INVENTORY CONTROL MEANING InventoryA physical resource that a

INVENTORY CONTROL

MEANING Inventory-A physical resource that a firm holds in stock with the intent of selling it or transforming it into a more valuable state. � Inventory System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be. It involves inventory planning and decision making with regard to the quantity and time of purchase, fixation of stock levels, maintenance of stores record and continuous stock taking. �

THE INVENTORY DECISION � In an Inventory control situation, there are three basic questions to be answered. They are: 1. How much to order? 2. When should the order be placed? 3. How much safety stock should be kept?

TYPES OF INVENTORIES Types of Inventories Direct Inventories Raw Material Work in Progress Transit Inventories Indirect Inventories Finished Goods Buffer Inventories Lot Size Inventories Decoupling Inventories Seasonal Inventories Fluctuation Inventories

Factors Affecting Inventory Control Policy A. 1. 2. 3. 4. 5. Characteristics of the manufacturing system: Degree of Specialization and differentiation of the products at various stages. Process capability and flexibility. Production capacity and storage facility. Quality requirements. Nature of production system. B. 1. 2. 3. 4. 5. 6. Amount of protection against storages: Changes in size and frequency of orders. Unpredictability of sales. Physical and economic structure of distribution pattern. Costs associated with failure to meet demand. Accuracy, frequency and detail of demand forecasts. Protection against breakdown or other interruptions in production.

Objectives of Inventory Control 1. 2. 3. 4. 5. 6. 7. 8. 9. A hedge against inflation. Protection against fluctuation in demand. Protection against fluctuation in supply. To avoid stock outs and shortages. Quantity discounts. Optimum use of men, machines & materials. Maintaining different level of stock. Control of stock volume. The decoupling function.

Scope of Inventory Control 1. 2. 3. 4. 5. 6. 7. Formulation of policy. Organization structure. Determination of economic order quantity. Determination of safety stock. Determination of lead time. Minimum material handling & storage cost. Effectiveness towards running of store.

TOOLS & TECHNIQUES OF INVENTORY MANAGEMENT 1. DETERMINATION OF STOCK LEVELS 2. DETERMINATION OF SAFETY STOCKS 3. INVENTORY CONTROL SYSTEMS 4. ECONOMIC ORDER QUANTITY 5. PRODUCTION QUANTITY MODEL 6. QUANTITY DISCOUNTS 7. ABC ANALYSIS 8. JIT CONTROL SYSTEM 9. VED ANALYSIS 10. FNSD ANALYSIS 11. PREPETUAL INVENTORY SYSTEM 12. PRICE BREAKS APPROACH 13. OTHER MODELS OF INVENTORY CONTROL

1. Determination Of Stock Levels Reorder Point Level of inventory at which a new order is placed. R = d. L where d = demand rate period L = lead time

Re-ordering level It is the level of stock quantity between minimum and maximum level and material order was sent for getting fresh stock. Formula : maximum usage of stock X maximum delivery period

Minimum level � It is the minimum balance, which must be maintained in hand at all times, so that there is no stoppage of production due to non availability of inventory. Remember You must need re-order level for getting it. Formula : Re-order level - ( Normal usage X average period )

Maximum level � It shows maximum quantity which should be in the stock, if we buy more, it means we are wasting money. Formula : re-order level X re-order quantity - ( minimum usage X minimum period )

Average Stock Level � This is the average of minimum and maximum level and it can be calculated by adding minimum level and maximum level and divided by 2. formula : minimum level + maximum level / 2

Danger level � It is the level at which normal issues of the raw material inventory are stopped and emergency issues are only made. formula : average consumption X lead time for emergency purchases

2. Determination of Safety Stocks Safety stock buffer added to on hand inventory during lead time Stockout an inventory shortage Service level probability that the inventory available during lead time will meet demand

Variable Demand with a Reorder Point Inventory level Q Reorder point, R 0 LT LT Time

Inventory level Reorder Point with a Safety Stock Q Reorder point, R Safety Stock 0 LT LT Time

