INVENTORY CONTROL

Inventory:- Any resource that has a certain value and which can be used at a later time, when the demand for that item will arise. It is thus a stock of goods, which may be in the form of raw materials, semi-finished goods ( WIP) or finished product.

An inventory system is the set of policies and controls that monitor levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be

Firms invest 25-35 percent of assets in inventory but many do not manage inventories well

To maintain independence of operations Provide “optimal” amount of cushion between work

centers Ensure smooth work flow

To allow flexibility in production scheduling

To meet variation in product demand

To provide a safeguard for variation in raw material or parts delivery time Protect against supply delivery problems (strikes, weather,

natural disasters, war, etc.)

To take advantage of economic purchase-order size

Improve customer service

Raw

Materials

Works

in

Process

Finished

Goods

Finished

Goods

in Field

Types

Direct Inventories

Raw Material Inventory

Work in progress Inventories

Finished goods inventories

Indirect inventories

1. Direct Inventories:- Items which form an integral part of the finished goods.

2. Indirect Inventories:- Stored items, which do not form an integral part of the finished product but are necessary for upkeep of the plant facilities like lubricants, coolants, office material, etc.

Holding (or carrying) costs. Costs for capital, taxes, insurance, etc. (Dealing with

storage and handling)

Setup (or production change) costs. (manufacturing)

Costs for arranging specific equipment setups, etc.

Ordering costs (services & manufacturing)

Costs of someone placing an order, etc.

Shortage (backordering) costs. Costs of canceling an order, customer goodwill, etc.

Total Inventory cost= Purchase cost + Inventory carrying cost + ordering cost + shortage cost.

Ordering cost= Unit cost of placing an order = Co/q ( Co= cost of placing an order, q=

order quantity)

S= annual requirement, Annual cost of ordering = Co/q x S

Annual Carrying cost= Cu x i x q/2

Cu = unit purchase cost, i = interest rate and Cui= annual carrying cost per unit.

Shortage cost= { cost of being short one unit in the inventory} x { Average number of units short in the inventory) Average Number of units short = (Min. shortage in the inventory + Mx

shortage/2) x Time for which shortage exist

Inventory Models

Static Inventory Models (Only one order is

placed to fulfill demand)

Dynamic Inventory Models

Probabilistic models or Stochastic inventory

model

Deterministic Inventory models

Based on assumptions that the demand as well as lead time of an item are deterministic.

Classification:- Single Product (item) Inventory models.

Multi Product inventory models

Single Product inventory models:- Deterministic inventory models with no shortages:-

Inventory model with uniform demand

Inventory model with several production runs of unequal length

Inventory models with finite replenishment (Production)

Inventory model with shortages:- Inventory model with instantaneous production and variable order cycle.

Inventory model with instantaneous production and fixed order cycle.

Inventory models with finite replenishment (Production)

Inventory models when quantity discount is allowed:- With one price break

More than one price break

Probabilistic models:- Take into account the variation in demand and lead time.

Basically 3 models comes under this category:- Model 1:- Uniform Demand Rate, Infinite Production Rate Model 2:- Gradual replacement Model

Model 3: EOQ model with shortages

Model 1 :- Uniform Demand Rate:- Developed by Ford Harris in 1915, modified by R.H. Wilson in 1943 Mode for uniform demand rate and infinite production rate.

Salient Features:- Inventory is know with certainty. Demand rate is constant Single lot placement of order Quantity discount is not allowed. Thus, purchase cost per unit is fixed. Lead time is constant and it is independent of demand. Inventory is controlled form one point of the system i.e. in a stockroom or

in a warehouse.

Notions used in this Model:- D = Annual demand of parts in units

Q = Quantity ordered each time

Q* = Optimum quantity of inventory ordered for min. total cost

C = Cost of inventory per unit

CC= Carrying cost of per unit of individual item.

CO= Ordering , set-up or procurement cost per order

TC= Total annual cost

TL= Lead time

CS= Cost of shortages due to non-availability of inventory.

Assumes lead time is Zero.

TC = Co x N + Cc x Qavg

EOQ = Q* = √2DCo/Cc

R = Reorder point

Q = Economic order quantity

L = Lead time

L L

Q Q Q

R

Time

Number

of units

on hand

1. You receive an order quantity Q.

2. Your start using them

up over time. 3. When you reach down to a level

of inventory of R, you place your

next Q sized order.

4. The cycle then repeats.

17-13

Ordering Costs

Holding

Costs

(EOQ)QOPTIMAL Order Quantity (Q)

C O S T

Annual Cost of

Items (DC)

Total Cost

By adding the item, holding, and ordering costs together, we

determine the total cost curve, which in turn is used to find the

Qoptimal (a.k.a. “EOQ”) inventory order point that minimizes total

costs.

