inventory management and inventory control must be designed to meet the dictates of the marketplace...

8/14/2019 Inventory Management and Inventory Control must be designed to meet the dictates of the marketplace and sup

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Inventory Management and Inventory Control must be designed to meet the

dictates of the marketplace and support the company's strategic plan. The

many changes in market demand, new opportunities due to worldwide marketing,

global sourcing of materials, and new manufacturing technology, means many

companies need to change their Inventory Management approach and change the

process for Inventory Control.

Despite the many changes that companies go through, the basic principles of

Inventory Management and Inventory Control remain the same. Some of the new

approaches and techniques are wrapped in new terminology, but the underlying

principles for accomplishing good Inventory Management and Inventory

activities have not changed.

The Inventory Management system and the Inventory Control Process provides

information to efficiently manage the flow of materials, effectively utilize peopleand equipment, coordinate internal activities, and communicate with

customers. Inventory Management and the activities of Inventory Control do not

make decisions or manage operations; they provide the information to Managers

who make more accurate and timely decisions to manage their operations.

The basic building blocks for the Inventory Management system and Inventory

Control activities are:

Sales Forecasting or Demand Management

Sales and Operations Planning

Production Planning Material Requirements Planning

Inventory Reduction

The emphases on each area will vary depending on the company and how it

operates, and what requirements are placed on it due to market demands. Each of

the areas above will need to be addressed in some form or another to have a

successful program of Inventory Management and Inventory Control.

Inventory is a list forgoods and materials, or those goods and materials

themselves, held available in stock by abusiness. It is also used for a list of the

contents of a household and for a list fortestamentary purposes of the possessions

of someone who has died. In accounting inventory is considered an asset.

Origins of the word Inventory
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The word inventory was first recorded in 1601. The French term inventaire, or

"detailed list of goods," dates back to 1415.

Business inventory

The reasons for keeping stock

There are three basic reasons for keeping an inventory:

1. Time - The time lags present in the supply chain, from supplier to user at

every stage, requires that you maintain certain amount of inventory to use in

this "lead time"

2. Uncertainty - Inventories are maintained as buffers to meet uncertainties in

demand, supply and movements of goods.

3. Economies of scale - Ideal condition of "one unit at a time at a place where

user needs it, when he needs it" principle tends to incur lots of costs in terms

of logistics. So bulk buying, movement and storing brings in economies of

scale, thus inventory.

All these stock reasons can apply to any owner or product stage.

Buffer stockis held in individual workstations against the possibility that

the upstream workstation may be a little delayed in long setup or change-

over time. This stock is then used while that change-over is happening. This

stock can be eliminated by tools like SMED.

These classifications apply along the whole Supply chain not just within a facility

or plant.

Where these stocks contain the same or similar items it is often the work practice

to hold all these stocks mixed together before or after the sub-process to which

they relate. This 'reduces' costs. Because they are mixed-up together there is no

visual reminder to operators of the adjacent sub-processes or line management of

the stock which is due to a particular cause and should be a particular individual's

responsibility with inevitable consequences. Some plants have centralized stockholding across sub-processes which makes the situation even more acute.

[edit] Special terms used in dealing with inventory

Stock Keeping Unit(SKU) is a unique combination of all the components

that are assembled into the purchasable item. Therefore any change in the
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packaging or product is a new SKU. This level of detailed specification

assists in managing inventory.

Stockoutmeans running out of the inventory of an SKU.[1]

"New old stock" (sometimes abbreviated NOS) is a term used in business to

refer to merchandise being offered for sale which was manufactured long

ago but that has never been used. Such merchandise may not be produced

any more, and the new old stock may represent the only market source of a

particular item at the present time.

[edit] Typology

1. Buffer/safety stock

2. Cycle stock (Used in batch processes, it is the available inventory excluding

buffer stock)

3. De-coupling (Buffer stock that is held by both the supplier and the user)4. Anticipation stock (building up extra stock for periods of increased demand -

e.g. ice cream for summer)

5. Pipeline stock (goods still in transit or in the process of distribution - have

left the factory but not arrived at the customer yet)

[edit] Inventory examples

While accountants often discuss inventory in terms of goods for sale, organizations

- manufacturers, service-providers and not-for-profits - also have inventories

(fixtures, furniture, supplies, ...) that they do not intend to sell. Manufacturers',distributors', and wholesalers' inventory tends to cluster in warehouses. Retailers'

inventory may exist in a warehouse or in a shop or store accessible to customers.

Inventories not intended for sale to customers or to clients may be held in any

premises an organization uses. Stock ties up cash and if uncontrolled it will be

impossible to know the actual level of stocks and therefore impossible to control

them.

Whilst the reasons for holding stock are covered earlier, most manufacturing

organizations usually divide their "goods for sale" inventory into:

Raw materials - materials and components scheduled for use in making a

product.

Work in process, WIP - materials and components that have begun their

transformation to finished goods.

Finished goods - goods ready for sale to customers.

Goods for resale - returned goods that are salable.
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Spare parts

For example:

[edit] Manufacturing

A canned food manufacturer's materials inventory includes the ingredients to form

the foods to be canned, empty cans and their lids (or coils of steel or aluminum for

constructing those components), labels, and anything else (solder, glue, ...) that will

form part of a finished can. The firm's work in process includes those materials

from the time of release to the work floor until they become complete and ready

for sale to wholesale or retail customers. This may be vats of prepared food, filled

cans not yet labelled or sub-assemblies of food components. It may also include

finished cans that are not yet packaged into cartons or pallets. Its finished good

inventory consists of all the filled and labelled cans of food in its warehouse that it

has manufactured and wishes to sell to food distributors (wholesalers), to grocery

stores (retailers), and even perhaps to consumers through arrangements like factory

stores and outlet centers.

[edit] Logistics or distribution

The logistics chain includes the owners (wholesalers and retailers), manufacturers'

agents, and transportation channels that an item passes through between initialmanufacture and final purchase by a consumer. At each stage, goods belong (as

assets) to the seller until the buyer accepts them. Distribution includes four

components:

1. Manufacturers' agents: Distributors who hold and transport a consignment of

finished goods for manufacturers without everowningit. Accountants refer

to manufacturers' agents' inventory as "matriel" in order to differentiate it

from goods for sale.