Reorder Point With Variable Demand R = d. L + z d L where d = average daily demand L = lead time d = the standard deviation of daily demand z = number of standard deviations corresponding to the service level probability z d L = safety stock

Reorder Point for a Service Level Probability of meeting demand during lead time = service level Probability of a stockout Safety stock z d L d. L Demand R

Reorder Point for Variable Demand The carpet store wants a reorder point with a 95% service level and a 5% stockout probability d = 30 yards per day L = 10 days d = 5 yards per day For a 95% service level, z = 1. 65 R = d. L + z d L Safety stock = z d L = 30(10) + (1. 65)(5)( 10) = 326. 1 yards = 26. 1 yards

3. Inventory Control Systems Continuous system (fixedorder-quantity or Q Systems) constant amount ordered when inventory declines to predetermined level Periodic system (fixed-timeperiod or P Systems) order placed for variable amount after fixed passage of time

Fixed Order Quantity System or Q Systems – In reorder level system, a replenishment order fixed size (Q) is placed when the stock level falls to the fixed reorder level (R). Thus a fixed quantity is ordered at various interval of time. � Periodic Review System or P System – In periodic review system, the inventory levels are reviewed at fixed points of time, when the quantity to be ordered is decided. By this method variable quantities are ordered at fixed time intervals �

4. ECONOMIC ORDER QUANTITY (EOQ) � Economic order quantity is the size of the lot to be purchased which is economically viable. This the quantity of materials which can be purchased at minimum costs. � ASSUMPTIONS � Demand rate D is constant, recurring, and known Amount in inventory is known at all times Ordering (setup) cost S per order is fixed Lead time L is constant and known. Unit cost C is constant (no quantity discounts) Annual carrying cost is i time the average RUPEE value of the inventory No stock outs allowed. Material is ordered or produced in a lot or batch and the lot is received all at once � � � �

EOQ Inventory Order Cycle Order qty, Q Inventory Level Demand rate ave = Q/2 Reorder point, R 0 As Q increases, average inventory level increases, but number of orders placed decreases Lead time Order Placed Received Lead Time time Order Placed Received

EOQ Cost Model Co - cost of placing order Cc - annual per-unit carrying cost D - annual demand Q - order quantity Annual ordering cost = Co D Q Annual carrying cost = Cc Q 2 Co D Cc Q Total cost = + Q 2

EOQ Cost Model Deriving Qopt Co D Cc Q TC = + Q 2 Co D Cc TC = 2 + Q 2 Q C 0 D Cc 0= + Q 2 2 Qopt = 2 Co. D Cc Proving equality of costs at optimal point Co D Cc Q = Q 2 2 Co. D = Cc Qopt = 2 Co. D Cc

EOQ Cost Model (cont. ) Annual cost ($) Total Cost Slope = 0 Cc. Q Carrying Cost = 2 Minimum total cost Co D Ordering Cost = Q Optimal order Qopt Order Quantity, Q

EOQ Example Cc = $0. 75 per yard Qopt = 2 Co. D Cc Qopt = 2(150)(10, 000) (0. 75) Co = $150 Qopt = 2, 000 yards Orders per year = = = D/Qopt 10, 000/2, 000 5 orders/year D = 10, 000 yards Co. D Cc Q TCmin = + Q 2 TCmin = (150)(10, 000) (0. 75)(2, 000) + 2, 000 2 TCmin = $750 + $750 = $1, 500 Order cycle time = = = 311 days/(D/Qopt) 311/5 62. 2 store days

5. Production Quantity Model An inventory system in which an order is received gradually, as inventory is simultaneously being depleted � AKA non-instantaneous receipt model � �assumption that Q is received all at once is relaxed p - daily rate at which an order is received over time, a. k. a. production rate � d - daily rate at which inventory is demanded �

Production Quantity Model (cont. ) Inventory level Q(1 -d/p) Maximum inventory level Q (1 -d/p) 2 Average inventory level 0 Order receipt period Begin End order receipt Time