Minimum Total Annual Stocking cost

Optimum Ordering Interval (t*):- EOQ = demand rate x optimum ordering interval

Q* = Dt*

t* = √( 2 x setup cost) / ( Demand / carrying cost)

t* = √ 2Co/ DCc

Given the information, what are the EOQ and reorder point:- Annual Demand= 1,00 units

Days per year considered in daily Demand = 365

Cost to place and order = $ 10

Holding cost per unit per year = $ 2.5

Lead time = 7 days

Cost per unit= $ 15

EOQ= √ 2DCo/Cc = √ 2 ( 1000)(10)/ 2.5 = 89.443 units or 90 units

Re order Point = dl= (1000/365) x 7 = 19.18 (20 units)

Also known as Production-Consumption Model

Instantaneous supply of delivery may not be possible.

Supplier continuously replenishes items at rate, which is more than the consumption rate.

Because the time inventory is supplied the consumption also continues.

The supply is gradual.

Notions:-

P = Production rate ( Unit Per day)

C = Consumption Rate ( Unit Per day)

D = Demand rate ( Unit per day)

Q = Size of lot ordered or produced

Tp= Procurement time

TD= Depletion time

Supply is gradual for period Tp ( Procurement Time)

Inventory builds up at a rate ( P-C) and after Tp, inventory depletes at rate C.

Tp= Q/P

Maximum on-hand inventory :- Tp (P-C) i.e. Q/P (P-C) = Q (1-C/P)

Depletion Time = TD= Q (1- (C/P)/C)

Average Inventory level QAVG= Q/2 ( 1-C/P)

Total Cost= D/ Q.CO + Q/2 ( 1- C/P)

= (Number of units placed in a year X Ordering Cost) + (Carrying cost per unit X Average Inventory Level during year)

EOQ = Q* = √2DCo/( 1-C/P)Cc

There is a stock- out situation, the customer demand is not satisfied.

In case of raw material/work in process shortages, the production get disrupted.

Causes loss due to emergency purchase.

Unsatisfied customer result in loss of goodwill and lost-sale.

Lost sale due to 2 reason:- The customer may post-pose or drop the idea to purchase

Customer may go to another producer f similar product or services.

Demand is deterministic and known

Shortages are allowed.

Production rate is infinite

Lead time is zero.

Reordering is allowed.

EOQ = Q* = √2DCo/Cc X √ (Cs + Cc)/ Cs Q*= Economic order quantity

D = Demand rate

Co= Cost of ordering

Cc= Annual Cost of carrying one unit of inventory

Cs= Penalty for the shortage f one unit per year or shortage cost.

Maximum Inventory Level (S):-

Optimum Value of S = S*

S* = √2D.Co/Cc X √Cs/(Cs+Cc)

Time between receipt of order, also gives when to order (t*):- t*= Q*/D

Optimal inventory cost:

TC* = √2D.Co.Cc X √Cs/(Cs+Cc)

Material are made available at most economical rate.

There is no shortage of raw material etc. at any stage of production

Material of required quality is procured in time.

Production schedules are not disturbed.

It helps in achieving the production targets in time.

Purchasing the material in bulk reduces the unit cost and overheads.

Helps in segregating the items from one another.

Tells about the value of the item to the total value.

It classify the inventories on the basis of cost and usage.

The inventories are classified on the basis of control:- ABC Classification (Pareto Principle)

A Items: very tight control, complete and accurate records, frequent review

B Items: less tightly controlled, good records, regular review

C Items: simplest controls possible, minimal records, large inventories, periodic review and reorder

These are high value, low-volume of inventories.

Their annual consumptions is very less.

These are very costly items. Despite needed in less quantity, their annual monetary value is quite

high, only a small percentage (10-20%) accounts for major percentage (say 70-80%) of total inventory monetary consumption.

ABC analysis recommends careful control of A-type inventory. More periodic review is needed.

These are low value, high volume type of inventories.

Their annual consumption is high.

These are not too costly items.

A high volume not constitutes more annual monetary consumptions. Majority of items (60-70%) constitute only a minor fraction of the total annual monetary consumption (5-15%) in inventories.

The control needed for these items may not to very stringent.

These items may be under the supervision of lower level of management.

These are medium volume, medium value type inventories.

Their annual consumption is moderate

These items constitutes medium cost.

The items other then type A and C constitutes 20-30% of volume and 10 to 25% in value.

Their control and supervision are moderate.

It provide the framework for the integration of information, material and finance , right form the suppliers to the customers.

