Ch. 4 Inventory Management

80/20 rule - ABC system

Generally, A items account for approx. 20% of the total number of items, but about 80% of the total inventory cost. B & C account for 80% total items, but only 20% of total inventory cost

Service Inventory

activities carried out in advance of the customer's arrival (service companies do not maintain inventory since services are basically produced and consumed immediately upon demand)

Strategic stock

additional inventory beyond cycle and safety stock, generally used for a very specific purpose or future event, and for a defined period of time; carry safety stock to: take advantage of price discount, hedge currency fluctuations, etc.

Periodic Review System (when to review)

at the time of review, if the stock levels are below the pre-determined level, an order for replenishment is placed, otherwise no action is taken until the next cycle; greater risk of inventory dropping well below the reorder point advantage: reduces time spent analyzing inventory and less expensive than continuous review system disadvantage: may not provide accurate inventory counts and can make inventory accounting less accurate

Barcodes

barcode systems help business track products and stock levels for inventory management

Inventory turnover ratio

cost of goods sold (cost sales or cost of rev.)/ average inventory at cost

Costs related to inventory

direct, indirect, fixed, variable, order, carrying

Having too much inventory can result in effects like

financial resources tied up in inventory; no incentive for process improvements; underlying problems being hidden rather than being exposed and solved

A key decision in any product-based supply chain is

how much inventory to keep on hand

Order costs

labor costs associated with placing an order for inventory and the cost of receiving the order

Inventory can be a liability because

more inventory -> more space needed -> cost of space needed (storage cost, security, insurance, tax) -unusable due to expiration, damage, spoilage

Make-to-stock

product is produced prior to receipt of a customer order; produced based on forecast and demand plan; significant amount of inventory maintained

Safety stock "buffer stock"

quantity of stock planned to be in inventory to protect against fluctuations in demand or supply (utilized mainly by companies in a make-to-stock environment)

Four categories of inventory

raw materials, work in progress, finished goods, MRO (maintenance, repair, operating) supplies

Inventory turnover

the number of times that an inventory cycles during the year

Careful management of inventory is essential because

-Inventory is one of the company's largest assets -allows company to fill customer orders immediately -support manufacturing operations while avoiding delays

Functions of Inventory

1. to meet customer demand (cycle stock) 2. to buffer against uncertainty in demand and or supply (safety stock) 3. to decouple supply from demand (strategic stock) - speculative buying in anticipation of price increase 4. To decouple dependencies in the supply chain - separating operations in a process

Common metrics for inventory

1. units 2. dollars 3. weeks of supply (avg. on hand inventory)/(avg. weekly usage) 4. inventory turns (cost of good sold)/(avg. inventory value)

ABC Inventory System

classifies inventory based on the degree of importance determine annual usage or sale for each item -> determine % of total usage or sales each item represents -> ranks items from highest to lowest % -> classify items into groups: A. Highest value B. Moderate C. Least

Carrying costs

costs for physically having inventory on-site and for maintaining the infrastructure needed to store the inventory and to secure and insure it over time

Fixed Order Quantity System (how much to order)

if the review determines that an order should be placed, then the order for a pre-defined quantity for that item is placed; calculate reorder point or order quantity

Pipeline Inventory

inventory in the transportation network and the distribution system; inventory that is already out in the market being held by wholesalers, distributors, retailers, and even consumers

Inventory stock level - external inventory

pipeline inventory

EOQ calculation

sqrt. ((2 x order cost x annual demand volume)/(annual carrying cost % x unit cost))

Goal of inventory management

to help a company be more profitable by lowering the cost of goods sold and/or by increasing sales reducing the amount of inventory held in stock while ensuring there is enough inventory to satisfy customer demand

Single-Period Inventory Model

type of inventory system in which inventory is only ordered for a one-time stocking ex. Christmas tree lots

Base Stock Level System

type of inventory system that issues an order whenever a withdrawal is made from inventory - used primarily for very expensive items; form of JIT

Strategies for how much finished goods to maintain

1. Make to order 2. Make to stock

Strategies on how much raw material to buy

1. buy from supplier and have it delivered to the operation just in time for when it is needed 2. buy and hold a larger quantity for strategic reasons (companies willing to increase cost if they feel the price will soon increase or they fear a shortage of inventory)

Fixed-Time Period System - determining q

Q = R - IP Q=order quantity R=target inventory level IP=inventory position

Work in Progress

a good or goods in various stages of completion throughout the plant, spanning from raw material that has been released for initial processing up to fully processed material awaiting final inspection and acceptance as finished goods

Inventory policy - establishing target inventory

addresses three fundamental questions: when to review, when to order, how much to order

Continuous Review System (when to review)

as soon as inventory levels fall below a pre-determined level, a replenishment order is triggered advantage: real-time updates of inventory and facilitates accurate accounting disadvantage: cost of implementation

Indirect costs

cannot be traced directly to the unit produced ex. MRO items, buildings, equipment

Inventory stock levels - 3 levels of internal inventory

cycle stock, safety stock, strategic stock

Direct costs

directly traceable to unit produced ex. materials, labor

Failure to manage inventory leads to inefficiencies including

dissatisfied customers, lost sales and revenues, higher costs

Make-to-order

finished goods are not produced until a customer order is received; little to no finished good inventory maintained

Economic Order Quantity Model (EOQ)

fixed-order quantity model; based on the trade-off between annual inventory carrying costs and annual order costs; seeks to determine an optimal order quantity where sum of the annual order costs and the annual inventory carrying costs are minimized

Cycle Stock

inventory a company builds to satisfy its immediate demand; depletes with customer orders and replenishes when supply orders are received

Fixed Time Period System (how much to order)

inventory is checked in fixed time periods against a target inventory level

Bin Inventory System

inventory system that uses either one or two bins to hold a quantity of the item being inventoried - used for small or low value items; second bin is used to hold enough inventory to cover demand during the replenishment lead time

Finished goods

items on which all manufacturing operations, including final testing, have been completed; available for sale or shipment

Facilitating Goods (in service industry)

items that are used to help facilitate the service being provided ex. food and tableware in resturaunts

Maintenance, Repair, Operation suplies (MRO)

items used in support of general operations and maintenance such as maintenance supplies, spare parts, and consumables used in the manufacturing process and supporting operations; do not end up part of the finished good

Having too little inventory can result in effects like

production disruptions; longer delivery replenishment lead times; reduced responsiveness

Raw materials

purchased items converted via the manufacturing process into components and products

Inventory

quantity of goods/materials held in stock

Obsolete Inventory

stock that is expired, damaged, or no longer needed; takes up space and costs money to maintain; may be donated to a non-profit if has any remaining value

Reorder Point (ROP) (when to order)

the lowest inventory level at which a new order must be placed to avoid a stockout; set at a level that provides enough inventory so demand is covered during the lead time needed to replenish inventory ROP = demand during lead time (dL)

Absolute Inventory Value

the value of inventory at either its cost or its market value; generally found on the balance sheet