Inventory Management and Control

1. Inventory Management and Control

2. Inventory Management …generally involves development and administration of policies systems and procedures, which will minimize total cost related to inventory decisions and related functions such as production, scheduling, purchasing and traffic (related to demand/supply orders)

3. Shadow Inventory “For every home currently listed for sale in Mecklenburg County, US at least two more homes are poised to come on the market” “In Spain, huge projects are completely empty and bad debts mounts as the Spanish banks play extend-and-pretend with developers. Most of these units have never been sold, and though they were finished just three years ago, they are already falling into disrepair, the concrete chipping off the sides of the buildings. Vandals have stolen piping, radiators, doors — anything they could get their hands on.”

5. Shadow Inventory - Meaning • Refers to real estate properties that have been either foreclosuredand have not yet been sold or homes that owners are delaying putting on the market until prices improve. • Can create uncertainty about the best time to sell (for owners) and when a local market can expect full recovery. • Can cause reported data on housing inventory to understate the actual number of inventory in the market.

6. Shadow Inventory - Reasons • Crony banking system • Job losses • Moral Hazard • Credit ratings A situation where an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions

7. Inventory Control As per meaning in Merriam-Webster …coordination and supervision of the supply, storage, distribution, and recording of materials to maintain quantities adequate for current needs without excessive oversupply or loss What about costs? Are they accounted for during inventory control?

8. Inventory Control Techniques • ABC Analysis of Inventories • Inventory categorization technique • Based on the principle that small portion of items may typically represent the bulk of money value of total inventory used in production process, while a relatively large number of items may form a small part of money value of stores (Pareto principle) • Three categories: A, B and C • ‘A’ items are very important; ‘B’ items are important and; ‘C’ items are marginally important • Example: “A Category” – 5% to 10% of the items represent 70% to 75% of the money value (or 70 to 75% of annual inventory consumption) “B” Category – 15% to 20% of the items represent 15% to 20% of the money(or 15% to 20% of annual inventory consumption) “C” Category – The remaining number of the items represent 5% to 10% of the money value.(or 10% or below of the annual inventory consumption) • Example implies that ‘A’ should be in maximum control; ‘B’ may not be given much attention and ‘C’ may be under a loose control

9. Steps in ABC Analysis • Identify annual usage in units for each item • Multiply annual usage with average unit price of each item to calculate the annual usage in value terms • Item with the highest value annually is ranked first, the value lower than the first is ranked second, and so on till the lowest item is listed in the last • Arrange the items in the inventory by cumulative annual usage (in value terms) and by cumulative percentage. • Categorise the items into A, B and C categories

10. ABC Analysis Example

11. ABC Analysis Example (Contd…)

12. ABC Analysis Example (Contd…) SUMMARY Under A: 1 out of 10, Under B: 2 out of 10 Under C: 7/10 5500/7749.1; 1350/7749.1; 899.1/7749.1 Corresponding value to respective items

13. Inventory Control Techniques (contd…) • Advantages of ABC Analysis of Inventories • It ensures a closer and a more strict control over such items, which are having a sizable investment in them. • It releases working capital, which would otherwise have been locked up for a more profitable channel of investment. • It reduces inventory-carrying cost. • It enables the relaxation of control for the ‘C’ items and thus makes it possible for a sufficient buffer stock to be created. • It enables the maintenance of high inventory turn over rate

14. Inventory Control Techniques (contd…) • Economic Order Quantity (EOQ) • Definition: EOQ is an accounting formula that determines at which the combination of order, costs and inventory carrying costs (??) are the least • Determines optimum order quantity that a company should hold in its inventory given a set cost of production, demand and other variables

15. Inventory Cost • Ordering Costs: Costs of processing an order of goods (or raw materials) from suppliers and inbound logistics. These include the costs of preparing a requisition, a purchase order, and a receiving ticket, stocking the items when they arrive, processing the supplier's invoice, and remitting the payment to the supplier. • Carrying Costs: The price of holding or “carrying” inventory. Two types of carrying costs: • Inventory Storage that include Cost of Building Rental and facility maintenance and related costs. Cost of Material Handling Equipment, IT Hardware and applications, including cost of purchase, depreciation or rental or lease as the case may be. Further costs include operational costs, consumables, communication costs and utilities, besides the cost of human resources employed in operations as well as management. • Cost of capital that includesthe costs of investments, interest on working capital, taxes on inventory paid, insurance costs and other costs associate with legal liabilities. • Stockout costs: Also known as costs of replenishment includes the following: • Cost of Loss, pilferage, shrinkage and obsolescence etc. • Cost of Logistics • Sales Discounts, Volume discounts and other related costs.

16. Ordering and Carrying Costs • Ordering costs vary inversely than carrying costs • Implies more orders a business places with its suppliers, the higher will be the ordering costs. However, more orders mean smaller average inventory levels and hence lower carrying costs. • Important for a business to minimise the sum of ordering and carrying costs

17. Economic Order Quantity (EOQ) Formulae EOQ = Square root of (2AP/S) where EOQ = order quantity A = demand per time period (example: annual demand or monthly demand) S = carrying cost/holding cost of 1 unit of stock for one time period P = Order Cost

18. Objective of EOQ • To determine the quantity to order which minimises the total annual inventory management cost • Minimise the total cost per period, which includes the inventory (carrying) holding per period plus order cost per period • Where order cost = the number of orders placed in the period multiplied by order cost and • Carrying cost = average inventory level multiplied by the carrying costs of 1 unit of stock per period

19. Assumptions of EOQ • Demand is known and is constant • The lead time (time between the placement of the order and the receipt of the order) is known and constant • The receipt of inventory is instantaneous • Quantity discounts are not possible (price remains the same) • Only costs pertinent to inventory model are the cost of placing an order and cost of holding or storing inventory over time.

20. EOQ Example 1 • ABC Ltd. is engaged in sale of footballs. Its cost per order is Rs.400 and its carrying cost unit is Rs.10 per unit per annum. The company has a demand for 20,000 units per year. Calculate the order size, total orders required during a year and total carrying costs. EOQ= sqrt[(2x20000x400)/10]=1265 Annual demand is 20,000 units so the company will have to place 16 orders (annual demand of 20,000 divided by order size of 1,265). Total ordering cost is hence Rs. 6,400 (Rs. 400 multiplied by 16). Average inventory held is 632.5 ((0+1,265)/2) which means total carrying costs of Rs. 6,325 (i.e. 632.5 × Rs10).

21. EOQ Example 2 Calculate the economic order quantity if annual demand for product is 5000 units. The ordering cost is Rs 30 per order and holding cost is Rs 6 per unit per annum. Also calculate total orders required during a year and the total carrying costs Here A = 5000 units, S = Rs 30 and P = Rs 6 EOQ = sqrt[(2x5000x30)/6]= 223.61 The company would have to place orders of (5000/223.61 =) 22.36 units Total ordering cost is Rs 670.8 (30x22.36) Average inventory held = (0+223.61)/2 = 111.8, which implies carrying cost to be Rs 670.8 (111.8x6)

22. Advantages of EOQ Technique • Avoids over purchasing • Devoted attention on only those items that are required • Positive control can be easily exerted to maintain total inventory investment at a desired level, simply by manipulating the plant maximum and minimum levels

23. Disadvantages of EOQ Technique • Orders raised at irregular intervals may not be convenient for suppliers • EOQ may give an order quantity which may be below the supplier minimum, and there is always a chance that the ordering level for an item has been reached but not noticed in which case a stock out may occur • Can be applied to higher volume items and items worth inventorying (not for bolts and screws) • Cannot be feasible for products whose technology gets upgraded continuously (What happened with Dell!)