Introduction

y There are three types of inventories:y Raw material y Work

in process y Finished goods

y Raw material :- Material and component that are y y y y

inputs in making the final products . Work in- process:- also called stock in process, refers to goods in intermediate stages of production Finished goods:- consists of all final products that are ready for sale. Manufacturing firm hold all three types of inventories. Distribution firm hold mostly finished goods.

y Inventories represent the second largest assets

category for manufacturing companies, next only to plant and equipment. y The proportion of inventories to total assets generally varies between 15 and 30 percent y Decision relating to inventory are taken primarily by executive in production, purchasing and marketing departments. y Usually raw material policies are shaped by purchasing and production executives

y Work in process inventory is influenced by the

decision of production executive. y Finished goods inventory is evolved by production and marketing executives.

Purpose/ benefit of holding Inventory

y The Transaction Motive :- for continuous production

and timely execution of sales order y The Precautionary motive:- holding of inventories for meeting the unpredictable changes in demand and supplies of material y The Speculative motive :- holding inventories for taking advantage of price fluctuations , saving in reordering costs and quantity discounts.

Risk and cost of holding inventory

y Capital cost y Storage and handling cost y Risk of price decline y Risk of obsolescence y Risk of deteriorate in quality

Objective of inventory management

Objectives1. 2. 3. 4. 5. 6. 7. 8.

For continuous supply for uninterrupted production To reduce wastage & losses To introduce scientific inventory management techniques To reduce cost of purchase & storage To reduce excessive or shortage of inventory To have uninterrupted production for effective utilization of store space To provide right material at right time, from right source & right prices.

Needs for inventories

y What purpose is served by inventories y Process or movement inventories

Order Quantity EOQ Model

y There are two basic questions relatinig to inventory

management:y What should be the size of order ? y At what level should order be placed?

y Economic Order quantity(EOQ):- the quantity to be

purchased should neither be small nor big. y Economic order quantity (EOQ) is that size of the order which gives maximum economy in purchasing any material and ultimately contributes towards maintaining the materials at the optimum level and at the minimum cost. y In other words, the economic order quantity (EOQ) is the amount of inventory to be ordered at one time for purposes of minimizing annual inventory cost.

y The quantity to order at a given time must be determined by

balancing two factors: y (1) the cost of possessing or carrying materials. (Carrying Cost) y (2) the cost of acquiring or ordering materials. (Ordering cost) y Purchasing larger quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the cost of carrying materials in stock for a longer period of time.
y y y y y y

The carrying cost of inventory may include: Interest on investment of working capital Property tax and insurance Storage cost, handling cost Deterioration and shrinkage of stocks Obsolescence of stocks

y Ordering Cost includes:y Cost of staff posted for ordering of goods. y Expenses incurred on transportation of goods

purchased. y Inspection cost y Cost of stationery, typing , postage, telephone charges.

y Formula of Economic Order Quantity (EOQ): y The different formulas have been developed for the

calculation of economic order quantity (EOQ). The following formula is usually used for the calculation of EOQ. y EOQ = 2 A Co Cc A = Annual Consumption Co = Ordering cost Cc =Carrying Cost

y Example: y Pam runs a mail-order business for gym

y y y y

equipment. Annual demand for the Trade mill is 16,000. The annual holding cost per unit is $2.50 and the cost to place an order is $50. Calculate economic order quantity (EOQ) Calculation: 2 * 16000* 50 2.50 = 800 units per order

y Assumptions of Economic Order Quantity: y The ordering cost is constant. y The rate of demand is constant y The lead time is fixed y The purchase price of the item is constant i.e no

discount is available y The replenishment is made instantaneously, the whole batch is delivered at once.

Re-order Level
y This is that level of materials at which a new order for supply of materials is to

be placed. In other words, at this level a purchase requisition is made out. This level is fixed somewhere between maximum and minimum levels. Order points are based on usage during time necessary to requisition order, and receive materials, plus an allowance for protection against stock out. y The order point is reached when inventory on hand and quantities due in are equal to the lead time usage quantity plus the safety stock quantity. y Formula of Re-order Level or Ordering Point:
y Ordering point or re-order level = Maximum daily or weekly or monthly

usage Lead time y The above formula is used when usage and lead time are known with certainty; therefore, no safety stock is provided. When safety stock is provided then the following formula will be applicable: y Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time + Safety

y Example 1: y Maximum daily requirement 800 units Time required to receive emergency supplies 4 days Average daily requirement 700 units Minimum daily requirement 600 units Time required for refresh supplies One month (30 days) Calculate ordering point or re-order levelCalculation: y Ordering point = Ordering point or re-order level = Maximum daily or weekly or monthly usage Lead time y = 800 30 y = 24,000 units

y y y y y

Example 2: Tow types of materials are used as follows: Minimum usage

20 units per week each Maximum usage 40 units per week each Normal usage 60 units per week each Re-order period or Lead time Material A: Material B 3 to 5 weeks 2 to 4 weeks Calculate re order point for two types of materials. Calculation: y Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-order period y A: 60 5 = 300 units B: 60 4 = 240 units

Safety Stock
y Definition y Inventory held as buffer against mismatch between

forecasted and actual consumption or demand, between expected and actual delivery time, and unforeseen emergencies. Also called reserve inventory.