2. Transportation: The movement of goods between owners, or between

locations of a given owner. The seller owns goods in transit until the buyeraccepts them. Sellers or buyers may transport goods but most transportation

providers act as the agent of the owner of the goods.

3. Wholesaling: Distributors who buy goods from manufacturers and other

suppliers (farmers, fishermen, etc.) for re-sale work in the wholesale

industry. A wholesaler's inventory consists of all the products in its

warehouse that it has purchased from manufacturers or other suppliers. A
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produce-wholesaler (or distributor) may buy from distributors in other parts

of the world or from local farmers. Food distributors wish to sell their

inventory to grocery stores, other distributors, or possibly to consumers.

4. Retailing: A retailer's inventory of goods for sale consists of all the products

on its shelves that it has purchased from manufacturers or wholesalers. The

store attempts to sell its inventory (soup, bolts, sweaters, or other goods) to

consumers.

It is a key observation in the "Lean Manufacturing" that it is often the case that

more than 90% of a product's life prior to end user sale is spent in distribution of

one form or another. On the assumption that the time is not itself valuable to the

customer this adds enormously to the working capital tied up in the business as

well as the complexity of the supply chain. Reduction and elimination of these

inventory 'wait' states is a key concept in Lean.

[edit] High level inventory management

It seems that around about 1880[2] there was a change in manufacturing practice

from companies with relatively homogeneous lines of products to vertically

integrated companies with unprecedented diversity in processes and products.

Those companies (especially in metalworking) attempted to achieve success

through economies of scope - the gains of jointly producing two or more products

in one facility. The managers now needed information on the effect of product mix

decisions on overall profits and therefore needed accurate product cost

information. A variety of attempts to achieve this were unsuccessful due to thehuge overhead of the information processing of the time. However, the burgeoning

need for financial reporting after 1900 created unavoidable pressure forfinancial

accounting of stock and the management need to cost manage products became

overshadowed. In particular it was the need for audited accounts that sealed the

fate of managerial cost accounting. The dominance of financial reporting

accounting overmanagement accounting remains to this day with few exceptions

and the financial reporting definitions of 'cost' have distorted effective management

'cost' accounting since that time. This is particularly true of inventory.

Hence high level financial inventory has these two basic formulas which relate to

the accounting period:

1. Cost ofBeginning Inventory at the start of the period + inventorypurchases

within the period + cost ofproduction within the period = cost of goods
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2. Cost of goods cost ofending inventory at the end of the period = cost of

goods sold

The benefit of these formulae is that the first absorbs all overheads of production

and raw material costs in to a value of inventory for reporting. The second formula

then creates the new start point for the next period and gives a figure to be

subtracted from sales price to determine some form of sales margin figure.

Manufacturing management is more interested in inventory turnover ratio or

average days to sell inventory since it tells them something about relativeinventory levels.

Inventory turn over ratio (also known as inventory turns) = cost of goods

sold / Average Inventory = Cost of Goods Sold / ((Beginning Inventory +

Ending Inventory) / 2)

and its inverse

Average Days to Sell Inventory = Number of Days a Year / Inventory Turn

Over Ratio = 365 days a year / Inventory Turn Over Ratio

This ratio estimates how many times the inventory turns over a year. This number

tells us how much cash/goods are tied up waiting for the process and is a critical

measure of process reliability and effectiveness. So a factory with two inventory

turns has six months stock on hand which generally not a good figure (dependingupon industry) whereas a factory that moves from six turns to twelve turns has

probably improved effectiveness by 100%. This improvement will have some

negative results in the financial reporting since the 'value' now stored in the factory

as inventory is reduced.

Whilst the simplicity of these accounting measures of inventory are very useful

they are in the end fraught with the danger of their own assumptions. There are in

fact so many things which can vary hidden under this appearance of simplicity that

a variety of 'adjusting' assumptions may be used. These include:

Specific Identification

Weighted Average Cost

Moving-Average Cost

FIFO and LIFO.
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Inventory Turn is a financial accounting tools for evaluating inventory and it is not

necessarily a management tool. Inventory management should be forward looking.

The methodology applied is based on historical cost of goods sold. The ratio may

not be able to reflect the usability of future production demand as well as customer

demand.

Business models including Just in Time (JIT) Inventory, Vendor Managed

Inventory (VMI) and Customer Managed Inventory (CMI) attempt to minimize on-

hand inventory and increase inventory turns. VMI and CMI have gained

considerable attention due to the success of third party vendors who offer added

expertise and knowledge that organizations may not possess.

[edit] Accounting perspectives

[edit] The basis of Inventory accounting

Inventory needs to be accounted where it is held across accounting period

boundaries since generally expenses should be matched against the results of that

expense within the same period. When processes were simple and short then

inventories were small but with more complex processes then inventories became

larger and significant valued items on the balance sheet[3]. This need to value

unsold and incomplete goods has driven many new behaviours into management

practise. Perhaps most significant of these are the complexities of fixed cost

recovery, transfer pricing, and the separation of direct from indirect costs. This,

supposedly, precluded "anticipating income" or "declaring dividends out ofcapital". It is one of the intangible benefits ofLean and the TPS that process times

shorten and stock levels decline to the point where the importance of this activity is

hugely reduced and therefore effort, especially managerial, to achieve it can be

minimised.

[edit] Accounting for Inventory

Each country has its own rules about accounting for inventory that fit with their

financial reporting rules.

So for example, organizations in the U.S. define inventory to suit their needs

within US Generally Accepted Accounting Practices (GAAP), the rules defined by

the Financial Accounting Standards Board (FASB) (and others) and enforced by

the U.S. Securities and Exchange Commission (SEC) and other federal and state

agencies. Other countries often have similar arrangements but with their own

GAAP and national agencies instead.
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It is intentional that financial accounting uses standards that allow the public to

compare firms' performance, cost accounting functions internally to an

organization and potentially with much greater flexibility. A discussion of

inventory from standard and Theory of Constraints-based (throughput) cost

accounting perspective follows some examples and a discussion of inventory from

a financial accounting perspective.

