Inventory is any stock of economic resources that is stored for future us e it is commonly used to store materials, in process packing materials, spares etc, stocked in order to meet respected demand or distribution in the future. Although inventory of any materials is an idle resources the sense, it is not meant for immediate use. It is necessary to maintain some inventories lot the smooth functioning f the organization. Inventories are essential:
The following is the list of the major reasons for maintaining Inventory a) Protect against irregular demand: Inventories are kept to meet fluctuating demand. b) Protect against irregular supply: a strike by the suppliers employees is one reason why deliveries may not teach on time. Lacks of materials at supplier’s level, strikes in transportation network are other possible reasons for delays in supply. Inventory is used as buffer that can be used until late deliveries arrive. c) Protection against inflation: Inventories are often kept as a hedge against inflation. In this case inventories are building up in anticipation of price increase. This speculative practice is common in commodity markets. d)Benefits of large quantities purchasing quantities of an item often entities the buyers to a discount. Similarly in case of manufacturing large production lots, the utilization of make efficient automotive equipment can be equipment can be justified by reducing the per unit manufacturing cost.
e)Saving the order cost: ordering in large quantities reduces the number of time the order must be placed and processed. Since the fixed cost of ordering will be.
f) Other reasons: Inventories are kept for several other reasons; an Inventory may improve the bargaining power of firm with a supplier (or with its own employees) by making the company less dependent on them. Inventories are also kept so that machine can be shut down for overhear.
THE STRUCTURE OF THE INVENTORY SYSTEM
The Inventory system involves a cycle process, which is assumed to run over several periods, whose major characteristics are:
a) Inventory level: an item is stocked in a warehouse, store or any other storage area. This stock continues an Inventory. The size of the Inventory is called the Inventory level (or Inventory on Hand). b) Depletion: the Inventory is depleted as demand occurs. Assume that one starts with an Inventory of 100 units. As time passes the Inventory is reduced. The rate of demand can be constant (e.g three units every day). A constant demand reduces the Inventory leveling equal steps. c) Recording: to rebuild an inventory, the item is replenished periodically. When the inventory level is reduced to a certain level called the record point, a replacement order is placed.
The time between reordering and receiving is called lead-time. d) Replacement, shortages and surpluses: in most basic inventory models, it is assumed that the reorder is scheduled so that the replacement will arrive exactly when the inventory level reaches zero. Such an assumption holds if the demand is constant. However if the demand fluctuates and the lead- time varies, the shipment may arrive either before or after stock is completely depleted, that is the depletion and replacement and replacement does not coincide. In such a case a surplus or shortage will occur. If the shipment arrives after depletion, then the demand cannot be met and shortage will occur. When the shipment arrive prior depletion, an inventory level larger than zero or surplus exists. e) Safety stock: shortage can be eliminated or reduced by deliberately building up a safety stock.
It is extra inventory held against the possibility of stock out. f) The average inventory: the balance of inventory on hand in case of constant demand, it is about half the maximum inventory. g) Basic inventory decisions: the major decisions the management makes in the inventory area are: ➢ How much to order at one time (what order quantity should be) ➢ When to order this quantity (what the reorder point should be) ➢ Should safety stock be build up? How large should it be?
INVENTORY CARRYING COSTS
Inventory carrying costs refers to the cost of handling stocks. The following elements constitute the Inventory carrying costs
a) Capital cost is an important item in determining the pest of carrying inventory. Capital cost is either the cost of borrowing capital or the cost of diverting companies finds to invest in inventories. The former means the interest rate the later implies the foregone opportunity cost. There are thus two methods of determining capital cost. The first method is to use the bank lending rate, if the money were to be borrowed. The other method is to consider the opportunity cost of the money (the return that the money will yield if invested elsewhere). b) Storage cost; includes cost of storage (i.e. annual rent or depreciation), cost of preservation i.e. rust preventive oils and ‘eases), cost of record keeping, and cost of periodic/annual stock verification etc.
c) Deterioration and. obsolescence: deterioration is the loss, from reduction in the inventory value due to one or more of the following reasons:
The part/item/material may have limited shelf life and hence may deteriorate if stored for a long time, e.g. rubber parts may crack after approximate six months life, and for example, ammonia sheets may spoil if stocked beyond three months. The items also deteriorate when the storage conditions are inadequate, unsatisfactory or both. Some of the parts may also get damp, dried up, or spoiled Deterioration can also result from poor handling of the stores. Some of the fragile items may collide with other and break. This process of deterioration, thus, reduces the value of the stocks and they may not be now worth the value recorded in the accounts book.
Obsolescence is the loss from reduction in inventory value of the items/ components rendered unusable by the company due to changes in design or due to development in the field. The risk of Obsolescence varies from industry to industry and is obviously greater than those industries where modifications are frequent and new, developments are regular. The problem is still severe in industries producing fashion goods. That is why many progressive business firms tend to get rid of theft surplus stocks which otherwise would become obsolete by some sort of periodic action such as clearance sales etc. d) Insurance cost: inventories, like other assets, are covered by insurance cost is thus the premium paid or payable to cover the company against loss due to unforeseen across such as fire, theft etc.
