Inventory Management Dr Manish dadhich 1192019 Inventory Definition

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Inventory Management • Dr. Manish dadhich 11/9/2019

Inventory Management • Dr. Manish dadhich 11/9/2019

Inventory Definition A stock of items held to meet future demand Inventory is a

Inventory Definition A stock of items held to meet future demand Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business. 12/10/20 11/9/2019 18 2

 Introductio n Constitute significant part of current assets On an average approximately 60%

Introductio n Constitute significant part of current assets On an average approximately 60% of current assets in Public Limited Companies in India A considerable amount of fund is required Effective and efficient management is imperative to avoid unnecessary investment Improper inventory management affects long term profitability and may fail ultimately 10 to 20% of inventory can be reduced without any adverse effect on production and sales by using simple inventory planning and control techniques 11/9/2019 3

Types of Inventory Work in process Vendors Raw Materials Work in process Finished Customer

Types of Inventory Work in process Vendors Raw Materials Work in process Finished Customer goods Work in process 11/9/2019 4

Nature of Inventories Raw Materials – Basic inputs that are converted into finished product

Nature of Inventories Raw Materials – Basic inputs that are converted into finished product through the manufacturing process Work-in-progress – Semi-manufactured products need some more works before they become finished goods for sale Finished Goods – Completely manufactured products ready for sale Supplies – Office and plant cleaning materials not directly enter production but are necessary for production process and do not involve significant investment. 11/9/2019

Reasons To Hold Inventory Meet variations in customer demand: Pricing related: Meet unexpected demand

Reasons To Hold Inventory Meet variations in customer demand: Pricing related: Meet unexpected demand Smooth seasonal or cyclical demand Temporary price discounts Hedge against price increases Take advantage of quantity discounts Process & supply surprises 11/9/2019 Internal – upsets in parts of or our own processes External – delays in incoming goods 6

Objective of Inventory Management To maintain a optimum size of inventory for efficient and

Objective of Inventory Management To maintain a optimum size of inventory for efficient and smooth production and sales operations To maintain a minimum investment in inventories to maximize the profitability Effort should be made to place an order at the right time with right source to acquire the right quantity at the right price and right quality 11/9/2019 7

An effective inventory management should Ensure a continuous supply of raw materials to facilitate

An effective inventory management should Ensure a continuous supply of raw materials to facilitate uninterrupted production Maintain sufficient stocks of raw materials in periods of short supply and anticipate price changes Maintain sufficient finished goods inventory for smooth sales operation, and efficient customer service Minimize the carrying cost and time Control investment in inventories and keep it at an optimum level 11/9/2019 8

Types of costs in Inventory Management • There are three types of costs that

Types of costs in Inventory Management • There are three types of costs that must be considered in setting inventory levels: 1. Carrying cost: They are expenses such as storage, handling, insurance, taxes, obsolescence, theft, and interest on funds financing the goods. These charges increase as inventory levels rise. To minimize carrying costs, management makes frequent orders of small quantities. 2. Ordering costs: Ordering costs are those fees associated with placing an order, including expenses related to personnel in purchasing department, communications, and the handling of related paper work. 3. Stock out costs: They include sales that are lost, both short and long term, when a desired item is not available; the costs associated with back ordering the missing item; or expenses related to stopping the production line because a component part has not arrived. 11/9/2019

An optimum inventory level involves three types of costs Ordering costs: Quotation or tendering

An optimum inventory level involves three types of costs Ordering costs: Quotation or tendering Requisitioning Order placing Transportation Receiving, inspecting and storing Quality control Clerical and staff Stock-out cost Loss of sale Failure to meet delivery commitments 11/9/2019 Carrying costs: Warehousing or storage Handling Clerical and staff Insurance Interest Deterioration, shrinkage, evaporation and obsolescence Taxes Cost of capital 9

Dangers of Over investment Unnecessary tie-up of firm’s fund and loss of profit –

Dangers of Over investment Unnecessary tie-up of firm’s fund and loss of profit – involves opportunity cost Excessive carrying cost Risk of liquidity- difficult to convert into cash Physical deterioration of inventories while in storage due to mishandling and improper storage facilities 11/9/2019 10

Dangers of underinvestment Production hold-ups – loss of labor hours Failure to meet delivery

Dangers of underinvestment Production hold-ups – loss of labor hours Failure to meet delivery commitments Customers may shift to competitors which will amount to a permanent loss to the firm May affect the goodwill and image of the firm 11/9/2019 11

Functions of Inventory Management -Track inventory –How much to order –When to order 11/9/2019

