11 - Inventory Management

Demand: Independent demand

An inventory of an item falls into the category of independent demand when the demand for such an item is not dependant upon the demand for another item. Independent demands for inventories are based on confirmed customer orders, forecasts, estimates and past historical data. Independent demand is demand for a finished product, such as a computer, a bicycle, or a pizza. Relating to: Finished goods and MRO

The order timing decision: Cyclical review system

Check stock levels at regular intervals (e.g. once a week or month). Reorder the quantity needed to return stock to a predetermined maximum level. Reorder quantity may vary each time. The maximum level aims to meet demand until the next review time, plus the delivery lead time. A simple system to operate: The stock checks are easy to plan into staff workloads (but neglect will cause problems). Suppliers receive regular orders. Periodic stock checks mean fewer recording errors.

The order timing decision: Reorder level system

Continuously monitors stock levels. Requires that records are constantly and accurately updated in real time. An order for replacement stock is placed immediately when the stock level falls to a predetermined reorder level. The reorder quantity is determined from past usage rates and quoted lead times. Assumes that the level of demand and the lead time are constant. Aims for the replacement stock to arrive just before stocks run out. A buffer of safety stock is usually held in case of extra demand or unreliable supply. Simple to operate as reorder quantities are always the same. Reorder quantities can be calculated from EOQ.

Demand: Dependent Demand

Dependent Demand If the demand for inventory of an item is dependant upon another item, such demands are categorized as dependant demand. Raw materials and component inventories are dependant upon the demand for finished Goods and hence can be called as Dependant demand inventories. For example, this would be the microchips in the computer, the wheels on the bicycle, or the cheese on the pizza.

Economic Batch Size

Despite the limitations of EOQ, it is still widely used in practice and it remains helpful in minimising the cost of ordering and holding stocks. The formula can also be used to calculate the optimum size of a batch of items to be manufactured. This is referred to as the Economic Batch Size (EBS) Economic Batch Quantity (EBQ), also known as the optimal production quantity (EPQ), is the order size of a production batch that minimizes the total cost. Batch production is a technique which is commonly used today for distributing the total production in a series of small batches rather than mass producing in one go. Sometimes the production of goods in batches is necessary because, for example, certain equipment used in manufacturing (e.g. dyes) may wear out and need replacement before the production can run again.

Raw materials can be divided into two groups:

Direct materials are used within the final product. Examples include the wood used to make furniture or the fabric used to make clothing. Indirect materials are used throughout the production process, but are not directly included in the final product. Examples include the oils used to maintain machinery or the lightbulbs in a factory.

The order quantity decision

Economic order quantity (EOQ) is the ideal order quantity a company should purchase for its inventory given a set cost of production, a certain demand rate, and other variables. This is done to minimize inventory holding costs and order-related costs. The equation for EOQ also takes into account inventory holding costs such as storage, ordering costs and shortage costs.

Inventory level analysis: Enterprise Resource Planning

Enterprise resource planning (ERP) is software used to plan, monitor and control all organizational activities, using a fully integrated computer system. Suppliers include SAP, Oracle, Sage and Microsoft. Integrates data from all functions (operations, marketing, HRM, finance, etc.). Suitable for any type of business, not just manufacturing. Beneficial for large, complex international organizations. Improves stock control and inventory tracking. Can be very expensive to install and maintain. Difficult to customize. Implementation requires external support, from vendors or consultants. Extensive staff training required.

Finished Goods Inventory

Finished goods are the final products obtained after the application of the manufacturing processes on the raw materials and the semi-finished goods .They are saleable and their sale contributes fully to the revenue from the core operations of the company.

Managing Independent Demand Inventory

Independent demand is where demand for an item occurs separately from that of any other item. Finished goods typically exhibit independent demand as it is determined by the market forces, usually by customer purchase behavior. MRO items often appears to exhibit a random pattern due to the varied usage by people, equipment and manufacturing processes. Approaches to stock control for independent demand centers around: Forecast likely demand. Hold sufficient stock to ensure demand can be met as it arises. Replenish the stock as it runs down. Two key decisions: How much stock to order at any one time - the order quantity decision, When to order it - the order timing decision.

Cost of not holding stock

Inefficiencies in operations. Costly expediting and emergency purchases. An inability to supply customers, customer dissatisfaction and lost sales.