The internal costing/valuation of inventory can be complex. Whereas in the past

most enterprises ran simple one process factories, this is quite probably in the

minority in the 21st century. Where 'one process' factories exist then there is a

market for the goods created which establishes an independent market value for the

good. Today with multi-stage process companies there is much inventory that

would once have been finished goods which is now held as 'work-in-process'

(WIP). This needs to be valued in the accounts but the valuation is a management

decision since there is no market for the partially finished product. This somewhatarbitrary 'valuation' of WIP combined with the allocation of overheads to it has led

to some unintended and undesirable results.

[edit] Financial accounting

An organization's inventory can appear a mixed blessing, since it counts as an asset

on thebalance sheet, but it also ties up money that could serve for other purposes

and requires additional expense for its protection. Inventory may also cause

significant tax expenses, depending on particular countries' laws regarding

depreciation of inventory, as in Thor Power Tool Company v. Commissioner.

Inventory appears as a current asset on an organization's balance sheet because the

organization can, in principle, turn it into cash by selling it. Some organizations

hold larger inventories than their operations require in order to inflate their

apparent asset value and their perceived profitability.

In addition to the money tied up by acquiring inventory, inventory also brings

associated costs for warehouse space, for utilities, and forinsurance to cover staff

to handle and protect it, fire and other disasters, obsolescence, shrinkage (theft and

errors), and others. Such holding costs can mount up: between a third and a half of

its acquisition value per year.

Businesses that stock too little inventory cannot take advantage of large orders

from customers if they cannot deliver. The conflicting objectives of cost control

and customer service often pit an organization's financial and operating managers

against its sales and marketing departments. Sales people, in particular, often
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receive sales commission payments, so unavailable goods may reduce their

potential personal income. This conflict can be minimised by reducing production

time to being near or less than customer expected delivery time. This effort, known

as "Lean production" will significantly reduce working capital tied up in inventory

and reduce manufacturing costs (See the Toyota Production System).

[edit] The role of a cost accountant on the 21st-century in a manufacturing

organization

By helping the organization to make better decisions, the accountants can help the

public sector to change in a very positive way that delivers increased value for the

taxpayers investment. It can also help to incentivise progress and to ensure that

reforms are sustainable and effective in the long term, by ensuring that success is

appropriately recognized in both the formal and informal reward systems of the

organization.

To say that they have a key role to play is an understatement. Finance is connected

to most, if not all, of the key business processes within the organization. It should

be steering the stewardship and accountability systems that ensure that the

organization is conducting its business in an appropriate, ethical manner. It is

critical that these foundations are firmly laid. So often they are the litmus test by

which public confidence in the institution is either won or lost.

Finance should also be providing the information, analysis and advice to enable the

organizations service managers to operate effectively. This goes beyond thetraditional preoccupation with budgets how much have we spent so far, how

much have we left to spend? It is about helping the organization to better

understand its own performance. That means making the connections and

understanding the relationships between given inputs the resources brought to

bear and the outputs and outcomes that they achieve. It is also about

understanding and actively managing risks within the organization and its

activities.

[edit] FIFO vs. LIFO accounting

Main article:FIFO and LIFO accounting

When a dealer sells goods from inventory, the value of the inventory is reduced by

the cost of goods sold (CoG sold). This is simple where the CoG has not varied

across those held in stock; but where it has, then an agreed method must be derived

to evaluate it. Forcommodity items that one cannot track individually, accountants
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must choose a method that fits the nature of the sale. Two popular methods which

normally exist are: FIFO and LIFO accounting (first in - first out, last in - first out).

FIFO regards the first unit that arrived in inventory as the first one sold. LIFO

considers the last unit arriving in inventory as the first one sold. Which method an

accountant selects can have a significant effect on net income andbook value and,

in turn, on taxation. Using LIFO accounting for inventory, a company generally

reports lower net income and lower book value, due to the effects of inflation. This

generally results in lower taxation. Due to LIFO's potential to skew inventory

value, UK GAAP and IAS have effectively banned LIFO inventory accounting.

[edit] Standard cost accounting

Standard cost accounting uses ratios called efficiencies that compare the labour and

materials actually used to produce a good with those that the same goods would

have required under "standard" conditions. As long as similar actual and standardconditions obtain, few problems arise. Unfortunately, standard cost accounting

methods developed about 100 years ago, when labor comprised the most important

cost in manufactured goods. Standard methods continue to emphasize labor

efficiency even though that resource now constitutes a (very) small part of cost in

most cases.

Standard cost accounting can hurt managers, workers, and firms in several ways.

For example, a policy decision to increase inventory can harm a manufacturing

managers'performance evaluation. Increasing inventory requires increased

production, which means that processes must operate at higher rates. When (not if)something goes wrong, the process takes longer and uses more than the standard

labor time. The manager appears responsible for the excess, even though s/he has

no control over the production requirement or the problem.

In adverse economic times, firms use the same efficiencies to downsize, rightsize,

or otherwise reduce their labor force. Workers laid off under those circumstances

have even less control over excess inventory and cost efficiencies than their

managers.

Many financial and cost accountants have agreed for many years on the desirability

of replacing standard cost accounting. They have not, however, found a successor.

[edit] Theory of Constraints cost accounting

Eliyahu M. Goldratt developed the Theory of Constraints in part to address the

cost-accounting problems in what he calls the "cost world". He offers a substitute,
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called throughput accounting, that uses throughput (money for goods sold to

customers) in place of output (goods produced that may sell or may boost

inventory) and considers labor as a fixed rather than as a variable cost. He defines

inventory simply as everything the organization owns that it plans to sell, including

buildings, machinery, and many other things in addition to the categories listed

here. Throughput accounting recognizes only one class of variable costs: the trully

variable costs like materials and components that vary directly with the quantity

produced.

Finished goods inventories remainbalance-sheet assets, but labor efficiency ratios

no longer evaluate managers and workers. Instead of an incentive to reduce labor

cost, throughput accounting focuses attention on the relationships between

throughput (revenue or income) on one hand and controllable operating expenses

and changes in inventory on the other. Those relationships direct attention to the

constraints orbottlenecks that prevent the system from producing more throughput,rather than to people - who have little or no control over their situations.

[edit] National accounts

Inventories also play an important role in national accounts and the analysis of the

business cycle. Some short-term macroeconomic fluctuations are attributed to the

inventory cycle.