Functions of Inventory Management -Track inventory –How much to order –When to order 11/9/2019 12

Technique of inventory management • ABC Analysis • JUST IN TIME (JIT) • HML

Technique of inventory management • ABC Analysis • JUST IN TIME (JIT) • HML Analysis XYZ Analysis VED Analysis FSN Analysis SDF Analysis GOLF Analysis SOS Analysis • • • 11/9/2019

ABC Analysis • ABC analysis stands for Always Better Control Analysis. It is an

ABC Analysis • ABC analysis stands for Always Better Control Analysis. It is an inventory management technique where inventory items are classified into three categories namely: A, B, and C. • The items in A category of inventory are closely controlled as it consists of high priced inventory which may be less in number but are very expensive. • The items in B category are relatively lesser expensive inventory as compared to A category and the number of items in B category is moderate so control level is also moderate. • The C category consists of a high number of inventory items which require lesser investments so the control level is minimum. 11/9/2019

ABC Classification • • In most of the cases 10 to 20 % of

ABC Classification • • In most of the cases 10 to 20 % of the inventory account for 70 to 80% of the annual activity. A typical manufacturing operation shows that the top 15% of the lin e items, in terms of annual rupees usag e, r epresent 80% of total annual rupees usag e. Next 15% of items reflect 15% of annual rupees Next 70% accounts only for 5% usage 11/9/2019

Just in Time method • In Just in Time method of inventory control, the

Just in Time method • In Just in Time method of inventory control, the company keeps only as much inventory as it needs during the production process. With no excess inventory in hand, the company saves the cost of storage and insurance. The company orders further inventory when the old stock of inventory is close to replenishment. 11/9/2019

XYZ Analysis On the basis of value of inventory stored Whereas ABC was on

XYZ Analysis On the basis of value of inventory stored Whereas ABC was on the basis of value of consumption to value. X – High Value Y – Medium value Z – Least value Aimed to identify items which are extensively stocked. 11/9/2019

HML Analysis On the basis of unit value of item There is 1000 unit

HML Analysis On the basis of unit value of item There is 1000 unit of Q @ Rs. 10 and 10, 000 units of W @ Rs. 5. Aimed to control the purchase of raw materials. H – High, M- Medium, L - Low 11/9/2019

VED Analysis • • Mainly for spare parts because their consumption pattern is different

VED Analysis • • Mainly for spare parts because their consumption pattern is different from raw materials. Raw materials on market demand D Items has to be less stocked Spare parts on performance of plant and machinery. V – Vital, E – Essential, D – Desirable 11/9/2019

V – Vital, E – Essential, D – Desirable VED • VED stands for

V – Vital, E – Essential, D – Desirable VED • VED stands for Vital Essential and Desirable. Organizations mainly use this technique for controlling spare parts of inventory. • Like, a higher level of inventory is required for vital parts that are very costly and essential for production. Others are essential spare parts, whose absence may slow down the production process, hence it is necessary to maintain such inventory. • Similarly, an organization can maintain a low level of inventory for desirable parts, which are not often required for production. 11/9/2019

FSN Analysis F – Fast moving S – Slow moving N – Non Moving

FSN Analysis F – Fast moving S – Slow moving N – Non Moving This method of inventory control is very useful for controlling obsolescence. All the items of inventory are not used in the same order; some are required frequently, while some are not required at all. So this method classifies inventory into three categories, fast moving inventory, slow moving inventory, and non moving inventory. The order for new inventory is placed based on the utilization of inventory. 11/9/2019

SDF & GOLF Analysis Based on source of procurement S – Scarce, D- Difficult,

SDF & GOLF Analysis Based on source of procurement S – Scarce, D- Difficult, E- Easy. GOLF G – Government, O – Ordinary, L – Local, F – Foreign. 11/9/2019

SOS Analysis Raw materials especially for agriculture units S – Seasonal OS – Off

SOS Analysis Raw materials especially for agriculture units S – Seasonal OS – Off seasonal 11/9/2019

Importance of Inventory Control • The aim of holding inventories is to allow the

Importance of Inventory Control • The aim of holding inventories is to allow the firm to separate the process of purchasing, manufac turing, and marketing of its primary products. Inventories are a component of the firm’s working capital and as such represent a current account. 11/9/2019

Importance of Inventory Control 1. Reducing Risk of Production Shortages: Firms mostly manufacture goods