Demand

Inventory Management deals essentially with balancing the inventory levels. Inventory is categorized into two types based on the demand pattern, which creates the need for inventory. The two types of demand are: Independent Demand Dependant Demand for inventories.

inventory management

Inventory management simply refers to the handling and controlling of a company's non-capitalised assets. For most retailers, this involves the overseeing and controlling of finished items that are ready to be sold. The fundamental goal is to keep inventory levels balanced at all times without ever having too much or too little product in stock. So staying on top of ordering, forecasting and storage are key parts of good quality inventory management.

MRO

Maintenance, repair, and operating (MRO) supplies materials that are consumed in the production processes but do not form a part of the finished goods or form a very small part of the finished goods. E.g. The maintenance and repair supplies include the lubricating oil, coolant, bolt, nuts etc. that are used during the production of various machines and machine components. Operating supplies include the stationery and office supplies used by a company.

Types of Inventory

Raw materials Work in Progress Finished goods Maintenance, repair and operating (MRO)

Raw Materials

Raw materials are materials or substances used in the primary production or manufacturing of goods. Raw materials are materials that have been received from a supplier and are awaiting processing. Example of Raw Materials: The raw materials involved in chocolate chip cookies are butter, sugar, eggs, flour, vanilla, baking powder and chocolate. It is important to optimize the raw material inventory. This is because if a company keeps too much of raw material inventory in stock, it will incur higher carrying costs and there is also the undesirable possibility of the inventory getting obsolete.

Cost of holding inventory

Running out of stock, particularly raw materials, WIP or MRO, can cause disruption of stoppages to operations, which may lead to the inability to supply customers with the output they require. Running out of finished goods risks dissatisfaction from those customers who are unable to take the delivery of goods as anticipated. Such dissatisfaction may lead to loss of business if those customers can go elsewhere. There can be significant costs associated with holding stocks. These include: The opportunity cost of investment capital tied up in stocks: Finances could have been used to fund other business activities at a higher rate of return. Storage costs: The cost of space and any specific storage conditions (temperature, humidity, etc.), or special security arrangements to prevent theft or damage. Deterioration and damage: Some goods may have a limited shelf life (e.g. food, medicine). Any stored goods run the risk of damage. Obsolescence: The value of some stocks can diminish with time due to obsolescence (e.g. technology, fashion, seasonal goods). Pilferage: Theft from internal or external individuals. Insurance costs: Premiums to insure inventory against loss.

Inventory level analysis: ABC analysis of stock

The ABC approach states that, when reviewing inventory, a company should rate items from A to C, basing its ratings on the following rules: A-items are goods which annual consumption value is the highest. The top 70-80% of the annual consumption value of the company typically accounts for only 10-20% of total inventory items. B-items are the interclass items, with a medium consumption value. Those 15-25% of annual consumption value typically accounts for 30% of total inventory items. C-items are, on the contrary, items with the lowest consumption value. The lower 5% of the annual consumption value typically accounts for 50% of total inventory items.

The order timing decision

The main aim in managing independent demand items is to ensure that stocks do not run out. The main requirement of a stock control system is to determine when and how much to order from suppliers this is achieved by implementing an order point system.

Reasons for holding inventory - MRO

To act as a buffer against uncertain demand To act as a buffer against uncertain supply In anticipation of extra demand due to planned maintenance

Reasons for holding inventory - raw materials

To act as a buffer against uncertainty of supply To secure purchase discounts To buy when prices are low To avoid anticipated shortages To act as a buffer against unpredictable demand in operations

Reasons for holding inventory - Finished goods

To provide 'off the shelf' availability To act as a buffer against variability or uncertainty in supply To act as a buffer against fluctuations in demand To build up stock to meet anticipated sales (e.g. seasonality or sales promotions)

Reasons for holding inventory - WIP

To provide flexibility by disengaging the different stages in the process To improve utilization rates at individual stages in the process

The order timing decision: Order point system

When the quantity of an item on hand in inventory falls to a predetermined level, called an order point, an order is placed. The quantity ordered is usually precalculated and based on economic-order-quantity concepts. There are two types of order point systems: Reorder level system Cyclical review system

Work in Progress (WIP)

Work in progress inventory (WIP) can also be called semi-finished goods. They are the raw materials that have been taken out of the raw materials store and are now undergoing the process of their conversion into the final products. These are the partly processed raw materials lying on the production floor and they have also not reached the stage where they have been converted into the final product.