[edit] Distressed inventory

Also known as distressed or expired stock, distressed inventory is inventory whose

potential to be sold at a normal cost has or will soon pass. In certain industries it

could also mean that the stock is or will soon be impossible to sell. Examples of

distressed inventory include products that have reached its expiry date, or has

reached a date in advance of expiry at which the planned market will no longer

purchase it (e.g. 3 months left to expiry), clothing that is defective or out of

fashion, and old newspapers or magazines. It also includes computer or consumer-

electronic equipment that is obsolescent or discontinued and whose manufacturer

is unable to support it. One current example of distressed inventory is the VHS

format.[4]

[edit] Inventory credit

Inventory credit refers to the use of stock, or inventory, as collateral to raise

finance. Where banks may be reluctant to accept traditional collateral, for example

in developing countries where land title may be lacking, inventory credit is a
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12/43

potentially important way of overcoming financing constraints. This is not a new

concept; archaeological evidence suggests that it was practiced in Ancient Rome.

Obtaining finance against stocks of a wide range of products held in abonded

warehouse is common in much of the world. It is, for example, used with parmesan

cheese in Italy.[5] Inventory credit on the basis of stored agricultural produce is

widely used in Latin American countries and in some Asian countries. [6]A

precondition for such credit is that banks must be confident that the stored product

will be available if they need to call on the collateral; this implies the existence of a

reliable network of certified warehouses. Banks also face problems in valuing the

inventory. The possibility of sudden falls in commodity prices means that they are

usually reluctant to lend more than about 60% of the value of the inventory at the

time of the loan.

Inventory Management and Inventory Control must be designed to meet the

dictates of the marketplace and support the company's strategic plan. Themany changes in market demand, new opportunities due to worldwide marketing,

global sourcing of materials, and new manufacturing technology, means many

companies need to change their Inventory Management approach and change the

process for Inventory Control.

Despite the many changes that companies go through, the basic principles of

Inventory Management and Inventory Control remain the same. Some of the new

approaches and techniques are wrapped in new terminology, but the underlying

principles for accomplishing good Inventory Management and Inventory

activities have not changed.

The Inventory Management system and the Inventory Control Process provides

information to efficiently manage the flow of materials, effectively utilize people

and equipment, coordinate internal activities, and communicate with

customers. Inventory Management and the activities of Inventory Control do not

make decisions or manage operations; they provide the information to Managers

who make more accurate and timely decisions to manage their operations.

The basic building blocks for the Inventory Management system and Inventory

Control activities are:

Sales Forecasting or Demand Management

Sales and Operations Planning

Production Planning

Material Requirements Planning

Inventory Reduction
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What is "Inventory Management"Inventory management is the active control program whichallows the management of sales, purchases and payments.

Inventory management software helps create invoices, purchaseorders, receiving lists, payment receipts and can print bar codedlabels. An inventory management software system configured toyour warehouse, retail or product line will help to create revenuefor your company. The Inventory Management will controloperating costs and provide better understanding. We are yoursource for inventory management information, inventorymanagement software and tools.

A complete Inventory Management Control system contains thefollowing components:

Inventory Management Definition

Inventory Management Terms Inventory Management Purposes Definition and Objectives for Inventory Management Organizational Hierarchy of Inventory Management

Inventory Management Planning Inventory Management Controls for Inventory

Determining Inventory Management Stock Levels

Read our inventory management blog articles.

Inventory management, or inventory control, is an attempt to balance

inventory needs and requirements with the need to minimize costs

resulting from obtaining and holding inventory. There are several schools

of thought that view inventory and its function differently. These will be

addressed later, but first we present a foundation to facilitate the reader'sunderstanding of inventory and its function.

WHAT IS INVENTORY?
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Inventory is a quantity or store of goods that is held for some purpose or

use (the term may also be used as a verb, meaning to take inventory or to

count all goods held in inventory). Inventory may be kept "in-house,"

meaning on the premises or nearby for immediate use; or it may be held in

a distant warehouse or distribution center for future use. With the

exception of firms utilizing just-in-time methods, more often than not, the

term "inventory" implies a stored quantity of goods that exceeds what is

needed for the firm to function at the current time (e.g., within the next few

hours).

WHY KEEP INVENTORY?

Why would a firm hold more inventory than is currently necessary to

ensure the firm's operation? The following is a list of reasons for

maintaining what would appear to be "excess" inventory.

MEET DEMAND.

In order for a retailer to stay in business, it must have the products that the

customer wants on hand when the customer wants them. If not, the retailer

will have to back-order the product. If the customer can get the good fromsome other source, he or she may choose to do so rather than electing to

allow the original retailer to meet demand later (through back-order).

Hence, in many instances, if a good is not in inventory, a sale is lost forever.

KEEP OPERATIONS RUNNING.

A manufacturer must have certain purchased items (raw materials,

components, or subassemblies) in order to manufacture its product.Running out of only one item can prevent a manufacturer from completing

the production of its finished goods.

Inventory between successive dependent operations also serves to decouple

the dependency of the operations. A machine or workcenter is often


15/43

dependent upon the previous operation to provide it with parts to work on.

If work ceases at a workcenter, then all subsequent centers will shut down

for lack of work. If a supply of work-in-process inventory is kept between

each workcenter, then each machine can maintain its operations for a

limited time, hopefully until operations resume the original center.

LEAD TIME.

Lead time is the time that elapses between the placing of an order (either a

purchase order or a production order issued to the shop or the factory

floor) and actually receiving the goods ordered.

If a supplier (an external firm or an internal department or plant) cannotsupply the required goods on demand, then the client firm must keep an

inventory of the needed goods. The longer the lead time, the larger the

quantity of goods the firm must carry in inventory.

A just-in-time (JIT) manufacturing firm, such as Nissan in Smyrna,

Tennessee, can maintain extremely low levels of inventory. Nissan takes

delivery on truck seats as many as 18 times per day. However, steel mills

may have a lead time of up to three months. That means that a firm thatuses steel produced at the mill must place orders at least three months in

advance of their need. In order to keep their operations running in the

meantime, an on-hand inventory of three months' steel requirements

would be necessary.

HEDGE.

Inventory can also be used as a hedge against price increases and inflation.Salesmen routinely call purchasing agents shortly before a price increase

goes into effect. This gives the buyer a chance to purchase material, in

excess of current need, at a price that is lower than it would be if the buyer

waited until after the price increase occurs.


16/43

QUANTITY DISCOUNT.

Often firms are given a price discount when purchasing large quantities of a

good. This also frequently results in inventory in excess of what is currently

needed to meet demand. However, if the discount is sufficient to offset the

extra holding cost incurred as a result of the excess inventory, the decision

to buy the large quantity is justified.

SMOOTHING REQUIREMENTS.

Sometimes inventory is used to smooth demand requirements in a market

where demand is somewhat erratic. Consider the demand forecast and

production schedule outlined in Table 1.

Notice how the use of inventory has allowed the firm to maintain a steady

rate of output (thus avoiding the cost of hiring and training new personnel),

while building up inventory in anticipation of an increase in demand. In

fact, this is often called anticipation inventory. In essence, the use of

inventory has allowed the firm to move demand requirements to earlier

periods, thus smoothing the demand.

CONTROLLING INVENTORY

Firms that carry hundreds or even thousands of different part numbers can

be faced with the impossible task of monitoring the inventory levels of each

part number. In order to facilitate this, many firm's use an ABC approach.

ABC analysis is based on Pareto Analysis, also known as the "80/20" rule.

The 80/20 comes from Pareto's finding that 20 percent of the populace

possessed 80 percent of the wealth. From an inventory perspective it canrestated thusly: approximately 20 percent of all inventory items represent

80 percent of inventory costs. Therefore, a firm can control 80 percent of

its inventory costs by monitoring and controlling 20 percent of its

inventory. But, it has to be the correct 20 percent.


17/43

The top 20 percent of the firm's most costly items are termed "A" items

(this should approximately represent 80 percent of total inventory costs).

Items that are extremely inexpensive or have low demand are termed "C"

items, with "B" items falling in between A and C items. The percentages

may vary with each firm, but B items usually represent about 30 percent of

the total inventory items and 15 percent of the costs. C items generally

constitute 50 percent of all inventory items but only around 5 percent of the

costs.

By classifying each inventory item as an A, B or C the firm can determine

the resources (time, effort and money) to dedicate to each item. Usually this

means that the firm monitors A items very closely but can check on B and C

items on a periodic basis (for example, monthly for B items and quarterly

for C items).

Another control method related to the ABC concept is cycle counting. Cycle

counting is used instead of the traditional "once-a-year" inventory count

where firms shut down for a short period of time and physically count all

inventory assets in an attempt to reconcile any possible discrepancies in

their inventory records. When cycle counting is used the firm is continually

taking a physical count but not of total inventory.

A firm may physically count a certain section of the plant or warehouse,

moving on to other sections upon completion, until the entire facility is

counted. Then the process starts all over again.

The firm may also choose to count all the A items, then the B items, and

finally the C items. Certainly, the counting frequency will vary with the

classification of each item. In other words, A item may be counted monthly,

B items quarterly, and C items yearly. In addition the required accuracy of

inventory records may vary according to classification, with A items

requiring the most accurate record keeping.

BALANCING INVENTORY AND COSTS


18/43

As stated earlier, inventory management is an attempt to maintain an

adequate supply of goods while minimizing inventory costs. We saw a

variety of reasons companies hold inventory and these reasons dictate what

is deemed to be an adequate supply of inventory. Now, how do we balance

this supply with its costs? First let's look at what kind of costs we are talking

about.

There are three types of costs that together constitute total inventory costs:

holding costs, set-up costs, and purchasing costs.

HOLDING COSTS.

Holding costs, also called carrying costs, are the costs that result frommaintaining the inventory. Inventory in excess of current demand

frequently means that its holder must provide a place for its storage when

not in use. This could range from a small storage area near the production

line to a huge warehouse or distribution center. A storage facility requires

personnel to move the inventory when needed and to keep track of what is

stored and where it is stored. If the inventory is heavy or bulky, forklifts

may be necessary to move it around.

Storage facilities also require heating, cooling, lighting, and water. The firm

must pay taxes on the inventory, and opportunity costs occur from the lost

use of the funds that were spent on the inventory. Also, obsolescence,

pilferage (theft), and shrinkage are problems. All of these things add cost to

holding or carrying inventory.

If the firm can determine the cost of holding one unit of inventory for one

year (H) it can determine its annual holding cost by multiplying the cost ofholding one unit by the average inventory held for a one-year period.

Average inventory can be computed by dividing the amount of goods that

are ordered every time an order is placed (Q) by two. Thus, average

inventory is expressed as Q/2. Annual holding cost, then, can be expressed

asH(Q/2).


19/43

SET-UP COSTS.

Set-up costs are the costs incurred from getting a machine ready to produce

the desired good. In a manufacturing setting this would require the use of a

skilled technician (a cost) who disassembles the tooling that is currently in

use on the machine. The disassembled tooling is then taken to a tool room

or tool shop for maintenance or possible repair (another cost). The

technician then takes the currently needed tooling from the tool room

(where it has been maintained; another cost) and brings it to the machine

in question.

There the technician has to assemble the tooling on the machine in the

manner required for the good to be produced (this is known as a "set-up").

Then the technician has to calibrate the machine and probably will run a

number of parts, that will have to be scrapped (a cost), in order to get the

machine correctly calibrated and running. All the while the machine has

been idle and not producing any parts (opportunity cost). As one can see,

there is considerable cost involved in set-up.

If the firm purchases the part or raw material, then an order cost, rather

than a set-up cost, is incurred. Ordering costs include the purchasing

agent's salary and travel/entertainment budget, administrative and

secretarial support, office space, copiers and office supplies, forms and

documents, long-distance telephone bills, and computer systems and

support. Also, some firms include the cost of shipping the purchased goods

in the order cost.

If the firm can determine the cost of one set-up (S) or one order, it can

determine its annual setup/order cost by multiplying the cost of one set-up

by the number of set-ups made or orders placed annually. Suppose a firm

has an annual demand (D) of 1,000 units. If the firm orders 100 units (Q)

every time it places and order, the firm will obviously place 10 orders per

year (D/Q). Hence, annual set-up/order cost can be expressed as S(D/Q).


20/43

PURCHASING COST.

Purchasing cost is simply the cost of the purchased item itself. If the firm

purchases a part that goes into its finished product, the firm can determine

its annual purchasing cost by multiplying the cost of one purchased unit (P)

by the number of finished products demanded in a year (D). Hence,

purchasing cost is expressed as PD.

Now total inventory cost can be expressed as:

Total = Holding cost + Set-up/Order cost + Purchasing cost

or

Total = H(Q/2) + S(D/Q) +PD

If holding costs and set-up costs were plotted as lines on a graph, the point

at which they intersect (that is, the point at which they are equal) would

indicate the lowest total inventory cost. Therefore, if we want to minimize

total inventory cost, every time we place an order, we should order the

quantity (Q) that corresponds to the point where the two values are equal.

If we set the two costs equal and solve for Q we get:

H(Q/2) =S(D/Q)

Q = 2DS/H

The quantityQ is known as the economic order quantity (EOQ). In order to

minimize total inventory cost, the firm will order Q every time it places an

order. For example, a firm with an annual demand of 12,000 units (at a

purchase price of $25 each), annual holding cost of $10 per unit and an

order cost of $150 per order (with orders placed once a month) could save

$800 annually by utilizing the EOQ. First, we determine the total costs

without using the EOQ method:

Q = $10(1000/2) + $150(12,000/1000) + $25(12,000) = $306,800

Then we calculate EOQ:

EOQ = 2(12,000)($150)/$10= 600

And we calculate total costs at the EOQ of 600:


21/43

Q = $10(600/2) + $150(12,000/600) + $25(12,000) = $306,000

Finally, we subtract the total cost ofQ from Q to determine the savings:

$306,800 306,000 = $800

Notice that if you remove purchasing cost from the equation, the savings is

still $800. We might assume this means that purchasing cost is not

relevant to our order decision and can be eliminated from the equation. It

must be noted that this is true only as long as no quantity discount exists. If

a quantity discount is available, the firm must determine whether the

savings of the quantity discount are sufficient to offset the loss of the

savings resulting from the use of the EOQ.

There are a number of assumptions that must be made with the use of the

EOQ. These include:

Only one product is involved.

Deterministic demand (demand is known with certainty).

Constant demand (demand is stable through-out the year).

No quantity discounts.

Constant costs (no price increases or inflation).

While these assumptions would seem to make EOQ irrelevant for use in a

realistic situation, it is relevant for items that have independent demand.

This means that the demand for the item is not derived from the demand

for something else (usually a parent item for which the unit in question is a

component). For example, the demand for steering wheels would be

derived from the demand for automobiles (dependent demand) but the

demand for purses is not derived from anything else; purses have

independent demand.

OTHER LOT-SIZING TECHNIQUES


22/43

There are a number of other lot-sizing techniques available in addition to

EOQ. These include the fixed-order quantity, fixed-order-interval model,

the single-period model, and part-period balancing.

FIXED-ORDER-QUANTITY MODEL.

EOQ is an example of the fixed-order-quantity model since the same

quantity is ordered every time an order is placed. A firm might also use a

fixed-order quantity when it is captive to packaging situations. If you were

to walk into an office supply store and ask to buy 22 paper clips, chances

are you would walk out with 100 paper clips. You were captive to the

packaging requirements of paper clips, i.e., they come 100 to a box and you

cannot purchase a partial box. It works the same way for other purchasing

situations. A supplier may package their goods in certain quantities so that

their customers must buy that quantity or a multiple of that quantity.

FIXED-ORDER-INTERVAL MODEL.

The fixed-order-interval model is used when orders have to be placed at

fixed time intervals such as weekly, biweekly, or monthly. The lot size is

dependent upon how much inventory is needed from the time of order untilthe next order must be placed (order cycle). This system requires periodic

checks of inventory levels and is used by many retail firms such as drug

stores and small grocery stores.

SINGLE-PERIOD MODEL.

The single-period model is used in ordering perishables, such as food and

flowers, and items with a limited life, such as newspapers. Unsold orunused goods are not typically carried over from one period to another and

there may even be some disposal costs involved. This model tries to balance

the cost of lost customer goodwill and opportunity cost that is incurred

from not having enough inventory, with the cost of having excess inventory

left at the end of a period.


23/43

PART-PERIOD BALANCING.

Part-period balancing attempts to select the number of periods covered by

the inventory order that will make total carrying costs as close as possible to

the set-up/order cost.

When a proper lot size has been determined, utilizing one of the above

techniques, the reorder point, or point at which an order should be placed,

can be determined by the rate of demand and the lead time. If safety stock

is necessary it would be added to the reorder point quantity.

Reorder point =

Expected demand during lead time + Safety stock

Thus, an inventory item with a demand of 100 per month, a two-month

lead time and a desired safety stock of two weeks would have reorder point

of 250. In other words, an order would be placed whenever the inventory

level for that good reached 250 units.

Reorder point =

100/month 2 months + 2 weeks' safety stock = 250

OTHER SCHOOLS OF THOUGHTIN INVENTORY MANAGEMENT

There are a number of techniques and philosophies that view inventory

management from different perspectives.

MRP AND MRP II.

MRP and MRP II are computer-based resource management systems

designed for items that have dependent demand. MRP and MRP II look at

order quantities period by period and, as such, allow discrete ordering

(ordering only what is currently needed). In this way inventory levels can

be kept at a very low level; a necessity for a complex item with dependent

demand.


24/43

JUST-IN-TIME (JIT).

Just-in-time (JIT) is a philosophy that advocates the lowest possible levels

of inventory. JIT espouses that firms need only keep inventory in the right

quantity at the right time with the right quality. The ideal lot size for JIT is

one, even though one hears the term "zero inventory" used.

THEORY OF CONSTRAINTS (TOC).

Theory of constraints (TOC) is a philosophy which emphasizes that all

management actions should center around the firm's constraints. While it

agrees with JIT that inventory should be at the lowest level possible in most

instances, it advocates that there be some buffer inventory around anycapacity constraint (e.g., the slowest machine) and before finished goods.

THE FUTURE OF INVENTORY

MANAGEMENT

The advent, through altruism or legislation, of environmental management

has added a new dimension to inventory management-reverse supply chain

logistics. Environmental management has expanded the number ofinventory types that firms have to coordinate. In addition to raw materials,

work-in-process, finished goods, and MRO goods, firms now have to deal

with post-consumer items such as scrap, returned goods, reusable or

recyclable containers, and any number of items that require repair, reuse,

recycling, or secondary use in another product. Retailers have the same

type problems dealing with inventory that has been returned due to

defective material or manufacture, poor fit, finish, or color, or outright "I

changed my mind" responses from customers.

