Detailed Scheduling and Planning (Lesson 2)

Detailed Scheduling and Planning
Unit 2
UUnit
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DDetailed
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cheduling aand
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PPlanning
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Lesson 2
Customer Service and Inventory Management
Unit 2
© 2004 e - SCP -The Centre for Excellence in Supply Chain Management
No portion of this publication may be reproduced in whole or in part.
The Leading Edge Group will not be responsible for any statements, beliefs, or opinions expressed by the
authors of this workbook. The views expressed are solely those of the authors and do not necessarily
reflect any endorsement by The Leading Edge Training Institute Limited.
This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA, CFPIM,
CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and Certification
Council for use as study material for the APICS CPIM certification examination.
The Leading Edge Training Institute Limited

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© Copyright Leading Edge Training Institute Limited ii

Unit 2
Preface............................................................................................................4
Course Description................................................................................................................. 4
Lesson 2 – Customer Service and Inventory Management...............................5
Introduction and Objectives.................................................................................................. 5
Safety Stock............................................................................................................................. 5
Customer Service.................................................................................................................... 6
Safety Stock and Statistical Formulae................................................................................ 11
Inventory Valuation............................................................................................................. 18
Types of Inventory Valuation.............................................................................................. 18
Data Integrity and Inventory Accuracy ............................................................................. 21
ABC Classification and Inventory Analysis ...................................................................... 23
Methods of Ensuring Inventory Accuracy......................................................................... 27
Inventory Policy.................................................................................................................... 29
Summary ............................................................................................................................... 31
Further Reading ................................................................................................................... 31
Review ................................................................................................................................... 32
What’s Next? ........................................................................................................................ 33
Appendix.......................................................................................................34
Answers to Review Questions .............................................................................................. 35
Glossary ........................................................................................................37
© Copyright Leading Edge Training Institute Limited iii

Unit 2
Preface
Course Description
This document contains the second lesson in the Detailed Scheduling and Planning unit, which is
one of five units designed to prepare students to take the APICS CPIM examination. Before
completing the Detailed Scheduling and Planning unit, you should complete the Basics of
Supply Chain Management unit or gain equivalent knowledge. The five units that cover the
CPIM syllabus are:
Basics of Supply Chain Management
Master Planning of Resources
Execution and Control of Operations
Strategic Management of Resources
Please refer to the preface of Lesson 1 for further details about the support available to you
during this course of study.
This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA,
CFPIM, CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and
Certification Council for use as study material for the APICS CPIM certification examination.
© Copyright Leading Edge Training Institute Limited 4

Unit 2
Lesson 2 – Customer Service and Inventory Management
Introduction and Objectives
This lesson covers techniques related to the management of safety stock, valuation of inventory,
preservation of data accuracy and inventory accuracy. It also reviews and expands on the ABC
analysis and cycle counting techniques. Finally, the lesson explores characteristics and features
of inventory policies. The aim of this lesson is to review factors that may be input to material
requirements planning (MRP), reviewing the techniques to ensure an accurate understanding of
each.
On completion of this lesson you will be able to:
Describe safety-stock processes
Identify ways in which safety stock processes support customer service strategies
Identify the purpose of inventory valuation
Calculate safety stocks to support a required level of customer service using the table of
safety factors
State the effect of inventory valuation on inventory investment
Describe inventory accuracy methodologies used to maintain and improve part-count and
inventory valuation accuracy
Distinguish between various customer services measurements
Safety Stock
Safety stock is inventory held to support customer service level objectives, one of the primary
reasons for holding inventory. Safety stock is needed when there is uncertainty of demand or
when the supply of parts or raw materials is unreliable. For example, safety stock of bespoke
packaging materials may be held by a company to guard against time delays in replenishment
from the supplier.
Safety stock protects against stockouts up to a defined level. The higher the level of safety stock,
the greater the chance that stock-outs will be prevented. However, as safety stock levels increase,
costs to the company also increase.
For items that are subject to variable demand but where permanent safety
stock is undesirable, safety lead time may be an option. This ensures that all
scheduled receipts for that item will arrive a specified length of time before
they are actually needed. For example, a catering company that produces
airline meals may order disposable crockery and hot food containers with a
due date two days before the current stock is likely to run out. This reduces
the likelihood of a stock-out due to increased demand or late delivery of the
order.
Safety stock is the quantity of stock planned for inventory to protect against unforeseen
fluctuations in either demand or supply