Importance of Inventory Control 1. Reducing Risk of Production Shortages: Firms mostly manufacture goods with hundreds of components. The entire production operation can be halted if any of these are missing. To avoid the shortage of raw material the firm can maintain larger inventories. 2. Reducing Order Cost: Where a firm places an order, it incurs certain expenses. Different forms have to be completed. Approvals have to obtained, and goods that arrive must be accepted, inspected and counted. These costs will vary with the number of orders placed. Smaller the inventories lesser the capital needed to carry inventories. 11/9/2019

Importance of Inventory Control 3. Minimize the Blockage of Financial Resources: • The importance

Importance of Inventory Control 3. Minimize the Blockage of Financial Resources: • The importance of inventory control is to minimise the blockage of financial resources. It reduces the unnecessary tying up of capital in excess inventories. It also improves the liquidity position of the firm. 4. Avoiding Lost Sales: • Most firms would lose business without goods on hand. Generally a firm must be prepared to deliver goods on demand. By ensuring timely availability of adequate supply of goods, inventory control helps the firm as well as consumers. 11/9/2019

Importance of Inventory Control 5. Achieving Efficient Production Scheduling: • The manufacturing process can

Importance of Inventory Control 5. Achieving Efficient Production Scheduling: • The manufacturing process can occur in suffi ciently long production runs and with preplanned schedules to achieve efficiencies and economies. By maintaining reasonable level of inventory production scheduling becomes easier for the management. 6. Gaining Quantity Discounts: • While making bulk purchases many suppliers will reduce the price of supplies and component supplies will reduce the price of supplies and component parts. The large orders may allow the firm to achieve discounts on regular basis. These discounts in turn reduce the cost of goods and increase the profits. 11/9/2019

Importance of Inventory Control 7. Taking the Advantage of Price Fluctuations 8. Tiding over

Importance of Inventory Control 7. Taking the Advantage of Price Fluctuations 8. Tiding over Demand Fluctuations 9. Deciding timely Replenishment of Stocks: 11/9/2019

Most Important Techniques of Inventory Control System • To avoid over stocking and under

Most Important Techniques of Inventory Control System • To avoid over stocking and under stocking of materials, the management has to decide about the maximum level, minimum level, re order level, danger level and average level of materials to be kept in the store. 11/9/2019

(a) Re-ordering level It is also known as ‘ordering level’ or ‘ordering point’ or

(a) Re-ordering level It is also known as ‘ordering level’ or ‘ordering point’ or ‘ordering limit’. It is a point at which order for supply of material should be made. • Re order level =Maximum Rate of consumption x maximum lead time 11/9/2019

(b) Maximum Level • Maximum level is the level above which stock should never

(b) Maximum Level • Maximum level is the level above which stock should never reach. It is also known as ‘maximum limit’ or ‘maximum stock’. • This level can be determined with the following formula. Maximum Stock level = Reordering level + Reordering quantity — (Minimum Consumption x Minimum re ordering period) 11/9/2019

(c) Minimum Level: It represents the lowest quantity of a particular material below which

(c) Minimum Level: It represents the lowest quantity of a particular material below which stock should not be allowed to fall. This level must be maintained at every time so that production is not held up due to shortage of any material. Minimum Level = Re ordering level — (Normal rate of consumption x Normal delivery period) 11/9/2019

(d) Average Stock Level: Average stock level is determined by averaging the minimum and

(d) Average Stock Level: Average stock level is determined by averaging the minimum and maximum level of stock. • Average level =1/2 (Minimum stock level + Maximum stock level) 11/9/2019

(e) Danger Level: Danger level is that level below which the stock should under

(e) Danger Level: Danger level is that level below which the stock should under no circumstances be allowed to fall. Danger level is slightly below the minimum level and therefore the purchases manager should make special efforts to acquire required materials and stores. 11/9/2019

(f) Economic Order Quantity (E. O. Q. ) • One of the most important

(f) Economic Order Quantity (E. O. Q. ) • One of the most important problems faced by the purchasing department is how much to order at a time. Purchasing in large quantities involve lesser purchasing cost. But cost of carrying them tends to be higher. Likewise if purchases are made in smaller quantities, holding costs are lower while purchasing costs tend to be higher. • Hence, the most economic buying quantity or the optimum quantity should be determined by the purchase department by considering the factors such as cost of ordering, holding or carrying. • This can be calculated by the following formula: • Q = √ 2 AO/C • where Q stands for quantity per order ; • A stands for annual requirements of an item in terms of rupees; • O stands for cost of placement of an order in rupees; and • C stand for inventory carrying cost per unit per year in rupees. 11/9/2019