Finally, supply chain management has had a considerable impact on

inventory management. Instead of managing one's inventory to maximize

profit and minimize cost for the individual firm, today's firm has to make

inventory decisions that benefit the entire supply chain.


25/43

The Approach The SIA methodology has seven unique steps:

End-to-end solutions involve many different factors for every link in yoursupply management chain. If your company is operating on a significantglobal scale, then you may be feeling the compounding of that issue asevery new link in the supply chain carries its own concerns individuallyas well as dynamically in the way they can affect the other links in yoursupply chain. The ultimate aim in moving your product, however, is inefficient supply chain inventory management. Whether it's finding lessexpensive, more consistent ways to get raw materials delivered to yourmanufacturing facilities, or getting assembled products in the hands ofyour consumer base, there are distinct components of effective supplychain inventory management each play a significant role in your entiresupply chain management model.

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To learn more about how Infors enterprising supply chain inventorymanagement solutions can make a difference in your business,contact Infortoday.

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26/43

Manufacturers face a myriad of dynamic challenges that require notonly exceptional advanced planning, but a thorough network ofcommunication tools that allow you to address changes at a moment'snotice. From rapid locational and volume changes in customerdemand, to globalization, to natural disasters, any number of factorscan have a serious effect on your revenue projections. And when youhave inventory stuck in the supply chain, nobody is getting paid. Assuch, the ability to quickly (and intelligently) address inbound andoutbound issues through effective supply chain inventory managementsolutions not only ensures you keep the wheels of business turning, itgives you an advantage in being able to address consumer needs in away that slower, less agile manufacturers will be unable to do.

Offering global supply chain management tools, Infor can partner withyour company to leverage your manufacturing agility and help to meet(or exceed) forecasts through supply chain inventory managementsolutions that keep products moving.

Supply Chain Inventory Management in Transportation andLogistics

In addition to local concerns such as warehouse efficiencies andoptimal strategies for inventory replenishing, the nuts and boltsprocess of moving inventory from one location to another takes on awhole host of new transportation logistics management challengeswhen your company deals with a global market. From longer leadtimes, to regulatory requirements, to issues of customs and theireffective on the ability to establish efficient routines in cross-bordersupply chains, having versatile supply chain inventory managementsolutions on hand can ensure your inventory keeps moving. Further,

robust reporting tools from Infor's supply chain inventory managementgive you real-time visibility along your supply chain, so you can makeadjustments now. When your global growth depends outpacing thecompetition, the race is won in the turns. Prepare your company forwhatever twists and turns may happen with superior global supplychain management tools from Infor.
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Supply Chain Inventory Management in Retail

When you deal in retail, nothing is more important than the moment of

transaction. This may seem simple, but companies who lose sight ofthis principle for even a minute will be eclipsed by another companywho didn't. This key fundamental should be the premise for all supplychain inventory management decisions your company makes. All ofyour processes should be driven by the ability to facilitate theexchange of product for money. This means removing any obstaclesthat can slow (or potentially) stop this from happening. In a proactivesense, however, global supply chain management tools that allow yourcompany the ability to address event management on multiple fronts

maximizes profitability by increasing supply where marketing andother promotions are pushing demand. This level of coordination isabsolutely necessary in today's fiercely competitive global market. Ifyou have doubts in your current supply chain inventory managementsystems to achieve these goals, you are probably leaving money onthe table right now.

Supply Chain Inventory Management and Open Service Oriented

Architecture

Open service oriented architecture is the foundation upon which everyInfor business software solution is built. This is especially importantwith regards to supply chain inventory management. When you aremoving inventory across borders, the level of integrated operations tomake this happen with the greatest efficiency can be considerable.This means you may be using several different software applicationsto achieve your goals. When you implement any supply chain

management software solutions from Infor, our open service orientedarchitecture means these solutions will work with your existingtechnology to leverage your existing resources and, perhaps, evengive you integrated service options you didn't have before. When itcomes to supply chain inventory management, having more optionsmeans having more agility.
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Supply Chain Inventory Management Solutions from Infor

Industry specific solutions accompanied by powerful verticalcapabilities provide a distinct advantage for global companies,

especially those functioning in multiple industries. The ability offlexible, comprehensive global supply chain management to quicklyaddress consumer demand and deliver the goods while minimizingassociated inventory costs leads to instant ROI and return customers.

Supply Chain Management Solutions

Supply chain masters know the secret to supply chain successand itstarts with the very design of their network. Superior performance isdetermined by the location and capacity of manufacturing, distribution,

and transportation assets. To meet the challenges of expansion,competitiveness, and risk, companies need the ability to continuallyevaluate and strategically align these assets.

Infor SCM Strategic Network Design fine-tunes your supply chain,helping you determine the optimal number, location, and size offacilities necessary to meet your customer service goals. As newopportunities arise, youll have the essential tools to reconfigure yournetwork to changes in demand, supply, labor, transportation, andoutsourcing initiatives to sustain a strong, highly competitive supplychain.

A strategic decision-support toolset for analyzing and designing supplychain networks, Strategic Network Design offers extensive modelingand optimization features to help planners design more efficient supplychain networks. You can determine facility location and capacityrequirements, evaluate different transportation and inventorystrategies, select vendors, mitigate risks, and perform profitability andcost analysis. Plus, interactive map-based graphics and point-and-click functionality simplify the complexities of strategic supply chainplanning.

When combined with Tactical Planner, a time-phased strategicplanning application that tells you when to buy, when and where tomanufacture, and where to hold inventory, you can align demand withyour supply planning processes to deliver the most complete, capacityconstrainedand cost-effectivesupply chain
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Supply Chain Management Solutions

Profitability. Competitiveness. Growth. Infor provides enterprisingsupply chain management solutions that help organizations managethe complexities and regulations of today's volatile businessenvironment in order to improve efficiency and attain these vitalobjectives.

Discover how the many key elements of integrated supply chainsolutions from Infor SCM (Supply Chain Management) harmonize tocreate one inclusive, customizable, enterprise-wide solution capable offulfilling your specific concept-to-customer vision.

Integrated Supply Chain Solutions

Infor SCM supply chain management solutions take into account thedistinct challenges you face and are customizable to ensure efficientplanning and execution strategies are attained through the integrationof the following key components:

Strategic Network Design

Attaining maximized efficiency starts with the design of your network.Supply chain management solutions from Infor SCM are initiated bydetermining the ideal size, location, and number of facilities necessaryto adequately meet the needs of customers in your specific industry.

Demand PlanningThe unpredictable nature of today's business environment requiresorganizations to implement solutions that enable rapid response ratesto unforeseen changes in customer demand. Demand Planningsupply chain solutions from Infor provide the ability to more accurately

forecast and shape demand to reduce production costs and increasedelivery performance.

Distribution PlaningThe distribution complexities organizations face grow as supplychains merge and globalization impacts cross geographicalboundaries and regulations. Distribution Planning supply chainmanagement solutions from Infor enhance visibility of supply and
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demand across the entire organization while helping to reach superiorfulfillment at lower costs.

Manufacturing Planning

Obtaining and sustaining customer delight necessitates accuratemanufacturing planning on a consistent basis. Infor SCMManufacturing Planning provides advanced supply chain solutionswhich go beyond traditional ERP-based planning to optimize andsynchronize each facet of the manufacturing process.

Production SchedulingEvery minute counts in today's competitive business environment.Infor SCM Production Scheduling supply chain management solutionsfocus on coordinating products on all lines to maximize production

through the utilization of finite capacity scheduling (FCS).

Transportation & Logistics PlanningAs the customer base of organizations grow, so too do thecomplexities involved in efficiently delivering goods to the right placeat the right time. Transportation & Logistics Planning from Infor iscomprised of advanced supply chain solutions that help determineoptimal processes from inception to delivery, effectively reducinginventory and transportation costs while strengthening customer

relationships. Warehouse Management System

Improve end-to-end fulfillment and distribution with help from InforWarehouse Management system. Our enterprising supply chainmanagement solutions concentrate on enhancing the ability oforganizations to successfully align inventory and processes, meetingcustomer requirements in a cost-effective manner.

RFIDIncreased customers, inventory, facilities, and regulations require

organizations to implement effective supply chain solutions thatprovide improved visibility and data communication capabilities. Infor'sRFID solution connects all parties involved from inception to deliveryand allows for rapid response to unanticipated changes.

Event ManagementMake sense of the many intricacies involved in supply chainmanagement and acquire the ability to efficiently react to unplanned
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events. With proven supply chain management solutions from InforSCM, organizations can detect any conditional changes throughoutthe supply chain and quickly react in a timely, appropriate manner.

Overview: Inventory management is an important activity

towards ensuring smooth production process. Accounting

information plays a key role in inventory management. Just-in-

Time (JIT) manufacturing involves purchasing the raw materials

and going ahead with the production process as and when the

demand arises. JIT is an approach towards minimizing waste and

maximizing productivity. The costing system associated with JIT

manufacturing is known as Backflush Costing. The paper

examines inventory management with emphasis on JIT andBackflush Costing

JIT, or just in time, inventory is a inventory management strategy that isaimed at monitoring the inventory process in such a manner as to minimizethe costs associated with inventory control and maintenance. To a greatdegree, a just-in-time inventory process relies on the efficient monitoring ofthe usage of materials in the production of goods and ordering replacementgoods that arrive shortly before they are needed. This simple strategy helps

to prevent incurring the costs associated with carrying large inventories ofraw materials at any given point in time.

Another application of a just in time inventory focuses not on raw materialsbut on finished goods. Again, the idea is to develop a solid understandingof what is needed to produce goods and schedule them for shipment tocustomers within the shortest time frame possible. As with raw materials,shipping finished goods shortly after producing them leads to minimizingstorage costs and any taxes that may be applicable. This dual applicationof a just in time inventory strategy can significantly cut the operational

expenses of a business in regards to the amount of inventory that must bestored at any one time and the amount of taxes that must be paid on largerinventories.

A just in time inventory management process involves understanding howmuch of a given item is needed to maintain production while more of thesame item is ordered. This involves two key factors. First, it is necessary to
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know how long it will take for the item to be shipped from the supplier andarrive at the manufacturing facility. Second, the anticipated life or usage ofthe item must be determined. By knowing these two pieces of information,it is possible to establish procedures that allow the item to be reordered justin time to arrive and replace a worn item, without having the replacementset in storage for an extended period of time.

Many purchasing departments employ a just in time inventory for such keyitems as raw materials and machine parts. This means that records arekept that make it possible to place a new order for a given componentwhen the number of units on hand decreases to a pre-determined point. Intimes past, this type of inventory control often was accomplished bymaintaining a flip card inventory, such as the old Kardex system. Today,this same type of component usage is often managed with purchasing and

inventory control software.

The idea of a just in time inventory is not new. Henry Ford of the FordMotor Company is known to have applied this principle to the purchase ofraw materials for automobile manufacturing in the early years of the 20thcentury. Many small businesses engage in the use of a just in timeinventory approach out of necessity. With limited resources on hand,maintaining a small inventory of materials and parts simply makes sense.However, even large corporations today realize that the savings associatedwith this type of approach can save a significant amount of financial

resources, making it possible to redirect those resources toward otherrevenue generating processes.

In computing, just-in-time compilation (JIT), also known as dynamic

translation, is a technique for improving the runtime performance of a computer

program. JIT builds upon two earlier ideas in run-time environments: bytecodecompilation and dynamic compilation. It converts code at runtime prior to

executing it natively, for examplebytecode into native machine code. The

performance improvement over interpreters originates from caching the results of

translating blocks of code, and not simply reevaluating each line or operand eachtime it is met (see Interpreted language). It also has advantages over statically

compiling the code at development time, as it can recompile the code if this is

found to be advantageous, and may be able to enforce security guarantees. Thus

JIT can combine some of the advantages of interpretation and static (ahead-of-

time) compilation.
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Several modern runtime environments, such as Microsoft's .NET Frameworkand

most implementations ofJava, rely on JIT compilation for high-speed code

execution.

Overview

In a bytecode-compiled system, source code is translated to an intermediate

representation known asbytecode. Bytecode is not the machine code for any

pa

inventory management and inventory control must be designed to meet the dictates of the marketplace...

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