Minimum Level
y The minimum level or minimum stock is that level of stock below which stock should not be allowed to fall. In case of any item falling below this level, there is danger of stopping of production and, therefore, the management should give top priority to the acquisition of new supplies. y Formula: y Minimum level or minimum limit can be calculated by the following formula or equation: y Minimum limit or level = Re-order level or ordering point Average or normal usage Normal re-order period y Or the formula can be written as: y Minimum limit or level = Re-order level or ordering point Average usage for Normal period

y Example: Normal usage 100 units per day Maximum usage 130 units

y y y y y y y

per day Minimum usage 70 units per day Re-order period 25 to 30 days Calculate: minimum limit or level. To calculate minimum limit of materials we must calculate re-order point or re-order level first. Calculation: Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-order = 130 30 = 3,900 units Minimum limit or level = Re-order level or ordering point Average or normal usage Normal re-order period = 3900 (100 27.5*) 1150 units

Maximum level
y The maximum stock limit is upper level of the inventory and

the quantity that must not be exceeded without specific authority from management. In other words, the maximum stock level is that quantity of material above which the stock of any item should not normally be allowed to go. This level is fixed after taking into account such factors as: capital, rate of consumption of materials, storage space available, insurance cost, risk of deterioration and obsolescence and economic order quantity. y Formula: y Maximum level or maximum limit can be calculated by the help of following formula: y Maximum limit or level = Re-order level or ordering point Minimum usage Minimum re-order period + Economic order quantity

y Example: y Normal usage 100 units per day Maximum usage 130 units per day

y y y y y y y

Minimum usage 70 units per day Re-order period 25 to 30 days Economic order quantity 5,000 units Calculate maximum limit or level. In order to calculate maximum limit of stock we must calculate re-order point or re-order level first. Ordering point or re-order level = Maximum daily or weekly or monthly usage Maximum re-order = 130 30 = 39,000 units Calculation: Maximum limit or level = Re-order level or ordering point Minimum quantity used in re-order period usage + Economic order quantity = 3900 (70 25) + 5,000 = 7150 units

Danger Level
y Some enterprise also calculate danger level. When this level of stock is reached, then emergency steps are taken by the management to acquire material supplies. y When danger level is reached, the try is made to purchase materials from the nearest possible source or place so that the workers and plant and machinery may not remain idle due to shortage of materials supplies. y Formula: y Danger level can be calculated by the help of the following formula or equation: y Danger level = Average daily requirement Time required to get emergency supply

y Example: y Normal usage or average requirement 700 units per day Maximum usage 800 units per day Minimum usage 600 units per day Re-order period 25 to 30 days Time required to receive emergency supplies 4 Days Calculate danger level. y Calculation: y Danger level = Average daily requirement Time required to get emergency supply y = 700 4 y = 2,800 units

Lead time
y Amount of time required for an item to be available for use from the time it is ordered. y Lead time should include purchase order processing time, vendor processing time, in transit time, receiving, inspection, and any pre pack times. y However, based on the way many inventory systems work, there may be problems incorporating internal factors such as post-receipt processing in Lead-time, so in many systems, y the lead time just represents the period of time from which the item is ordered to the time it arrives at your dock.

Monitoring and control of inventories

y INTRODUCTION y Just-In-Time is an inventory strategy implemented to improve

the return on investment of a business by reducing in-process inventory and its associated carrying costs. The process is often driven by a series of signals, which can be KANBAN, that tell production processes when to make the next part. y DEFINITION y An inventory strategy companies employed to increase efficiency and decrease waste by receiving goods only as they are needed in production processes, thereby reducing inventory costs. y This method requires that producers are able to forecast the demand accurately.

y JIT y The philosophy of JIT is simple-inventory is define to be waste.

JIT is followed in order to manage the inventory system consequences. y In short, the Just-In-Time inventory system is all about having "the right material, at the right time, at the right place and in the exact amount", without the safety net of inventory. y JIT is implemented to remove inventory exposes pre-existing manufacturing issues. Under this way of working, businesses are encouraged to eliminate inventory that does not compensate for manufacturing issues, and then to constantly improve processes so that less inventor can be kept.

y MERITS y i. Setup times are significantly reduced in the factory. Cutting down the setup

time to be more productive will allow the company to improve their bottom line to look more efficient and focus time spent on other areas that may need improvement. This allows the reduction or elimination of the inventory held to cover the "change over" time; the tool used here is SMED (Single Minute Exchange of Die). ii. The flows of goods from warehouse to shelves are improved. iii. Employees who possess multiple skills are utilized more efficiently. iv. Better consistency of scheduling and consistency of employee work hours. v. Increased emphasis on suppliers relationship. vi. Supplies continue around the clock keeping workers productive and businesses focused on turnover.