Procurement cost is also called ordering cost, replenishment cost or recumbent cost is the cost incurred to replenish the stock of an item. It is in fact, the cost incurred at different stages of the procurement function & is obtained by dividing the cost of activities like requisitioning order writing, orders follow up, receiving and inspection, records keeping and bill payment per period by the number of orders processed during the period. Procurement cost, therefore , represents average cost to be expended to place an order and execute the delivery once. . Basic elements of procurement cost are as under:
(a) Paper work cost:
The procurement function is built around paper work since all orders, small or big, need paper work. Purchasing function sets out with paper work (materials requisitions) pushes through paper work (enquiry forms, purchase order forms goods receipt notes, inspection notes stores’ receipt notes) and ends up with paper work (cheques to pay suppliers invoices). The requirements of this paper v vary directly with the order frequency and its cost is considered as one of the elements of procurement cost. ‘ (b) Postage cost:
Postage cost is the cost expended to mail documents necessary to the business transaction. Purchase orders are sent to authorize vendors to supply the goods, delivery schedules are mailed communicate immediate as well as future requirements, amendments to purchase orders are issued to alter \ modify quantity, price or other terms, goods inspection notes: are posted to acknowledge receipts of materials & inform inspection results, discrepancy notes are sent to highlight shortage in the quantities received, cheques are dispatched to settle suppliers bill etc. Postage cost is also incurred for the exchange of statement of accounts; debit notes credit notes & other documents required in the transaction. , (c) Follow up cost;
Follow up cost is the function of seeing that the suppliers affect deliveries on time. The Follow up function nowadays has become the foremost function of the buyers. Vendors be it small manufacturers, traders or a supplier at a distance takes little initiative in delivering the goods on time. Major portion time of the buyers, therefore, is spent in purchase follow up; pre delivery follow up & shortage chasing.
Telephones, trunk calls, telegrams & telex are the aids commonly used by the buyers for the pre-delivery follow up as well as for shortage chasing. The costs on such communication Medias is yet another major element of procurement cost. (d) Costs of visits to the vendors plants:
Follow up with the vendors at times requires visits by purchase personnel & therefore costs of such visits are considered towards procurement cost. (e) Expediting cost:
Follow up with the vendors enables buyers to secure advance information of expected delays. Pre-delivery follow up enables buyer: > To make alternates arrangements (i.e. request other suppliers for early delivery), > To decide expedited routing of goods from suppliers.
For the single-source items, the buyers in the event of delaying may have no choice but to dire expedited routing of goods. The difference between the expedited routing costs and order routing costs, if borne by the buyer too forms a part of procurement cost. (f) Operating cost of vehicles;
Vehicles are employed for collection & delivery of materials from/and to the vendors, collection materials from transporters I railways godown etc. The operating cost of such vehicles should be considered (if the vehicle is exclusively used by the materials department for buying materials for local market, to chase vendors and / or to bring goods to the plant). As yet another element procurement cost. (g) Inspection &.testing:
Inspection & testing costs include costs of destructive test. Too frequent purchases increase inspection costs. (h) Administrative costs;
Purchase is a major function & it requires performance of number of activities. Indents are to inform the purchase department of the impending need, inquiries are floated, .quotations received, rates are compared, terms of payment are looked into and then an order is placed suppliers whose terms are attractive, progress on the order is reviewed and follow up with supplier done wherever necessary materials on arrival are checked for quantity & inspected for quality suppliers invoices are received, verified and paid for. All these activities add — up into big expenses, the salaries being the main expense. Other related expenses of these activities are indirect wages, gratuity, bonus ESIC provident fund, depreciation on office equipment etc.
Selective control means variations in method of control from item to item based on selection basis. The criterion used for the purpose may be cost of item, critically, lead to consumption, procurement difficulties, or something else. Various classifications are employed render selective treatment to different types of materials, each classification emphasizes in of particular aspect. For example, ABC analysis emphasizes usage value (Le. consumption of items in terms of money), VED analysis considers critically, HML employs prize criterion and 8DB analysis is based on procurement difficulties.
Selective control can be divided into 8 types as per table:
|Classification |Criterion Employed | |1.ABC analysis |Usage value (i.e consumption per period x prize per unit) | |2. HML analysis High-Medium-Low |Unit price (i.e it doesn’t take consumption into account) | |3.VED analysis Vital-Essential- Desirable) |Critically of the item (i.e loss of production) | |4.SDE analysis (Scarce- Difficult-Easy) |Procurement difficulties. | |5.GOLF analysis (Government-Ordinary- local-Foreign) |Source of procurement | |6. SOS analysis (Seasonal-OFF-Seasonal) |Seasonal | |7. FSN analysis (Fast-Slow-Non Moving) |Issue from stores | |8. XYZ analysis
|Inventory investment |
ABC analysis underlines a yen important principle ‘vital few trivial many’. Statistics reveal that just a handful of items account for bulk of annual expenditure on materials. These items are called ‘A’ items, therefore hold the key to business. Are numerous in numbers but their contribution is less significant. ABC analysis thus tends segregate all items into three categories: A, B and C on the basis of their annual usage .The categorizations made enables us top ay the right amount of attention as merited by the items. A-items: It is usually found that hardly 5 to 10 % of the total items account for 70 to 75% to total money spent on the materials. This items required detailed and rigid control and need to be stock in smaller quantities.
These items should be procured frequently, the quantity occasion being small. A healthy approach ,however, would be to enter into contract with the manufacturer of this items and have their supply in stagger lots according to pre determine programme of the buyer. This however will be possible when the demand is steady. Alternatively, the inventory can be at minimum by frequent ordering. B-items: This item are generally 10 to 15 % of the total items and represent 10 to 15% of the total expenditure on the materials. These are intermediate items.
The control on this item need not be as detail and as rigid as apply to A items C-items: These are numerous (as many as 70 to 80% of the total items), inexpensive (represent hardly 5 to 10% of total annual expenditure on materials), and hence insignificant (do not required loose control) items. The procurement policy of these items is exactly the reverse of A items. Items should be procured infrequently and in sufficient quantities. This enables the buyer to avail price discount and reduce workload of the concern department.
Conducting ABC Analysis
To conduct ABC analysis following 6 steps are necessary:
1) Prepare the list of the items and estimate their annual consumption (units)
2) Determine unit price (or cost0 of each item.
3) Multiply each annual consumption by its unit price (or cost) to obtain its annual consumption in rupees (annual usage) 4) Arrange items in ascending order of their annual usage starting with the highest annual usage starting with the highest annual usage down to the smallest usage. 5) Calculate cumulative annual usage and express the same as cumulative usage % so express the number of item into cumulative item percentage. 6) Plot cumulative usage percentage against cumulative item percentage and segregate the item to A, B, C categories.
ABC Analysis can be applied almost to all aspects of material management such as: a) Purchasing
d) Store keeping and
e) Issue of store
f) Verification of bills
g) Inventory control and
h) Value analysis etc.
Purpose of A-B-C Analysis:
i. To separate the pre dominant few from vast majority of items whose annual consumption is very low. ii. To avoid to cost
iii. To give selective control
iv. For better purchase policy to give maximum attention to A items v. For better pre-design and pre purchase analysis
vi. Effective value analysis
vii. Realistic market research
viii. Reliable source development and
ix. Better follow up
|A |B |C | |Very tight control on inventory |Moderate Control |Loose Control | |Only exact requirement to be procured |More or less exact
requirement |On estimated usage | |Posting of individual issues in stores card |Individual postage |Collective posting | |Continuous check on production schedule and |Broad check |Hardly any check | |revision of delivery deals | |
| |Very low safety stock if possible not at all |Low safety stock Bi-Monthly ordering or quarterly|Fairly large safety stock by Ordering | |Regular expediting and follow up & reduction in |Some follow up |No follow up necessary | |lead time | | | |Very Strict consumption control |Past consumption is the base |Desirable consumption comes with less attention | |Accurate material planning needed with respect to|Past consumption is the base |Rough estimate | |forecasts. Data base should be accurate & up to | | | |date | | | |Concerted effort of cost reduction |Moderate attempts are enough |Annual Review suffices |
H-M-L Analysis is similar to ABC analysis, except for the difference that instead of usage price criterion is used, The items under this analysis are classified into three groups) which are called high, medium and low. To classify, the items are listed he descending order of Unit price the management for deciding the three categories then fixes the cut of lines. For example, the management may decide that all items of unit. Price above RS.1000 will be category, and those having unit price between Rs 100 to R. 1000 will be of ‘M’ category, and having unit price below RS. 1 00 will be
of ‘L’ category.
HML analysis helps to
# Assess storage and security requirements e.g. high priced items like bearings, worm wheels etc. (required to be kept in cupboards).
# To keep control over consumption at the departmental head level e.g. indents of high medium priced items are authorized by the departmental head after careful scrutiny of the consumption figures.
# Determine the frequency of stock verification, eg. high priced items are checked more frequently than low priced items.
# To evolve buying policies to cntro1 purchases. e.g. excess supply than the order quantity may be accepted for ‘H’ and ‘M’ groups While it may be accepted for ‘L’ group.
# to delegate authorities to different buyers to make petty cash purchases, e.g ‘H’ and ‘M’ may be purchased by senior buyers and L’ items by junior buyers.
VED analysis represent classification of items based on criticality. The analysis classifies the item into three groups called Vital, Essential and Desirable.
Via1 category encompasses those items for want of which production would come to a halt. Essential group includes items whose stock out cost is very high and desirable group comprises of items, which d not cost any immediate loss of production. The stock these items entail nominal expenditure and cause major disruptions for a short duration.
VED analysis is best suited for spare inventory. Inflict it is advantageous
to use more than 1 method. E.g. ABC & VED analysis together would be helpful would be helpful for inventory control of spares.
SDE – ANALYSIS
SD E analysis is based on problems of procurement namely:
# Non-availability # scarcity # longer lead time
#Geographical location of suppliers and
# Reliability of suppliers etc,
S-DE analysis classifies the items into three groups called ‘Scares’, ‘Difficult’ and ‘Easy. The information so developed is then used to decide purchasing strategies.
‘Scarce’ classification comprises of items which are in short supply, imported chanalised through government agencies. Such items are best to procure once a year in lieu of effort and expenditure involved in the procedure for import. ‘Difficult’ classification includes those items, which are available indigenously but are not easy to procure. Also items which come from far off distance and for which reliable source do not exist fall into this category. Even the items, which are difficu1t to, manufacture arid only one or two manufacturers are available belong to this group. Supplies of such items require several months of advance notice.
‘Easy’ classification covers those items which are redily available. Items produced to commercial standards, items where supply exceeds demand and others which are locally available fall into this group.
The SDE analysis is employed by the purchase department:
(i) To decide on the method of buying. E1g. Forward buying method may be followed for some of the items in the ‘Scare’ group) scheduled buying and contract buying for Easy group. (ii) To fix responsibility of buyers. E.g. senior buyers may be given the responsibility of ‘S and ‘D’ groups while items in ‘E’ group may be handled by junior buyers or even directly by storekeeper.
G-NG-LF ANALYSIS /GOLF ANALYSIS
The G-NG-LF analysis (or GOLF analysis) like SDF analysis is based on the nature of the suppliers, which deteiir1ine quality, lead-time, and terms of payment, continuity or otherwise of supply and administrative work involved. The analysis classifies the items into four groups namely G, NG, L and F.
‘G’ group covers items procured from ‘Government’ suppliers such as the STC, the MMTC and the public sector undertakings. Transactions with this category of suppliers involve long lead-time and payments in advance or against delivery. ‘NG’ (0 in GOLF analysis) group comprises of items procured from Non-Government (or Ordinal Suppliers. Transactions with this category of suppliers involve moderate delivery time, end availability of credit, usually n the range of 30 to 45 day. ‘L’ group contains items bought from ‘Local supplier the items bought from local suppliers are those which are cash purchase or purchased on blank orders..
‘F’ group contain those items, which are purchased from ‘Foreign suppliers’. The transactions will such suppliers, # Involve a lot of Administrative and procedural work.
# Require initial clearance from government agencies such as DGTD. # Necessitate search-of foreign suppliers.
# Require opening of letter of credit.
# Require making of arrangement for shipping and port clearance.
S-OS analysis is based on seasonality or otherwise of the items. The analysis classifies the item into two groups: SOS (I.e. seasonal) and OS (off scasona1). The analysis identifies items, which are: (i) Seasonal items are available only for a limited period. For example agriculture products like raw mangoes raw material for cigarette and paper industries, etc are available for a limited time and therefore such items are procured to last the full year. (ii) Seasonal but are available throughout the year. Their prices however are lower during the harvest time. The quantity of such items requires to be fixed after comparing the cost saving due to lower prices against higher cost of carrying Inventories. (iii) Non-Seasonal items whose quantity is decided On different considerations.
F-S-N analysis is based on the consumption figures of the items. The items under this analysis are classified into three groups: F (Fast moving), S (Slow moving) and N (Non moving). To conduct the analysis, the last date of receipt or the last date of issue whichever is later taken into account. and the period usually in terms of number of months that has elapsed since the last movement is recorded.
Such an analysis helps to identify:
(i) Active items which require to be reviewed regularly.
(ii) Surplus items whose stocks are higher than their rate of consumption and (iii) Non moving items which are not being consumed.
The last two categories arc reviewed farther t decide on disposal action to deplete t stocks and their stocks and thereby release companies productive capital.
Further detailed analysis is made of the third category in regard to their year-wise stocks and the items can be sub-classified. As non-moving for 2 years, 3 years, 5 years and so on.
X-Y-Z Analysis is based. on value of the stocks on hand (i.e. inventory investment); Item whose inventory values are high are called X items while those whose inventory values are low are called Z items, Y items are those, which have moderate inventory stocks. Usually X-Y-Z analysis is used in
conjunction with either ABC analysis or HML analysis.; ‘.X-Y-Z analysis when combined with- ABC analysis is used as under. |Class of Item |A |B |C | |X |Efforts to be made to reduce stock to Z|Effort to be made convert them to Y |Steps to be taken dispose of surplus | | |category. |category |stocks | |Y |Efforts to be made to convert to Z | |Control may be further tightened | | |category | | | |Z | |Stocks levels may be reviewed | |
Basic (Wilson) EOQ model with infinite replenishment rate.
Assumptions underlying the EOQ model:
1. The demand of the item occurs uniformly over the period at the known rate.
2. The replenishment of the stock is instantaneous.
3. The time that elapses between the placing a replenishment order & receiving the item into stock, called lead-time is zero.
4. The price per unit is fixed & is independent of the order size.
5. The cost of placing an order & process the delivery is fixed & does not vary with the size.
6. The inventory carrying charges vary directly & linearly with the size of the inventory as is expressed as a percentage of average inventory
7. The item can be produced in quantities desired there being no restriction of any kind.
8. The item is fairly long shelf life, there being no fear of deterioration of spoilage.
Nowadays an EOQ technique is not much in sue because an open order with delivery schedule can be placed on a supplier for all future periods. This keeps down the purchasing cost. With the availability of computer links (networking techniques/email etc.) between the buyer & the supplier there is no need to physically raise a purchase order, avoiding major purchasing cost. At the same time computer helps in ensuring Just-In-Time inventory.
Limitations of EOQ
The assumption listed above may not come true in real life situations, thus limiting the use of model.
Price of material may not remain same throughout the year. Availability of materials is another constraint material will have to be purchased at the same time at which is available.
There can be delay in real situation in placing orders since many times the calculated EOQ is an inconvenient number and some time is wasted in taking decision for rounding off this number. In real situations suppliers receive in irregular.
Availability of materials is another constraint material will have to be purchased at the time at which is available.
There can be delays in real situation in placing orders since many times the calculated EOQ is inconvenient number and some time is wasted in taking decision for rounding off this number. In real situations suppliers receive an irregular stream of orders since the use of EOQ usually leads to orders at random points.
If suppliers are allowing discounts and if quantities are purchased above a particular level, the discount will also have to be taken into consideration for fixing the ordering quantity. Also purchasing costs are nowadays reduced to a great extent because of computer links between buyer and seller. So in practice purchasing cost and inventory carrying cost are not exactly opposite to each other. Often the inventory carrying cost and purchasing cost cannot be identified accurately and sometimes cannot be even identified properly.
One of the jobs of the materials department is to ensure uninterrupted supply of materials to the production department. To accomplish this task, the materials department has to monitor the stock levels and place order regularly. Two questions that arise are- 1. When to place an order? & 2. What quantities to order? Two main systems are followed for the same.
1. Fixed order quantity system
2. Fixed order interval system
Each system has certain conditions, which govern the circumstances of its use.
Fixed order quantity system (Q-system of Inventory): Here the quantity to be ordered is worked out as the economic order quantity (EOQ), and the minimum stock level is also worked out. When the stock in hand reaches this level, an order is placed for a quantity equals to the EOQ.
Features of fixes-order-quantity system:
a) Reorder quantity is always the same, which is equal to the EOQ.
b) The time interval between the orders varies.
c) Reordering is done when the stock in hand is equal to safety stock plus the lead time consumption (this is known as the reorder level).
d) Average inventory is equal to safety stock + Q/2.
e) Maximum inventory will be equal to the safety stock + Q.
f) Minimum inventory equals the safety stock.
g) This system is normally used for items of lower value where orders are placed infrequently and the lead time average consumption etc. is fairly constant.
To operate this system it is necessary to post the receipts and issues on the material card and a book stock worked out regularly. The reorder level is normally shown on the top right hand corner of the card; so that the book stock comes down to this level an order can be initiated. To simplify this system many firm use a two-bin system one is the main-bin & the other is reserve-bin. The stock in reserve bin equals the reorder level. When the main bin is empty it indicates an order has to be placed for the said item.
1. Fixed order quantity system:
Reorder level = safety stock + lead time consumption
Reorder quantity = Q
Maximum inventory = Q + safety stock
Minimum inventory = safety stock
Average inventory = Q/2 + safety stock
Total cost of ordering = no. of orders x cost per order = Annual consumption x cost per order
Cost carrying inventory = average inventory x cost per unit x inventory carrying cost
Total cost of managing the inventory = cost of ordering + cost of carrying.
Fixed order interval system (P-system of Inventory):
Under this system the stock in hand is reviewed at periodic intervals and an order is placed for which vary with the stock in hand, the review period is decided by the management and the consumption during this review period, and lead time consumption is worked out. The quantity ordered is decided depending on the stock in hand, so that the order quantity and the stock in hand will take care of the requirements till the next review period plus the lead time consumption plus the safety stock.
Features of fixed-order-interval system:
a) The interval between two orders is fixed.
b) The maximum level (basic parameters of the system) is equal to review period consumption. Lead time consumption + safety stock.
c) Reorder quantity equals the maximum level (as worked out above) minus the stock in hand plus stock on order.
d) Average inventory equals safety stock + lead time consumption/2.
e) Maximum inventory equals safety stock + lead time consumption.
f) This system is used for high consumption value items (A category) needing a strict control. Reestablishment where large numbers of items are produced and a continuous sale is made as to follow such a system.
Maximum level (basic parameters) = Review period consumption + lead time consumption + safety stock.
Reorder quantity = Max level – (stock in hand +stock on order).
Maximum inventory = safety stock + lead time consumption.
Average inventory = safety stock + lead time consumption/2
Total cost of managing the inventory = cost of ordering + cost of carrying.
Problem based on fixed order interval system:
The monthly consumption of a unit costing Rs. 400 the order cost is Rs. 36, and the inventory carrying cost is 1.5% p/m. if the review period = lead time = one month and the safety stock maintained is half the review period.
1. Fix the necessary parameters to operate a fixed order interval system.
2. What will be reorder quantity if the stock during the first reviews of 650 units.
3. What will be the reorder quantity if the stock during the second review is 200 units and also it is given that the order placed earlier has not yet been received.
Review period = lead time = 1 month.
Review period consumption = lead time consumption =400 units.
Safety stock = ½ month’s consumption = 200
Necessary parameters (maximum level) = review period consumption + lead time consumption +safety stock = 400 + 400 + 200 = 1000 units.
During the first review,
The reorder quantity = maximum level – stock in hand =100 – 650 =350 units.
During the second review,
The above ordered quantity is still not received, hence
Reorder quantity = maximum level – (stock in hand + stock on order)
= 100 – (200 + 350 ) = 1000 – 550 = 450 units.
Factors that influence the level of safety stock:
a) Category of item: In case of ‘A’ category items where a better control is exercised it may not be required to keep a high level of safety stock. In addition to this a high level of safety stock and high value of consumption item will also increase the inventory carrying costs.
b) Lead-time: Normally longer the lead time more is the chances of fluctuation and hence more is the requirement of safety stock.
c) Number of suppliers: In case there are a number of suppliers available for an item, it is not necessary to keep high level of safety stock as any stock out situation can be handled easily from alternate sources of supplies.
d) Criticality of an item: Safety stock for critical items needs to be high e.g. in case of packing materials the safety stock need to be high as stock cut in packing material will affect the delivery of finished goods to the customers, but in case of lubricants where lubrication can be delayed safely by a few days a lower safety stock can be maintained.
e) Availability of substitutes: Lesser safety stock can be kept for items where substitutes are available easily.
f) Possibility makes the item in-house: If it is possible to make an item in-house at a short notice on case of emergency. A lower safety stock will suffice.
g) Risk of obsolescence or deterioration: It is better to have lower safety stock for items where the cost of deterioration is higher than the cost of no stock situation.
h) Space restrictions: Restrictions in the storage space is another factor influencing the safety stock levels.
i) Stock out cost/management policy: The cost of stock out and the management’s decision to allow stoppage of production due to no stock situation (depending upon the market and company’s financial conditions) also influence the decision on the safety stock levels.
The amount of safety stock needed to determine by the service level desired by their company. The service level id probably that amount of inventory had during the lead time is sufficient to meet expected demand – i.e. the probability that a stock out will not occur, a service level of 90% means their id’s 90 probabilities that demand will be met during lead time.
Service level (SL) is the ratio of the no. The units delivered without the delay to the no. of units demanded.
SL = No. of units delivered without delay / No. of units demanded.
SL = No. of units demanded – No. of units short / No. of units demanded.
SL Range: 0 < SL < 1
I.e. SL = 0 means complete delivery failure.
SL = 1 means 100% service (No shortages)
SL is expressed as a%.
i. Percentage of stock outs = SL = No. of order periods when stocks were zero / Total No. of order periods x 100
This is indicative of the probability of being out of stock while awaiting a supplier’s delivery and is, therefore independent of the order size.
ii. Percentage of stock outs = SL = No. of working days in which stocks were zero / Total no. of working days x 100
This ratio is a measure of the probability of being out of stock during the year.
iii. Percentage of stock outs = SL = No. of units / No. of units demanded x 100
This ratio would show the average potential sale lost.
Service Level is a target specified by management defined in terms of,
a. Order Cycle Time
b. Cash Fill Rate
c. Line Fill Rate
d. Order Fill Rate
e. Any Combination of These.
a) Order Cycle Time (Performance Cycle of Lead Time):
The performance cycle is the elapsed time between the release of a purchase order by a customer and the receipt of the corresponding shipment.
b) Case Fill Rate:
It defines percentage of cases or units ordered that can be shipped or requested e.g. a 95% case fill rate indicates that, on average, 95% cases out of 100 could be filled from available stock. The remaining 5 cases would be back – ordered or deleted.
c) Line Fill Rate:
It is the percentage of order lines that could be filled completely. Each line on an order is a request for an individual product. So at order may have multiple lines e.g. when a customer order is received requesting 80 units of product A and 20 units of product B, the order contains 100 cases and two lines. If there are only 75 units of product A available and all 20 of product A, the case fill would be 955 (75 +20) / (80 + 20) and the line fill would be 50%.
d) Order Fill Rate:
It is the percentage of customer orders that could be filled completely. In the example above, the order could not be completely filled, so the resulting order fill would be zero.
The inventory function is a major element of the logistics process that must be integrated to meet service objectives. While a traditional approach is achieving a higher service level is to increase inventory, other approaches include use of faster transportation modes, better information management to reduce uncertainty, alternative sources of supply.
While it is the task of overall logistics management to meet the prescribed service objectives inventory management plays a particular key role.
Inventory Policy: Inventory policy consists of guidelines concerning
• What to purchase or manufacture
• When to take action
• In what quantity
It also includes decisions regarding inventory positioning and placement at plants and at distribution centers.
• Some firms may decide to postpone inventory positioning by maintaining stock at the plant.
• Other firms may choose to place more products in local distribution centers i.e. nearer to market.
Another inventory policy element concerns inventory management strategy. One approach is to manage inventory centrally. This
requires more coordination and communication.
Average inventory: Average inventory consists of the materials, components, work in progress and finished products typically stocked in logistical facilities. From a policy viewpoint, the appropriate level of average inventories include:-
a) Cycle inventory or base stock or lot size stock: It is the portion of average inventory that results from replenishment process. At the beginning of a performance cycle, stock is at a minimum level. Daily customer demands “draw off” (consumes) inventory until the stock level reaches zero. Prior to this, a replenishment order is initiated so that stock will arrive before a stock-out occurs. The replenishment order must be initiated when available inventory is greater than or equal to the customer demand during the performance cycle time.
The amount ordered for replenishment is called the order quantity.
The average inventory held as a result of the order process is referred to as Base Stock considering only the order quantity:
Cycle inventory or base stock or lot size stock = Order Quantity / 2
b) Safety Stock Inventory: The second part of the average inventory is the stock held to protect transit the impact of uncertainty on each facility. This portion of inventory is called safety stock. It is used only at the end of replenishment cycles when uncertainty has caused higher than expected demand or longer than expected performance cycle times.
Average Inventory = Order Quantity + Safety Stock / 2
c) Transit Inventory or Pipeline Inventory: It is the stock that is either moving or awaiting movement in transportation vehicles.
Transit Inventory is necessary to achieve order replenishment. From a logistics management perspective, transit inventory introduces two sources of complexity into the supply chain.
i. It represents real assets and must be paid for even though it is not accessible or usable.
ii. There has typically been a high degree of uncertainty associated with the transit inventory because shippers were unable to determine where a transport vehicle was located or when it was likely to arrive.
Increase focus on small order amounts, more frequent order cycles. JIT strategies have resulted in transit inventory becoming a larger percentage of total inventory assets.
Ownership of Transit Inventory
• If transferred at destination: It is not owned by consignee.
• If transferred at origin: It is owned by consignee.
Just In Time (JIT)
JIT is a Japanese management philosophy, which has been applied in practice since the early 1970’s in many Japanese manufacturing organizations. It was first developed and perfected within the Toyota manufacturing plants by Taiichi Ohno as means of meeting consumer demands with minimum delays. Taiichi Ohno is frequently referred to as the father of JIT
Toyota was able to meet the increasing challenges for survival through an approach that focused on people, plants and systems. Toyota realized that JIT would only be successful if every individual within the organization was involved and committed to it, if the plant and processes were arranged for maximum output and efficiency, and if quality and production programs were scheduled to meet demands exactly.
JIT manufacturing has the capacity, when properly adapted to the organization to strengthen the organization’s competitiveness in the market place substantially by reducing wastes and improving product quality and efficiency of production.
There are strong cultural aspects associated with the emergence of JIT in Japan. The Japanese work ethic involves the following concepts.
• Workers are highly motivated to seek constant improvement upon that which already exists. Although high standards are currently being met, there exist even higher standards to achieve.
• Companies should focus on group effort, which involves the combining of talents & sharing knowledge, problem-solving skills, ideas & the achievement of a common goal.
• Work itself takes precedence over leisure. It is not unusual for a Japanese employee to work 14 – hour a day.
• Employees tend to remain with one company throughout the course of their career span. This allows the opportunity for them to hone their skills & abilities at a constant rate while numerous benefits to the company.
• These benefits manifest themselves in employee loyalty, low turnover costs & fulfillment of company goals.
From above it is very clear what it needs to implement JIT successfully. In fact it also suggests the critical reasoning behind the fact that why in India JIT is not 100 percent followed. One more significant thing to be considered here is the correct interpretation of JIT. JIT is more of a manufacturing & waste elimination philosophy than commodity purchasing technique. It originally referred to the production of goods to meet customer demand exactly, in time, quality & quantity, whether the customer is the final purchaser of the product or another process further along the production line.
It has now come to mean producing with minimum waste. Waste is taken in its most general sense & includes time & resources as well as materials. There are seven types of waste namely:
• Waste from overproduction
• Waste of waiting time
• Transportation waste
• Processing waste
• Inventory waste
• Waste of motion
• Waste from product defects
Elements of JIT System
Successful JIT system is the logical outgrowth of the combination of the following practices:
• Continuous improvement
• Attacking fundamental problems – anything that does not add value to the product
• Devising systems to identify problems
• Striving for simplicity – simpler systems may be easier to understand,
easier to manage & less likely to go wrong
• A product – oriented layout produces less time spent in moving of materials & parts
• Quality control at source – each worker is responsible for the quality of their own output
• Poka-yoke – full proof tools, methods, jigs etc. to prevent mistakes
• Total productive maintenance – ensuring machinery & equipment functions perfectly when it is required, & continually improving it
• Good housekeeping – workplace cleanliness & organization
• Set up time reduction – increases flexibility & allows smaller batches
• Ideal batch size is 1 item per batch, i.e. single piece flow
• Multi-process handling – a multi-skilled workforce has greater productivity, flexibility & job satisfaction
• Leveled/mixed production – to smooth the flow of products through the factory
• Kanbans-simple tools to ‘pull’ products & components through the process
• Jidoka (Autonomation) – providing machines with the autonomous capability to use judgment, so workers can do more useful things than standing watching them work
• Andon (trouble lights) – to signal problems to initiate corrective action
Benefits of JIT Systems
JIT system has a number of benefits, few major are mentioned below:
• Reduced levels of in-process inventories, purchased goods, & finished goods.
• Reduced space requirements
• Increased product quality & reduced scrap & rework
• Reduced manufacturing lead times
• Greater flexibility in changing the production mix
• Smoother production flow with fewer disruptions
• Worker participation in problem solving
• Pressure to build good relationships with vendors
• Increased productivity levels & utilization of equipment’s
It can be said in summary that JIT is the management philosophy, which emphasizes on the waste elimination as well as vendor integration to create certainty in the material planning process, which ultimately results into no inventory, & hence inventory control means to follow JIT.
VENDOR MANAGED INVENTORY (VMI)
VMI can be defined as:
It is a streamlined approach to inventory & order fulfillment. With it, the supplier & not the retailer, is responsible for managing & replenishing inventory using an integral part of VMI, i.e. EDI, by electronic transfer of data over a network. It can also be seen as a mechanism where the supplier creates the purchase orders based on the demand information exchanged by the retailer/customer.
Vendor Managed Inventory (VMI) is basically evolved to facilitate the operations at retail stores. It involves a continuous replenishment program that uses the exchange of information between the retailer & the supplier to allow the supplier to manage & replenish merchandise stock at the store or warehouse level. In this program, the retailer supplies the vendor with the information necessary to maintain just enough merchandise stock to meet customer demand. These enable the supplier to better project & anticipate the amount of product it needs to produce or supply.
The manufacturer has access to the supplies inventory data & is responsible for generating purchase orders. VMI was first applied to the grocery industry, between companies like Procter & Gamble (supplier) & Wal-Mart (distributor). But if applied properly, VMI can provide the benefits of smoother demand, increased sales, lower inventories & still reduced costs of lost sales to the other industries.
JUST IN TIME (JIT) – II
VMI results into outsourcing of the inventory planning activity to the suppliers whereas JIT-II goes a step ahead where supplier manages the complete production plans.
LANCE DIXON ther father of JIT 2 describes it as-:
“This is the ultimate partnership program for the compatible customers and suppliers, because it is the next logical step in the application of the management cycle to the value cahin through management of time within the supply chain. It represents the use of alignment and mobilisation of strategies with suppliers using in-plant vendor representatives to achieve breakthrough changes”. JIT systrem was based upon the synchronised planning between the buyers needs and suppliers porduction capabilities.JIT 2 can be reagrded as a major catalyst for the productive change across organistions and qualifies a key component of the macro logistics management model.In other words, we can say that JIT
system assures the uninterrupted incoming material supply as per demand , whereas the JIT 2 ensures the uninterrupted production from manufacturing lihnes. Infact JIT-2 eliminates the need for the sales planning activities for sipplier organisation and the puirchasing and planning actrivities from the buyer organisation,which were carried out independently.
Bioth activitiea are carried out simultaneously in JIT-2 environment this results into more integrated and realistic plans to enable achieving targets It is based upon a mutual trust realtionship where the supplier represenataive is empowered to use the company’s purchase oreders to place orders, which in theory replaces the purchaser and the supplier’s sales person .In practice the supplier representative is brought into the plant on a full time basis. This person is allowed to attend any product design meetings for his product and has full accesss to all relevant facilities, personnel, and data. Purchasing staff is freed up from all the paper work and administartive tasks, allowing them toi cultivate other skills such as negotitiating and sourcing. PO placements and communication is improved;time is saved; material cost reduction is realized. JIT-2 provides a natural foundation for the EDI, effective paper work and administrative savings. Material costa re reduced on an ongoing basis. Supplier personnnel work onsite and perform various planning and buying aswell.
Because supplier personnel interface daily, increased insight leads to fewer schedule change surpirises. This results in reduced inventory as the supplier plans directly from the customers MRP system on real time basis. JIT-2 brings considerable technical knowledge and support onsite involves purchasing to design and engineering. Supplier inplant reperesntatives aer empowered with the combined authority of the materials planner, buyer and supplier, resulting in a uniquely effective and empowered support role.
Another advantage of JIT-2 to the supplier is that they usually get “EVERGREEN CONTRACT” which means n o end dates and rebidding.Coupled with EDI links and information technology exchanges, which arfe a p[art of the overall logistics packages, the JIT-2 concept can offera supplier a very serious strategy advantage.
BENEFITS OF EDI:
• Increased internal productivity through faster information transmission as reduced information entry redundancy. • Better accuracy by reducing the number of times and individuals involved entry. • Improved channel relationships.
• Increased external producvtivity.
• Increased ability to compete internationally.
• Decreased operating cost through:
a)Reduced labour and material costs associated with printing,mailing, and paper based transactions. b)Reduced telephone,fax, and telex communications. c)Reduced clerical cost.
Pcs are influencing logistics management in three ways: 1. Low cost and high portability wih a capability of bringing accurate information to the decision maker whether in offfice at he warehouse. ✓ Which markets to serve
✓ Which product to pick next in thw warehosue
✓ Driver reporting and delivery information.
✓ Reporting vehicle location
✓ Identifying lowest-cost fuel stop.
2)Repsonsiveness and flexibility offered by decentralised PCs enable more for service capabilities. The use of local area networks (LANs) wide arear network (WAN) and client/server architecture offers benefits of decnetralized responsiveness, flexibility, and redundacy while providing data integrated throughout the enterprise.
LAN is a network of PCs that use phone lines or cable to commuinicate and resources such as storage and printers. LAN is resticted to relativiely geographical locations such as an office and warehouse, WAN operates across a wide geography; while the architecture uses the decnetralized processiing power of PCs to provide LIS operation flexibility. Server is a large computer that allowes commom data ot be shared by a numvber of users. Client implies network of PCs that access the data and manipulate them in different ways to provide extensive flexiblity. The client/server network can globally track inventory in motion, provide shipment informatio to the customers when desired and also facilitate decisions regarding facility location, invenrotry analysis, routing and scheduling.
ARTIFICAIL INTELIGENCE (AI):
AI descrivbes technologies aimed at making computers imitate human reasoning and are concerned with symbolic reasonings rather than numeric processing. The applications of AI are :
▪ Carrier selection.
▪ International marketing and logistics
▪ Inventory Management
▪ Information system design
Historically logistics activities had a distinc disadvantage since they involved movements in either a transport ot material handling vehicle or were very decntralized. But nowadays information technology has significantly enhaced logistics perofrmance through faster and widespread communication. Applicatgion of Radio frequency (RF), satellite communcaitions, and image processing technologies has overcome the problems caused by porduct movement and geographical decentralization.
RADIO FREQUENCY TECHNOLOGY:
RF technology is used within relatively small areas, such as ditribution , to facilitate two-way information exhange. The applications are in:
➢ Real time communications with material hanlders such as forklift drivers and order selectors. ➢ Updating instructions and priorities to forklift drivers on real time basis. ➢ Two-way commuincations of warehouse selection instruction, warehouse cycle count verifaiction and
label prinintg for guiding package movement.
Satellite communication is used for providing a fast and high – volume channel for information movement around the globe. THE applications are as follows:
✓ Communications dishes on the top vehicles allow commuinations between drivers and departures. ✓ Provides uptodate infoormation regarding location and delivery and allows departures to redirect trucks in repsonse to need or traffic congestion. ✓ Used by retail chains to transmit quickly daily sales bac to the headquarters that help in activating store replenishment and also to provide input to marketing regarding local sales pattern.
POOR INVENTORY MANAGEMENT:
It Exhibits the following characteristics:
1.An increase in the number of back-orders,indicating too many stockouts. 2.A constant number of back orders,but rising inventory investment. 3.A higher than normal customer turnover.
4.A increasing number of cancelled oreders from customers or intermediairies. 5.Insufficeicnt storage space for too much inventory.
6.An increase in the number and RUPEE value of obsolete products. All these symptoms have a large finanical impact on the firm | | |INVENTORY PLANNING METHODS |
|FAIR SHARE ALLOCATION | |DISTRIBUTION REQUIREMENT PLANNING (DRP) |
Fig7 .2 Inventory planning methods
FAIR SHARE ALLOCATION:
It is a simplified inventory management method that provides each ditribution facility with an equitable or fair share of available inventory
from a common source such as a plant warehouse.
Fig 7.3: Fair Share Allocation
The figure under reference indicates current inventory level, and daily requirements for three distribution centres served by a common plant warehouse. Using fair share allocation rules, the inventory manager determines the amount of inventory that can be allocated to each distribution centre from the available inventory at the plant warehouse. Assume that from a total inventory units of 600, (see Fig.7.2) it is desirable to retain 100 units at the plant warehouse; therefore 500 units are available for the allocation. The calculation to determine the number of day’s supply is done as shown below.
DS= A + I/O
DS= No. of days supply for distribution centre inventories. A= Inventory units to be allocated from the warehouse.
I= Inventory in units for distribution centre J.
D= Daily demand for distribution centre J.
In the above example,
DS = 500 + (50 + 100 + 75 )/ (10 + 50 + 15) = (500 + 225 )/ 75 = 9.67 days
Thus, the fair share allocation means that each distribution centre should be brought unis to 9.67 days stock. The amount to be allocated to each distribution centre is determined by the expression: A = (DS – I/D) x D
A= Amount allocated to distribution centre J
DS = Day’s supply that each distribution centre is brought up to. I= Inventory in units for distribution centre J.
D = Daily demand for distribution centre J.
Thus the amount allocated to distribution centre 1 in the above example will be: A = (9.67 – 50/ 10 ) x 0 = (9.67 – 5) x 10 = 4.67 x 10 = 46.7 (rounded 247 units) The allocation for distribution centers 2 and 3 can be determined similarly as 38 and 70 units respectively. The key feature of the fair share allocation method is that it coordinates inventory level across multiple sites. It’s limitation lies in the fact that it does not consider site specific factors such as difference in performance cycle, time , economic order, quantity or safety stock requirement. Hence, the major limitation is the inability to manage multi stage inventories. DISTRIBUTION REQUIREMENT PLANNING:
DRP is the logical extension of manufacturing requirements planning ,MRP determined by production schedule that can be controlled by the enterpreise and generally operates in a dependent demand situation. DRP is guided by customer demand which are not controllable by the ebetrprise and operates in an independent environment where uncertain customer demand determines inventory requirements. Manufacturing requirements planning coordinates to scheduling an integration of materials into finished products. DRP takes over the responsibility of coordination once the finished goods are received in the plant warehouse. Constraints to the effectiveness OF INVENTORY PLANNING:
1. Requires accurate and cordinated forecasts for each distribution centre. 2. Requires forecasts for each distribution centre and SKU as well as adequate lead time to allow product movement. 3. The errors in forecast may exist because of prediction of demand at wrong location
Distribution Centre 1
Inventory- 50 units
Daily use- 10 units
Plant Warehouse : Inventory-600 units
Distribution Centre 3
Inventory- 75 units
Daily use- 15 units
Distribution Centre 2
Inventory- 100 units
Daily use- 50 units
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