Inventory Management Dr Hisham Madi 1 1 JustinTime

Inventory Management Dr. Hisham Madi 1 -1

Just-in-Time Purchasing Ø Just-in-time (JIT) purchasing is the purchase of materials (or goods) so that they are delivered just as needed for production (or sales). Example; Ø (HP’s) manufacture of computer printers Ø HP has long-term agreements with suppliers for the major components of its printers Ø Each supplier is required to make frequent deliveries of small orders directly to the production floor, based on the production schedule that HP gives its suppliers. Ø Suppliers work hard to keep their commitments because failure to deliver components on time, or to meet agreed-upon quality standards, can cause an HP assembly plant not to meet its own scheduled deliveries for printers. 1 -2

JIT Purchasing and EOQ Model Parameters Ø Companies moving toward JIT purchasing to reduce their costs of carrying inventories (parameter C in the EOQ model). Ø JIT reduces the cost of placing a purchase order because: § Companies are establishing long-term purchasing agreements that define price and quality terms over an extended period. Individual purchase orders covered by those agreements require no additional negotiation regarding price or quality. § Companies are using electronic links to place purchase orders at a cost that is estimated to be a small fraction of the cost of placing orders by telephone or by mail § Companies are using purchase-order cards (similar to consumer credit cards such as VISA and Master. Card) 1 -3

Relevant Costs of JIT Purchasing Ø JIT purchasing is not guided solely by the EOQ model. The EOQ model is designed only to emphasize the trade-off between relevant carrying and ordering costs Ø Inventory management also includes purchasing costs, stock-out costs, costs of quality, and shrinkage costs. Ø JIT relevant costs include: o Purchasing costs o Ordering costs o Opportunity costs o Carrying costs o Stockout costs o Quality costs 1 -4

Relevant Costs of JIT Purchasing 1 -5

Relevant Costs of JIT Purchasing 1 -6 Ø When comparing two or more purchasing policies the analysis should include only the relevant costs – those costs that differ between alternatives. Ø The difference between two incremental costs is the relevant savings from choosing a given purchasing policy

Supplier Evaluation and Relevant Costs of Quality and Timely Deliveries 1 -7 Ø Companies that implement JIT purchasing choose their suppliers carefully and develop long-term supplier relationships. Ø Some suppliers are very cooperative with a business’s attempts to adopt JIT purchasing Ø costs of quality and timely deliveries are particularly crucial in JIT purchasing environments. Ø When evaluating suppliers, companies have to pay special attention to quality costs of goods or materials (for example, incoming materials inspection costs, returns); costs of late deliveries (expediting costs, and forgone contribution margin on lost sales); and costs of early

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JIT Purchasing and Supply-Chain Analysis Ø Supply chain describes the flow of goods, services, and information from the initial sources of materials and services to the delivery of products to consumers Ø By sharing information and planning and coordinating activities throughout the supply chain among retailers, 1 -9

JIT Purchasing and Supply-Chain Analysis Ø Procter and Gamble’s (P&G’s) experience with its Pampers product. Ø Retailers selling Pampers encountered variability in weekly demand because families purchased disposable diapers randomly. Ø Anticipating even more demand variability and lacking information about available inventory with P&G, retailers’ orders to P&G became more variable that, in turn, increased variability of orders at P&G’s suppliers, resulting in high levels of inventory at all stages in the supply chain 1 -10

JIT Purchasing and Supply-Chain Analysis How did P&G respond to these problems? Ø Ø 1) 2) 3) 4) 1 -11 By sharing information and planning and coordinating activities throughout the supply chain among retailers, P&G, and P&G’s suppliers. Sharing sales information reduced the level of uncertainty that P&G and its suppliers had about retail demand for Pampers and led to: fewer stock-outs at the retail level, reduced manufacture of Pampers not immediately needed by retailers, fewer manufacturing orders that had to be “rushed” or “expedited, ” and lower inventories held by each company in the supply chain.

Inventory Management, Materials Requirements Planning (MRP) & JIT production Materials Requirements Planning ØMaterials requirements planning (MRP)is a “push-through” system that manufactures finished goods for inventory on the basis of demand forecasts. ØTo determine outputs at each stage of production, MRP uses (1) demand forecasts for final products; (2) a bill of materials detailing the materials, components, and subassemblies for each final product; and (3) available inventories of materials, components, and products 1 -12

Inventory Management, Materials Requirements Planning (MRP) & JIT production Ø Taking into account the lead time required to purchase materials and to manufacture components and finished products, a master production schedule specifies the quantity and timing of each item to be produced. Ø Once production starts as scheduled, the output of each department is pushed through the production line. 1 -13

JIT Production Ø Just-in-time (JIT) production, which is also called lean production, is a “demand-pull” manufacturing system that manufactures each component in a production line as soon as, and only when, needed by the next step in the production line. Ø In a JIT production line, manufacturing activity at any particular workstation is prompted by the need for that workstation’s output at the following workstation. 1 -14

JIT Production Goals = Ø JIT production systems result in close coordination among work -stations. Ø Smooths the flow of goods. Ø Achieves low quantities of inventory. JIT aims to simultaneously: ü Meet customer demand in a timely manner. ü Produce high quality products. ü Generate the lowest possible costs. 1 -15

Features of JIT Production Systems Ø Production is organized in manufacturing cells, which are work areas with different types of equipment grouped together to make related products. 1 -16

Features of JIT Production Systems 1 -17

Features of JIT Production Systems Ø Workers are hired and trained to be multi-skilled, capable of performing a variety of operations and tasks, including minor repairs and routine equipment maintenance. Ø Defects are aggressively eliminated. Because of the tight links between workstations in the production line and the minimal inventories at each workstation, defects arising at one workstation quickly affect other workstations in the line 1 -18

Features of JIT Production Systems Ø Setup time, the time required to get equipment, tools, and materials ready to start the production of a component or product, and manufacturing cycle time, the time from when an order is received by manufacturing until it becomes a finished good, are reduced. Ø Reducing setup time and costs makes production in smaller batches economical, which in turn reduces inventory levels. Reducing manufacturing cycle time enables a company to respond faster to changes in customer demand 1 -19

Features of JIT Production Systems Ø Suppliers are selected on the basis of their ability to deliver quality materials in a timely manner. Ø Most companies implementing JIT production also implement JIT purchasing 1 -20

Costs and Benefits of JIT Production Ø Lower inventory levels, lower carrying costs Ø Heightened emphasis on improving quality by eliminating the specific causes of rework, scrap, and waste Ø Lower manufacturing cycle times 1 -21

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Performance Measures and Control in JIT Ø Managers use financial and nonfinancial measures to evaluate and control JIT production Ø Financial performance measures such as inventory turnover ratio, which is expected to increase Ø Nonfinancial performance measures of time, inventory, and quality such as: Ø Number of days of inventory on hand, expected to decrease Ø Units produced per hour, expected to increase Ø % of scrapped/rework over total units started: expected to decrease Ø Manufacturing cycle time: expected to decrease. 1 -23

Effect of JIT Systems on Product Costing ØA unique production system such often leads to its own unique costing system as JIT Ø Organising manufacturing in cells, reducing defects and manufacturing lead time, and ensuring timely delivery of materials enables purchasing, production and sales to occur in quick succession with minimal stocks. Ø in-time production techniques, the absence of inventories makes choices about cost-flow assumptions or inventory costing methods unimportant. All manufacturing costs of the accounting period flow directly into cost of goods sold. This can permit a simplified costing system. 1 -24

Effect of JIT Systems on Product Costing Simplified normal or standard job costing Ø Traditional normal and standard costing systems use sequential tracking, which is a system of recording journal entries in the same order as purchases and progress in production. Ø These traditional systems track costs sequentially as products pass from direct materials, to work in progress, to finished goods and finally to sales. Ø A sequential-tracking costing system has four trigger points 1 -25

Effect of JIT Systems on Product Costing Back-flush Costing Ø a system that omits some of the journal entries relating to the four stages shown in a sequential tracking system. Ø it then uses budgeted or standard costs to work backwards to flush out manufacturing costs for the units produced 1 -26

Trigger Points Ø The term trigger point refers to a stage in a cycle going from purchase of direct materials to sale of finished goods at which journal entries are made in the accounting system. Ø A sequential tracking costing system would have four trigger points, corresponding to separate journal entries being made at different stages. 1 -27

Trigger Points Stage A: Purchase of direct materials Stage B: Production resulting in work-in-progress Stage C: Completion of a finished unit or product Stage D: Sale of finished goods 1 -28

Trigger Points Ø Assume trigger points A, C and D. Ø This company would have two stock accounts: Ø SVC determines that the standard direct material cost per keyboard unit is $19 and the standard conversion cost is $12 Ø SVC purchases $1, 950, 000 of direct materials. To focus on the basic concepts, we assume SVC has no direct materials variances. Actual conversion costs equal $1, 260, 000. SVC produces 100, 000 good keyboard units and sells 99, 000 units. Ø Any underallocated or overallocated conversion costs are written off to cost of goods sold at the end of April 1 -29

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Trigger Points The April 30 ending inventory balances under backflush costing are as follows: 1 -32

Accounting for Variances Ø Accounting for variances between actual and standard costs. Ø VC had an unfavorable direct materials price variance of $42, 000. Then the journal entry would be as follows: Ø Many companies will at least measure the direct materials efficiency variance in total by physically comparing what remains in direct materials inventory against what should remain based on the output of finished goods for the accounting period 1 -33

Trigger Points Ø The two trigger points are Purchase of direct materials and incurring of conversion costs (Stage A) and Sale of finished goods (Stage D) Ø Note that in this example, there is no journal entry for Production resulting in work in progress (Stage B) and Completion of good finished units of product (Stage C) because there are minimal work in process and finished goods inventories. Ø In this example, there is only one inventory account: direct materials, whether they are in storerooms, in process, or in finished goods. 1 -34

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Trigger Points Ø The two trigger points are Completion of good finished units of product (Stage C) and Sale of finished goods (Stage D). Ø This example has two trigger points. In contrast to Example 2, the first trigger point in Example 3 is delayed until Stage C, SVC’s completion of good finished units of product. Ø there are no journal entries for Purchase of direct materials and incurring of conversion costs (Stage A) and Production resulting in work in process (Stage B) because there are minimal direct materials and work-in-process inventories 1 -37

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