Different approaches Certainty approach Uncertain variables and risk are addressed separately Uncertainty approach Uncertain

Different approaches Certainty approach Uncertain variables and risk are addressed separately Uncertainty approach Uncertain variables and risk are addressed simultaneously Deterministic approach Probabilistic approach 11/9/2019

Basic EOQ Model Assumption • Seasonal fluctuation in demand are ruled out • Zero

Basic EOQ Model Assumption • Seasonal fluctuation in demand are ruled out • Zero lead time – Time lapsed between purchase order and inventory usage • Cost of placing an order and receiving are same and independent of the units ordered • Annual cost of carrying the inventory is constant • Total inventory cost = Ordering cost + carrying cost 11/9/2019

EOQ – Three Approaches Trial and Error method Order-formula approach Graphical approach 12/10/18 11/9/2019

EOQ – Three Approaches Trial and Error method Order-formula approach Graphical approach 12/10/18 11/9/2019 24

EOQ & Re-order point EOQ – gives answer to question “How much to Order”

EOQ & Re-order point EOQ – gives answer to question “How much to Order” Re-order point – gives answer to question “when to order” 12/10/18 11/9/2019 25

Trial & Error Method Assumptions: Annual requirement (C)=1200 units Carrying cost (I) = Rs.

Trial & Error Method Assumptions: Annual requirement (C)=1200 units Carrying cost (I) = Rs. 1 Ordering cost (O) =Rs. 37. 5 Order size Q 1200 600 400 300 240 200 150 120 100 Average inventory Q/2 600 300 200 150 120 100 75 60 50 1 2 3 4 5 6 8 10 12 Annual carrying cost I* Q/2 600 300 200 150 120 100 75 60 50 Annual ordering cost O*C/Q 37. 5 75 112. 5 150 187. 5 225 300 375 450 Total annual cost 637. 5 375 312. 5 300 307. 5 325 375 435 500 No. of orders C/Q 12/10/18 11/9/2019 26

Order- Formula approach 1/2 EOQ =(2 CO/I) C = Annual demand O = Ordering

Order- Formula approach 1/2 EOQ =(2 CO/I) C = Annual demand O = Ordering cost per order I = Carrying cost per unit 1/2 EOQ =(2*1200*37. 5/1) = 300 units 11/9/2019 27

Inventory level order quantity Certainty case of the inventory cycle Q Average inventory =

Inventory level order quantity Certainty case of the inventory cycle Q Average inventory = Q/2 0 T 1 T 3 T 2 T 4 Time 1. Here the negative slope from Q to T 1 represents the inventory being used up 2. T 1, T 2, T 3, T 4 represents the replenishment points 3. The inventory varies between 0 and Q 11/9/2019

Graphical method to find EOQ Cost in RS. ost c l a Tot /2

Graphical method to find EOQ Cost in RS. ost c l a Tot /2 Q C t = s o g c n i y r Car Ordering cost = DS/Q 0 11/9/2019 EOQ Order quantity

Extension of basic EOQ model This model can be extended to include quantity discounts,

Extension of basic EOQ model This model can be extended to include quantity discounts, were simple calculation for quantity discount is added. Non zeroleadtime 11/9/2019

Extension of basic EOQ model Non – zero lead time If the lead time

Extension of basic EOQ model Non – zero lead time If the lead time is ‘n’ then procurement must be done prior to ‘n’ days, i. e. T-n as shown in the figure Q Reorder point 0 T 1 n T 1 Placement of a order 11/9/2019 T 2 n T 2 Time T 3 n T 3 T 4 n T 4

Probabilistic inventory model 2. 3. In practical inventory management assumption may not be strictly

Probabilistic inventory model 2. 3. In practical inventory management assumption may not be strictly correct. Demand may fluctuate over time due to seasonal, cyclical and random influences. Lead time may also fluctuate because of transportation delay, strikes or natural disaster. For such reason most of the companies use safety stock. 11/9/2019

Probabilistic inventory model contd … But in some cases even the safety stock becomes

Probabilistic inventory model contd … But in some cases even the safety stock becomes ineffective to combat stock out. Like: - Reorder point Safety stock T 1 Placement of order 11/9/2019 T 2 Lead time T 3 T 4 T 5 T 6 Stock out

A Review So we have dealt with n n EOQ model Its extension Probabilistic

A Review So we have dealt with n n EOQ model Its extension Probabilistic model And now we will be dealing with special inventory models 11/9/2019

THANK YOU 11/9/2019

THANK YOU 11/9/2019