It is a network of facilities and distribution options that performs the function of procurement of material, transformation of these materials into products to customers.

It is the sequence of organizations - their facilities, functions, and activities - that are involved in producing and delivering a product or service.

As per Harland (1996), “ SCM is the management of a network of interconnected business involved in the ultimate provision of product and service packages required by end customers”.

It spans all movement and storage of raw materials, work-in- process inventory and finished goods from the point of origin to point of consumption.

As per APICS dictionary, “ Designing, planning, execution, control and monitoring of supply chain with the objective of creating net value, building a competitive infrastructure, leveraging worldwide logistics, synchronizing supply with demand and measuring performance globally”.

SUPPLY CHAIN

Logistics

Distribution

Consumption

Packaging

Purchasing Receiving Storage Operations Storage

Production Distribution

Supply Chain Structure

Information Flow

Raw Materials

RETAILER FACTORY DC RDC

SUPPLIER

Finished Goods

33

Suppliers Manufacturers Warehouses & Distribution Centers

Customers

Material Costs

Transportation Costs

Transportation Costs Transportation

Costs Inventory Costs Manufacturing Costs

Plan Source Make Deliver Buy

A set of approaches used to efficiently integrate

Suppliers

Manufacturers

Warehouses

Distribution centers

So that the product is produced and distributed

In the right quantities

To the right locations

And at the right time

System-wide costs are minimized and

Service level requirements are satisfied

Plan Source Make Deliver Buy

Supply Chain Decision

Strategic Operational

Location Decision

Production Decision

Inventory Decisions

Transportation ( Distributions)

Decision

Location Decision:- Geographic placement of production facilities, stocking points and sourcing points.

Production Decision:- Strategic decision include what products to produce and which plants

produce them, allocation of suppliers to plants, plants to DCs, and DC’s to customer markets.

It determines the exact paths through which a product flows to and from these facilities.

Operational decision focused on detailed production scheduling.

It include construction of master production schedules, scheduling production on machines and equipment maintenance.

Inventory Decisions:- Means by which inventories are managed.

Primary purpose to buffer against any uncertainty.

Strategic in sense as top management set goals.

Transportation Decisions:- The choice of mode is strategic decision.

The best choice of mode is often found by trading-off the cost of using the particular mode of transport with the indirect cost of inventory associated with that mode.

Shipment size, routing, scheduling of equipment are key factors.

Choice of mode among airway, seaway, rail or road.

Reduce operating cost

Reduce inventory levels and production costs

Improved responsiveness and reduce cycle time.

Improve customer service.

Simplify operations

Improve quality

Support significant volume growth

improved return on capital

Effectively support a growing or diverse customer base.

Effectively offer great variety of products

Focus on core competencies.

Extension of organizational control beyond firm boundaries.

Customer relationship management

Customer service management

Demand management

Order fulfillment

Manufacturing flow management

Supplier relationship management

Product Development and

commercialization

Returns management

Plan Source Make Deliver Return

SCM ERP

It is the brain of the enterprises It is the body of the enterprises

It is contained based and optimized It is linear and interactive

It provides capability to the enterprises so that it can make sense out of data to help to make decision.

Primary function of ERP is to generate data.

It afford forecasting and the decision support system

Excels in he transaction management.

It goes beyond the conventional boundaries of the organization and span in the entire supply chain.

Links process only within the organization

SAP India

Mastek

Oracle India

People Soft

J.D. Edwards

IBM Global services

Red Pepper

Manugistics

QAD

I1 Technologies

Numetrix

BaaN India

For dependent demand situations, normal reactive inventory model i.e. EOQ is not suitable because it result in high inventory cost and unreliable delivery schedule.

MRP is better suited for dependent demand items.

MRP, simple system of calculating arithmetically the requirement of input materials at different point of times based on actual production plan.

Also defined as scheduling system to meet time-phased material requirement for production operations.

Tries to meet delivery schedule of end products as specified in master schedule.

Reduction in inventory cost.

Meeting delivery schedule

Improved performance.

MATERIAL RESOURCE PLANNING SYSTEM

It provides answer for several questions :- What items are required?

When are they required?

How many are required?

Applied to both items, purchased from outside from suppliers and to sub-assemblies, produced internally.

Master production schedule

Bill of materials

Inventory status file.

OUTPUTS OF MRP Planned order receipts

Planned order release

Order rescheduling

Improved calculation of material requirements. Improved plant efficiency Improved productivity Improved production schedule Improved shipping performance Improved customer service Reduced inventory levels Reduced components shortages. Reduced purchasing cost Reduction in excess inventory Reduced freight cost Reduced manufacturing cost Less scrap and rework Simplified and accurate scheduling.