y DEMERITS y The major problem with Just-In-Time operation is that it leaves the supplies and downstream consumers open to supply shocks & large supply or demand charges. y COMPANIES USING JIT y The following are some of the notable companies which is involved in the process of JIT: y * HP * DELL * TOYOTA * FORD

ABC Analysis ( Activity Based Analysis)

y In most inventories , a small proportion of items accounts for a very small usage ( in terms of the monetary value of annual consumption). y And large proportion of items for a very small usage ( in terms of the monetary value of annual consumption). y ABC analysis based upon this empirical reality, advocates in essence a selective approach to inventory control which calls for greater concentration of efforts on inventory items accounting for the bulk of usage value. y This approach calls for classifying inventories into three broad categories A, B, C.

y Category A, representing the most important items,

generally consist of 15 to 25 percent of inventory and accounts for 60 to 75% of annual usage value. y Category B, representing item of moderate importance, generally consist of 20 to 30 % of inventory item and accounts for 20 to 30 % of annual usage value. y Category C, representing items of least importance , generally consists of 40 to 60 % of inventory items and accounts for 10 to 15% of annual usage value.

y Example of television, Picture tube or CRT is the

major part, contributing up to 70% of total cost but in quantity it is only one set or piece. So it comes in A class y And in B class other products like monitor, speaker parts, outer frame etc, contributing up to 20% of total cost and in quantity wise-around 20% of total parts. y In C class, other minor parts like screws, wires, circuit boards etc, contributing the remaining 10% of cost and in quantity wise 70% of parts..

VED analysis

Pricing of Raw material/ valuation of Stock

y LIFO :y which stands for "last-in-first-out," is an inventory

costing method which assumes that the last items placed in inventory are the first sold during an accounting year. y Thus, the inventory at the end of a year consists of the goods placed in inventory at the beginning of the year, rather than at the end. LIFO is one method used to determine Cost of Goods Sold for a business.

y The older inventory, therefore, is left over at the end of the accounting period. For the 200 loaves sold on Wednesday, the same bakery would assign $1.25 per loaf to COGS, while the remaining $1 loaves would be used to calculate the value of inventory at the end of the period. y LIFO isn't a good indicator of ending inventory value because the leftover inventory might be extremely old and, perhaps, obsolete. This results in a valuation that is much lower than today's prices. LIFO results in lower net income because cost of goods sold is higher.

FIFO
y FIFO, which stands for "first-in-first-out," is an

inventory costing method which assumes that the first items placed in inventory are the first sold. y Thus, the inventory at the end of a year consists of the goods most recently placed in inventory. FIFO is one method used to determine Cost of Goods Sold for a business .

y Batch 1: Quantity 2,000 pieces, Cost to produce $8000 y Batch 2: Quantity 1500 pieces, Cost to produce $7000 y Batch 3: Quantity 1700 pieces, Cost to produce $7700 y Let's say you sold 4000 units during the year, out of the

5200 produced.

y Then calculate the unit costs for each batch:

Batch 1: 8000/2000 = 4

y Batch 2: 7000/1500 = 4.667 y Batch 3: 7700/1700 = 4.529 y So, of the 4000 units sold, using FIFO

The first 2000 units sold from the first batch cost $4 per unit. unit.

y The next 1500 units sold from the second batch cost $4.667 per

y And the last 500 units sold from the third batch cost $4.529.

FIFO
y For example, let's say that a bakery produces 200 loaves of bread on Monday at a cost of $1 each, and 200 more on Tuesday at $1.25 each. FIFO states that if the bakery sold 200 loavs on Wednesday, the COGS is $1 per loaf (recorded on the income statement) because that was the cost of each of the first loaves in inventory. The $1.25 loaves would be allocated to ending inventory (appears on the balance sheet). y FIFO gives us a better indication of the value of ending inventory (on the balance sheet), but it also increases net income because inventory that might be several years old is used to value the cost of goods sold. Increasing net income sounds good, but remember that it also has the potential to increase the amount of taxes that a company must pay.

Average Cost Method

y Average cost produces results that fall somewhere

between FIFO and LIFO.

y This method assumes that we sell all our inventories

simultaneously.

The weighted average cost method is most commonly used in manufacturing businesses where inventories are piled or mixed together and cannot be differentiated, such as chemicals, oils, etc. Chemicals bought two months ago cannot be differentiated from those bought yesterday, as they are all mixed together. So we work out an average cost for all chemicals that we have in our possession. The method specifically involves working out an average cost per unit at each point in time after a purchase. y In our example above (assuming the weighted average cost method was allowed for valuing the lollypops), the value of our closing inventories would be calculated as follows: