365 I = $27,397.26

  13. Inventory Fundamentals • Inventory Management • Responsible for planning and controlling inventory from raw material to customer. • Objectives: • Maximize customer service • Low-cost plant operations • Minimum inventory investment

  14. Inventory Fundamentals • Customer Service • The ability of a company to satisfy the needs of customers. • The availability of items needed • Inventories help to maximize customer service by protecting against uncertainty

  15. Inventory Fundamentals • Operating Efficiency • Inventory helps manufacturing to be more productive by: • Allowing operations with different rates of production to operate separately. • Assist with production planning and production leveling through lower costs. • Allowing for longer production runs • Allowing the purchase of larger quantities

  16. Inventory Fundamentals • Operating Efficiency • Inventory investment must be balanced with: • Customer service • Cost of changing production levels • Cost of placing orders • Transportation costs • If inventory is carried there must be a benefit that exceeds the costs of carrying that inventory.

  17. Inventory Fundamentals • Inventory Costs • Item Cost • Price paid plus other direct costs associated with getting the time into the plant • Carrying Costs • All the expenses incurred by the firm because of the volume of inventory carried. • Capital costs • Storage costs • Risk costs

  18. Excess inventory* has a negative impact on cash flow. Carrying costs include warehousing, racking, shelving, interest costs and insurance premiums (typically represents 8% to 14% of inventory costs). Reduction in inventory can apply 10% to the bottom line. Slow moving, or obsolete, inventory reduces profits with financial reserves and possible write-offs. *Excess Inventory: On-hand balances in excess of the amount needed to support demand Inventory and Bottom-Line Profits

  19. Example: Carrying Costs Q: A bakery carries an average inventory of $15,000. If they estimate the cost of capital is 10%, storage costs are 5%, and the risk costs are 8%, what does it cost per year to carry this inventory? A: Total cost of carrying inventory = 10% + 5% + 8% = 23% Annual cost of carrying inventory = 0.23 X $15,000 = $3,450

  20. Inventory Fundamentals • Inventory Costs • Ordering Costs • Costs associated with placing an order either with the factory or a supplier. • Cost of placing an order does not depend on quantity ordered. • Annual ordering costs depend on the number of orders placed per year. • Ordering costs would include: • Production control costs • Setup and teardown costs • Lost capacity cost • Purchase order cost

  21. Example: Ordering Costs Q: Annual purchasing salaries are $85,000, operating expenses for the purchasing department are $35,000, and inspecting and receiving costs are $30/order. If the purchasing department places 12,000 orders/year, what is the average cost of ordering? What is the annual cost of ordering? A: Average ordering cost = (fixed costs / number of orders) + variable cost = (($85,000 + $35,000) / 12,000) + $30 = $40 Annual ordering cost = (Average ordering cost)(number of orders) = ($40)(12,000) = $480,000

  22. Inventory Fundamentals • Inventory Costs • Stockout Costs • Stockouts occur when demand during leadtime exceeds the forecast. • Could include back-order costs, lost sales and customers • Capacity Associated Costs • Costs associated with changing the level of output • Overtime, hiring, training, shifts, layoffs…..etc

  23. Inventory Fundamentals • Financial Performance Measures • Inventory Turns Ratio: • Inventory Turns = Annual COGS/Avg. Inventory $ • Widely used as a measure of inventory performance • Lumps all inventory together thereby hiding obsolete and slow movers • Between 1977 and 1997, typical US high-tech manufacturer nearly doubled its inventory performance – from 2.4 to 4.8 turns/year* • *1998 PRTM study http://www.prtm.com

  24. Example: Inventory Turns Q: What will be the inventory turns if the annual cost of goods sold is $32 million a year and the average inventory is $8 million? A: Inventory turns = annual cost of goods sold / average inventory in $ = $32,000,000 / $8,000,000 = 4 Q: What would be the reduction in inventory if inventory turns were increased to 8 times per year? If the carrying costs for inventory is 25%, what are the projected savings? A: Average Inventory= annual cost of goods sold / inventory turns = 32,000,000 / 8 = $4,000,000 Reduction in inventory = $8,000,000 - $4,000,000 = $4,000,000 Savings = Inventory reduction X 25% = $4,000,000 X 0.25 = $1,000,000

  25. Inventory Fundamentals • ABC Inventory Control • A scheme where inventory is classified by level of importance in terms of annual sales dollars. • Based on Pareto’s Law: • A items: 20% of items accounts for 80% of usage • B items: 30% of items account for 15% of usage • C items: 50% of items account for 5% of usage

  26. Inventory Fundamentals • ABC Analysis • Establish item characteristics • Usually annual dollar usage • Classify items into groups based on criteria • Apply control appropriate to classification

  27. Inventory Fundamentals • Control Based on ABC Classification • Have plenty of low-value items • Use the money and control effort saved to reduce the inventory of high-value items • A items get the tightest control and attention • B items get normal controls • C items get simple controls

  28. Inventory Quality Ration (IQR) • Developed by materials managers from 35 companies. • Collectively reduced inventories by $500M in two years. • Implementation typically reduces inventories of manufacturing and distribution companies by an average of 25%.

  29. Inventory Quality Ration (IQR) • A true dollar-based performance measure includes: • Establishing inventory classes (based on $ Rqmts.) • Setting target inventory levels • Measuring the dollars invested in inventory • Establishing specific inventory objectives • Analyzing the data • Continuously improve

  30. Future Requirements Recent Past Usage Neither IQR Logic and Methodology • Use ABC-type classifications using • Future dollar requirements • Past dollar usage • Current balances on hand • Establish a rule or target balance for each item • Group inventory • Active (A) • Excess (E) • Slow moving (SM) • No moving (NM)

  31. IQR and its Effects IQR = = • Perfect condition (i.e., no excess, slow moving or no moving inventories), the IQR = 100% • Average IQR = 30% – 45% range Active $ A1 + A2 Total $ A1 + A2 + E1 + E2 + SM + NM

  32. For Next Week. . . Do Problems: • 9.1 • 9.3 • 9.5 • 9.7 • 9.14 • 9.16

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