Production Quantity Model (cont. ) p = production rate Maximum inventory level = Q - d = demand rate Q d p =Q 1 - d p Q d Average inventory level = 1 p 2 Co D Cc Q d TC = Q + 2 1 - p Qopt = 2 Co. D d Cc 1 p

Production Quantity Model: Example Cc = $0. 75 per yard Co = $150 d = 10, 000/311 = 32. 2 yards per day 2 Co D Qopt = Cc 1 - d p D = 10, 000 yards p = 150 yards per day 2(150)(10, 000) = Co D Cc Q d TC = Q + 2 1 - p 32. 2 0. 75 1 150 = 2, 256. 8 yards = $1, 329 2, 256. 8 Q Production run = = = 15. 05 days per order p 150

Production Quantity Model: Example (cont. ) Number of production runs = 10, 000 D = = 4. 43 runs/year 2, 256. 8 Q Maximum inventory level = Q 1 - d p = 2, 256. 8 1 - = 1, 772 yards 32. 2 150

6. QUANTITY DISCOUNTS Price per unit decreases as order quantity increases Co. D Cc Q TC = + + PD Q 2 where P = per unit price of the item D = annual demand

Quantity Discount Model (cont. ) ORDER SIZE 0 - 99 100 – 199 200+ PRICE $10 8 (d 1) 6 (d 2) TC = ($10 ) TC (d 1 = $8 ) Inventory cost ($) TC (d 2 = $6 ) Carrying cost Ordering cost Q(d 1 ) = 100 Qopt Q(d 2 ) = 200

Quantity Discount: Example QUANTITY PRICE 1 - 49 50 - 89 90+ $1, 400 1, 100 900 Qopt = For Q = 72. 5 For Q = 90 2 Co D = Cc Co = $2, 500 Cc = $190 per computer D = 200 2(2500)(200) = 72. 5 PCs 190 Cc. Qopt Co D TC = + + PD = $233, 784 2 Qopt Cc Q Co D TC = + + PD = $194, 105 2 Q

7. ABC ANALYSIS v The materials are divided in to a number of categories for adopting a selective approach for material control. � Classification of items as a, b, or c Purpose: set priorities for management attention. � ‘A’ items: 20% of the items contributes, 80% value � ‘B’ items: 30 % of Items contributes , 15% Value � ‘C’ items: 50 % of Items contributes , 5% value � Three classes is arbitrary; could be any number. � Percents are approximate. �

ABC ANALYSIS EXAMPLE +Class C Percentage of dollar value 100 — +Class B 90 — Class A 80 — 70 — 60 — 50 — 40 — 30 — 20 — 10 — 0— 10 20 30 40 50 60 70 Percentage of items 80 90 100

ABC Classification � Class A � 5 – 15 % of units � 70 – 80 % of value � Class B � 30 % of units � 15 % of value � Class C � 50 – 60 % of units � 5 – 10 % of value

8. JIT CONTROL SYSTEM � Just in Time purchasing is the purchase of material in such a way that delivery of purchased items is assured before their use or demand.

9. VED Analysis � VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The spare, parts can be divided into three categories – vital, essential or desirable – keeping in view the critically to production.

10. FNSD Analysis � FNSD analysis divides the items into four categories in the descending order of their usage rate as follows: � ‘F’ means Fast moving items � ‘N’ means normal moving items � ‘S’ means slow moving items � ‘D’ means dead stock.

11. Perpetual Inventory System Perpetual Inventory is a system of records maintained by the controlling department, which reflects the physical movement of stocks and their current balance. It aims at devising the system of records by which the receipts and issues of stores may be recorded immediately at the time of each transaction and the balance may be brought out so as to show the up-to-date position. The records used for perpetual inventory are: (i) Bin Cards; (ii) Store Ledger Accounts or Stores Record cards; (iii) The forms and documents used for receipt, issue and transfer of materials.