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Purpose of Holding Safety Stock
Safety stock is required to guard against stockouts. It is important for items of independent
demand as it is unlikely that forecasts will ever be 100% accurate. Therefore, to ensure customer
service levels are maintained, a safety stock must be available at times where demand is higher
than expected and the available stock may be depleted before replenishment can be realistically
expected.
Dependent Demand and Safety Stock
Safety stock may be planned for dependent demand items but usually only if the supply of the
demand item is subject to change, due to either unreliable delivery, or unreliable scrap or yield
ratios in production. The demand for the product is totally dependent on the demand for its
parent and is calculated rather than forecast. Therefore, there is little chance that demand will
exceed supply.
Dependent and Independent Demand for the Same Item
Some parts may be subject to both dependent and independent demand. In this case, safety stock
may be held to cover for the independent demand. In this case, the part should be divided into
two categories in MRP so that gross requirements for the dependent demand can be calculated
separately to those for the independent demand.
Customer Service
What it means
In operational terms, customer service is the availability of items when they are required by the
customer, whether that customer is a consumer, distributor, or internal company department.
100% customer service level 100% of the time is rarely achievable, due to unanticipated large
demands, machine failures, late delivery of components or other causes. Despite these
difficulties, the success of a company depends on it aiming for a high level of customer service,
setting targets and measuring performance accordingly.
Measuring Customer Service

Customer service measurement should involve the monitoring of delivery performance relative
to promised dates, and the companies performance filling back orders and late deliveries. There
are two types of measurement that can be used: percentage measurements and absolute value
measurements.
Some absolute value type measures are most useful when compared against a standard. For
example, a company might set a target of not more than 12 order days out of stock in any 12
month period. It could then record actual order days out of stock and compare on a rolling
monthly cycle.
Percentage Measurements Absolute Value Measurements
Orders shipped on schedule Order days out of stock
Line items shipped on schedule Line item days out of stock
Total units shipped on schedule Total item days out of stock
Dollar volume shipped on schedule Dollar volume days out of stock
Profit volume shipped on schedule Idle time resulting from material or
component shortages

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Operating item days not out of stock
Ordering periods without stockout
1. What are the main reasons for holding safety stock for dependent demand
items? (Choose more than one option)
A. To guard against fluctuation in demand
B. To guard against changes in supply due to unreliable delivery
Review Q
C. To guard against high levels of scrap
D. To protect against low production yields
Percentage Measurements
Percentage of orders shipped on schedule
This is a good measure of customer service when all customer orders are of
similar value and the value of the order is evenly distributed among the line
items. However, if the few orders that did not ship on schedule were particularly
valuable, for example, accounting for 40% of total dollar volume, then the
picture from this measure is misleading.
% line items shipped on schedule
This takes into account the fact that orders can have very few or a great many line items. To a
certain extent it ensures the size of the order is taken into account with large orders having a
greater impact on the overall percentage than small orders. However, it does not take into
account the unit cost of each item. For example, the overall percentage might be high, but the
failures could all stem from the failure to ship high dollar value items, therefore the cost to the
company is greater than that illustrated by this measure.
% total units shipped on schedule
This measure takes into account the differences in quantities in orders and line items. However,
it does not take into account the dollar volume of orders. For example, Buzz Electronics sells
plasma televisions, hi- fi systems, and personal stereos to a particular distributor. It achieves 97%
of total units shipped on schedule. On first examination, as this matches the target set by
management, there is cause for celebration. However, it later transpires that all the delayed units
were plasma televisions. As these are by far the most expensive line items, the 3% delayed items,
in terms of dollar volume, are significant.
% ordering periods not out of stock
If a product is ordered weekly and 3 stockouts are experienced during the year, the customer
service level would be 94.2% using this measurement (49 / 52). This measurement is useful in
determining reorder points to achieve specified customer service levels.
Absolute Value Measurements

The absolute value measurements such as order days out of stock, line item days out of stock,
total item days out of stock and dollar volume days out of stock are of limited use in isolation.
They work best when they are tracked over time and the company sets objectives related to these

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measurements. For example, a company might aim to ensure that it never
experiences more than 8 order days out of stock in any 12 month period.
Idle time due to material or component shortages
This is a useful measure of the level of control from between purchasing
and PAC, particularly queue management and input/output control. It can
be used to compare similar facilities or the same facility over different
shifts. It is common among manufacturing plants operating against standard
production times to maintain a record of non-productive hours with associated causes, so the data
required to measure idle time is usually easily available.
Comparing Measurements
The importance of choosing the most appropriate measure or combination of measures for
customer service cannot be underestimated. Consider the following example, which shows the
range of the different measurements for the same situation.
ABC Beverages supplied 305,400 units of orange juice over 12 months to one of its key markets.
It received 2,454 orders from that market. 92 of those orders could not be filled from stock. This
represented a total of 11,120 units not shipped from stock. Over the 52 weeks, the company was
out of stock 9 times. Using this information, the following measurements can be calculated:
Percentage of orders shipped complete on schedule, (2,454 – 92) / 2,454 = 96.25 %
Percentage of items shipped on schedule, (305,400 – 11,120) / 305,400 = 96.36%
Percentage operating item days not out of stock, 1- (9 / 52) = 82.70%
Depending on the measurement chosen, the results vary widely. Thus it is important that a
company determines the most appropriate measurement for its particular circumstances. All
these measurements are inadequate in terms of measuring exactly how the customer rates the
company and its service. Ideally, opinions should be communicated directly to managers.
Delivery Performance and Backorders

When backorders occur, that is, the company has missed the original due date or promised date
for the customer; it must endeavour to retrieve the situation as soon as possible. The company
must measure its response to backorders to ensure they are filled quickly. Some of the measures
used in this situation are:
Average time and standard deviation of the time it takes to ship a backorder
% backorders shipped within a specified time period (e.g. 90% within 2 days, 100%
within 5 days)
Age limit imposed on backorders with goals associated with each backorder age bracket
(for example, 100% of backorders over 4 days old should be shipped the following day,
90% of backorders 2 days old should be shipped the following day)
Selecting Customer Service Measurements

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Before deciding on the appropriate measure, a company must identify the
types of data available. There is no point deciding to measure dollar
volume shipped on schedule if information on the dollar value of each
item in each order is not available. Also, there is no point in choosing a
measurement which is costly in terms of time and resources to collect
when there is little gain to be made from associated improvements.
In some cases, the ability to measure will have little impact on the
outcome. For example, where stockouts are experienced due to the
scarcity of purchased items that cannot be produced in-house, there is little
that can be done to remedy the situation.
To be valuable, the measurement chosen must relate productivity, profit and return on
investment. This may vary from one product group to the next. Thus, it may be necessary to
choose different measurements depending on the type of order and the type of inventory being
managed. The choice of measurement will be affected by:
The nature of the inventory
The availability of data
The use of measures by management
The relation of measures to the business objectives
The cost of implementing the measures
Customer Service Objectives

When the appropriate customer service measures ha ve been selected, performance objectives in
each area should be set. Often, different performance objectives may be set for each item family.
These objectives will be influenced by the cost of carrying the item compared to the cost of
stockouts. When an item is inexpensive and easy to store, and the cost of a stockout in that item
is high, the company should aim for a high customer service target.
Component parts and subassemblies that have dependent demand should have a 100% service
level as delays or stockouts will have a strong knock-on effect on finished products. For
example, if a finished product is assembled from 5 components, each with a service level of
95%, the overall service level of that product is likely to be (0.95 x 0.95 x 0.95 x 0.95 x 0.95) or
84%.
Appropriate and achievable customer service levels can be set by examining historical data on
customer service. Machine downtime and assembly line downtime is usually available and
generally it is possible to calculate how much downtime was due to lack of materials.
In general, the provision of a higher level of customer service leads to an exponentially greater
investment in inventory. However, sometimes improvements in inventory management can lead
to customer service improvements without the need for greater investment.
Customer Satisfaction
Customer satisfaction is an important factor in maintaining a customer base.
As organizations demand more from suppliers, it is important to offer more to
the customer. Losing a customer due to lack of fo cus is a very expensive
proposition. Loss of current revenue and reputation does not reflect directly on
the profit and loss statement but will be evident through lower profitability in

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the longer term.
Measurements of the total customer experience can include measures of responsiveness, design
suggestions for cost reductions or cycle time improvements, service and warranty.
As many organizations today are now dealing with a global customer base, the logistical
challenges associated with customer service are significant. Some ways in which customer
service may be improved are through service contracts and guaranteed access to computer
systems. When such services are important to customers network downtime can be very
expensive.
Transportation has a deep impact on customer satisfaction. It is very important that an
organization partners with a transportation company that can deliver product within defined time
frames.
Customer Service and Order Quantities

If customer service levels are expressed as performance goals for a specified period, for
example, every quarter, order quantity will have an impact on performance. The smaller the
order quantity, and therefore the shorter the order cycle, the more times per year there is an
opportunity for a stock out to occur.
Small orders create risks of more frequent stockouts, but these are usually brief in comparison to
the less frequent stock-outs that may occur with large order quantities and which may last for a
significant period of time. Items should be assessed from a customer service perspective when
establishing order quantities and safety stock levels.
2. Sparkle Cleaning Ltd produces a range of cleaning products for the hotel
and catering industry. The overall size and value of orders varies significantly
although there is little range in the value of line items. The company keeps
records of customer orders and line items in each order.
Review Q Which is likely to be the most appropriate customer service measurement?
A. Ordering periods without stockouts
B. Orders shipped on schedule
C. Line items shipped on schedule
D. Profit volume shipped on schedule

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Safety Stock and Statistical Formulae
It is important to establish an appropriate safety stock level for every inventory item. This
involves measuring the amount of demand variability relative to the average demand. This is
often known as forecast error. The usage data collected in issue transaction records is important
for this. There are several statistical methods that can be used in the calculation of an appropriate
safety stock level. These are explained below.
Normal Distribution
The normal distribution curve assumes that demand variation is symmetrical around an average
or mean demand (often represented by the Greek letter µ (mu). The mean is calculated by
adding the demand for several periods and dividing by the number of periods. In the normal
distribution curve, the mean is the center point. The variation of all demand values around the
mean is called the standard deviation (represented by sigma s). This measure of variability is the
value that needs to be determined in order to calculate a safety stock value. An example of the
normal distribution curve is shown below.
Mean Absolute Deviation (MAD) and Standard Deviation

Either the MAD or the standard deviation method may be used to measure the degree of demand
variability. Standard deviation needs a longer history of forecast and demand than MAD.
Sum of squared deviations

Standard Deviation =
v Number of periods - 1
The mean absolute deviation is the average of the absolute deviations from the forecast average
demand. It requires only the summary values from the previous month along with current values.
Sum of deviations
MAD =
Number of periods

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The table below shows the information needed to determine standard deviation and MAD.
Week Actual Sales Forecast Deviation Deviation2

1 9,800 10,000 -200 40,000
2 10,000 10,000 0 0
3 10,200 10,000 200 40,000
4 10,800 10,000 800 640,000
5 10,600 10,000 600 360,000
6 9,600 10,000 -400 160,000
7 10,400 10,000 400 160,000
8 10,000 10,000 0 0
9 9,800 10,000 -200 40,000
10 10,400 10,000 400 160,000
101,600 100,000 1600 2,560,000
Table 1 Actual Sales, Forecast Sales, Deviation and Deviation Squared
Note that the denominator n-1 for less than 30 periods and n for more than 30 periods. For
forecast purposes, the number of periods used is usually less than 30 so n-1 is appropriate.
Using the figures from the table above, the standard deviation formula is as follows:
2,560,000
Standard Deviation =
v 9
So in this example, the Standard Deviation = 533.3

Using the same figures, the MAD is equal to 1600 divided by 10, or 160.
Implications of Forecast Bias

A forecast is not expected to be accurate. The actual value of one period may be greater than
forecast while the value for the next period may be less than forecast. Overall, the errors should
fall equally either side of the forecast amount. However, this is not always the case. Some
forecasts err consistently on one side or other. This is known as bias.
A forecast bias analysis is used to check if forecasting is consistently too high or low. In the table
used previously, the sum of the forecast figures was 1000,000, compared to an actual sales figure
of 101,600. This indicates that there may be a negative bias in the forecasting process.
If the sum of the forecasts is very different from the sum of the actual sales values over a
specified period, the forecast is biased
If the sum of the forecasts over a period is consistently greater than actual sales, the bias
is positive, or too optimistic, and should be scaled back
If the sum of the forecasts over a period is less than the actual sales, the forecast bias is
negative.

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Tracking Signals
Tracking signals are used to check the deviation between actual and forecast figures over time. It
provides a numeric value that can be compared to a reference value or range, with optimal
performance close to zero. When the tracking signal is outside the acceptable range, the item
may be reviewed by the planner.
Usually a tracking signal is a running sum of forecast errors divided by the mean absolute
deviation for the periods in question. However, some items may require different tracking signals
depending on their cost or importance.
A tracking signal approaching +1 or – 1 indicates a consistently negative or positive error. Many
companies set a ‘trip value’ which is some form of threshold beyond which forecast bias is
suspected. When this is the case, the company can either search for the cause of the change in
demand, for example, a data error, or place a stronger emphasis on more recent demand data to
enable the system to correct itself. For important items, this trip va lue may be as low as 0.3 or
0.4. For less important items it may be more like 0.7.
The following table illustrates the calculation of a tracking signal:
Actual Forecast Error Sum of error Absolute sum Tracking
of errors signal
150 153 -3 -3 3 -1.00
146 155 -9 -12 12 -1.00
156 147 9 -3 21 -0.14
152 145 7 4 28 0.14
145 155 -10 -6 38 -0.16
146 154 -8 -14 46 -0.30
153 148 5 -9 51 -0.18
157 146 11 2 62 0.03
Initially, as all previous errors are assumed to be zero, the tracking signal looks very high. The
tracking signal is calculated as a ratio of the sums rather than of the averages.
3. To support a particular level of customer service, it is important to ensure

appropriate safety stock by:
A. Setting an arbitrary safety stock level
B. Setting safety stock levels based on the level of demand variability and the
Review Q level of customer service required
C. Setting safety stock levels equal to the MAD
D. Setting the safety stock level equal to the standard deviation
Using Variability Metrics

The traditional vie w of the standard variability curve (or bell curve) shows that the probability of
an event occurring with plus or minus one standard deviation from the mean is 68.26 %. Using
the figures given previously in Table 1, page 12, the forecast value was 10,000 units and the

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standard deviation was 533.3. This means that there is a 68.26 percent probability that the actual
usage will fall between 10,000 + 533.3 and 10,000 -533.3, or between 9,4667.7 and 10,533.3.
By maintaining a safety stock in finished goods equal to the forecast quantity, 50 percent of the
time there will be the correct amount of inventory to meet demand. By increasing safety stock,
this percentage can be increased. By adding one standard deviation worth of inventory (533
units) as safety stock, the customer service level will increase to around 84%. A safety stock of
two standard deviations (1066 units) will result in a 98% service level as shown below. (Note:
the horizontal lines in the bell curve refer to standard deviations from the mean (or center line).
99.86%
97.72%
84.13%
50%
Figure 1 Standard Deviation and Customer Service
Table of Safety Factors

The following table can be used to identify the level of service required and the corresponding
safety factor multiplier, which can be used to calculate the amount of safety stock required to
provide the chosen level of service. The safety stock is calculated by multiplying the amount in a
standard deviation by the safety factor multiplier.
Desired Service Level (%) Standard Deviation Safety MAD Safety

Factor Multiplier Factor Multiplier
50 0.00 0.000
80 0.84 0.672
84.13 1.00 0.800
90 1.28 1.024
95 1.65 1.320
97.72 2.00 1.600
98 2.05 1.640
99 2.33 1.864
99.87 3.00 2.400
99.93 3.20 2.560
99.99685 4.00 3.200
Table 2 Table of Safety Factors

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For example, if you want to ensure a service level of 99%, you need to maintain a safety stock
level equivalent to 2.33 times the standard deviation, remembering that the standard deviation is
equal to the square root of the sum of the squared deviations divided by the number of periods
less 1.
In the example used for explaining standard deviation, the amount of one standard deviation was
equal to 533.3. Using the table of safety factors above, the amount of safety stock needed to
ensure 99% customer service is 533.3 x 2.33. The safety stock should be 1243 units.
Factors to consider when determining safety stock quantities:
Always round up the amount of safety stock required to the nearest whole unit
The correlation between MAD and standard deviation can be displayed as MAD =
sigma/1.25
Further adjustments to the safety stock level must be made if the item’s replenishment
lead time is greater or less than the forecasting period. This is achieved by calculating a
lead time deviation.
4. If the standard deviation is 300 units and the target level of customer service
is 98%, what amount of safety stock should be held?
A. 146 units
B. 300 units
Review Q
C. 492 units
D. 615 units
Lead Time Deviation

If the forecast frequency and item lead time are different, the standard deviation should be
referred to as the lead time deviation. If the forecasting period is greater than the replenishment
lead time, less safety stock is needed. Howeve r, if the forecasting period is less than the
replenishment lead time for the item, a greater level of safety stock is required to achieve the
same service level.
The lead time deviation equation is used to compensate when the lead time does not equal the
forecast interval. Standard deviation is based on the forecast interval period. There will be a
greater risk of stock out if the lead time exceeds the forecast period.
Lead Time Deviation= Standard Deviation x ß (Lead Time / Forecast Interval)
Beta (ß) is a range between zero and one, which typically falls between 0.5 and 0.7.The beta
figure allows for lead times longer than the forecast period by increasing safety stock levels. The
worst case scenario is a beta factor of 1.
To continue the previous exa mple, assuming the forecast interval is four weeks, the
replenishment lead time is 6 weeks, and ß is 0.5, the lead time deviation would be equal to 533.3
multiplied by half of (6 divided by 4).

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Time Period Safety Stock
A time period safety stock provides an even amount of safety stock, equal to usage, over a
specified time period or days, weeks or months. The company works out how much of an item it
is likely to use in a given period, for example, a week, and sets that as the safety stock level. In
contrast to statistical safety stock calculation, where the level of safety stock is based on the
deviation from demand, time period safety stock changes in tandem with changes to dependent
or independent demand.
For example, Sugar’n’Spice Ltd, manufacturers of a range of herbs, spices and
condiments, use small plastic containers to package their produce. These
containers are a low-cost C class inventory item, bought in units of 100 and
reviewed monthly. The company anticipates demand over the coming month and
maintains a safety stock equal to that amount.
This protects against end-of- month reviews that do not generate a new order for material while
the level drops below the reorder point very shortly after. In this case, a formal review of
inventory levels will not take place until the end of the month so the safety stock will provide a
buffer.
Time period safety stock is projected based on actual demand, forecast demand, or both.
Assuming a monthly usage rate is known, the time period safety stock can be calculated as
follows:
Time Period Safety Stock = Forecast Monthly Usage x Safety Stock Time Period
The forecast should be normalized to fit the number of working days in each period so that there
will be a higher level of safety stock in January than in February. With a safety stock time period
of 2 weeks and a forecast monthly usage of 40 units over a month containing 20 working days,
the time period safety stock would be equal to 20 units.
Time Period Safety Stock Example
Safety stock time period: 2 weeks
Forecast monthly usage (normalised at 20 days per month): 40 units
Time Period Safety stock = . 2 weeks . x 40 units
4 weeks/month month
Time Period Safety stock = 20 units

Time Period safety stock is useful for items that are delivered daily or weekly. The time period
safety stock protects against stockouts due to delays in delivery. When demand varies, perhaps
due to seasonality, the time period safety stock totals the precise dependent and independent
demand for each period and the safety stock level varies accordingly.
Fixed Safety Stock

Fixed safety stock allows the planner to determine the safety stock level for an item without any
system calculations. It may be used when
A new part is introduced: as there is no history of use statistical safety stock cannot be
calculated
A part with a long history of use is being phased out: safety stock should be set to zero
and usage should be manually checked.

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Dependent demand items are completely planned by MPS and MRP and are never
impacted by unplanned usage. Safety stock should be set to zero.
Safety Stock Analysis

Alternative Required Appropriate
Create individual-part safety- Set a safety-stock level for Independent-demand part
stock quantities based on each part independent of any
statistical, fixed, or time- product relationships.
period techniques Calculate the quantity of
safety stock required.
Set up the value of having Allocate the cost among Dependent-demand parts
safety stock by product or various parts. Calculate the
product line quantity of safety stock
required
Establish an arbitrary dollar Allocated among parts When amount of money
level for safety stock through using some of the available to invest in safety
methods described previously? stock is limited
Safety stock should generally be held for independent demand items where the demand is
uncertain and any item where other issues may affect supply, for example, variable quality or
unreliable delivery dates.
Policy on safety stocks are usually set at executive level, depending on the expected customer fill
rate, the inventory stock levels to be achieved. Actual safety stock levels for individual items will
probably be set and modified at materials management or planning level.

Unit 2
Inventory Valuation
Inventory refers to all raw materials, work in process, and finished goods owned by a company
and is treated as an asset in financial reports. Therefore it is important to determine the value of
inventory held in order to determine the asset level, cost of goods sold, return on investment,
turnover, and strategy of a company.
Inventories may be valued at cost (the amount they cost to buy) or by market
value (the amount the inventory would fetch if sold in its present state). As the
value of an inventory item may change over time, the age of the inventory is also
a factor.
Purpose of Inventory Valuation

Inventory is a relatively short term asset as it is usually sold or used within a
short time frame. MRO inventories are usually classified as expenses rather
than assets because they do not contribute to the final product but are used
up in the production of the final product. Similarly equipment and vehicles
owned by a company are not inventory as they do not contribute to the final
product. They are classified as capital equipment, subject to depreciation
over time, as specified in Internal Revenue Service rulings.
Inventory valuation is important as it establishes the asset value of the
company. It also enables average inventory value, and therefore inventory turns, to be calculated.
This gives a company a good picture of how efficiently they are using their inventories. Note that
MRO inventories are not included when calculating inventory turns.
Cost of Goods Sold

When goods are transformed from raw ma terial to finished product they are sold on to the
customer. Once sold, the materials used to make these products are subtracted from the inventory
and are included in the income statement as the cost of goods sold.
Types of Inventory Valuation

There are various inventory valuation methods to use, depending on the nature of the business.
For example, a company specializing in one-off bespoke automation solutions in the beverage
industry may stock standard components at standard cost and use actual cost for items purchased
specifically for a customer order.
The types of inventory valuation commonly used include:
First- in-First-out (FIFO)
Last-in-First-out (LIFO)
Transfer Valuation
Standard Cost
Actual Cost
Project Cost
Process Cost

Unit 2
FIFO
This method assumes that the oldest inventory items are issued for use first. As the cost of the
inventory items changes over time, this would keep the total inventory value on the balance sheet
close to the current market value. It would also result in the cost of goods sold equating to the
least recent cost values. In a period of rising costs this will work to the company’s advantage.
The table below is an example of FIFO valuation
Date Units Receipts Total Units Issues Total Units Balance* Total
Unit cost Cost Unit Cost unit cost cost
cost
Jan 1 800 $6.00 $4,800
Jan 10 600 $6.00 $3,600 200 $6.00 $1,200
Jan 25 600 $6.60 3960 200 $6.00
600 $6.60 $5,160
Feb 3 200 $6.00 $1,200 600 $6.60 $3,960
Feb 400 $6.60 $2,640 200 $6.60 $1,320
18
Mar 1 800 $6.70 $5,360 200 $6.60
800 $6.70 $8,000
Mar 200 $6.60
10 400 $6.70 $4,000 400 $6.70 $2,680
Mar 800 $6.80 $5,440 400 $6.70
25 800 $6.80 $8,120
$11,440
*Quarter cost of goods sold = $11,440; asset value = $8,120
Table 3 FIFO Inventory Valuation
LIFO
This method assigns the cost of goods sold based on the most recent cost of the inventory item. It
assumes that the most recently arrived inventory items are the first to be issued for use. If the
cost of inventory items is constantly rising, this will lead to an undervaluing of the total
inventory held. The cost of goods sold would more accurately reflect current market values.
During a period of inflation, LIFO results in:
Higher cost of goods sold Decreased earnings before taxe s

Decreased taxes Increased cash flow compared to other methods
The following table is an example of LIFO valuation

Unit 2
Date Units Receipts Total Units Issues Total Units Balance* Total
Unit cost Cost Unit Cost unit cost cost
cost
Jan 1 800 $6.00 $4,800
Jan 10 600 $6.00 $3,600 200 $6.00 $1,200
Jan 25 600 $6.60 3960 200 $6.00
600 $6.60 $5,160
Feb 3 200 $6.00 $1,320 200 $6.00
400 $6.60 $3,840
Feb 400 $6.60 $2,640 200 $6.00 $1,200
18
Mar 1 800 $6.70 $5,360 200 $6.00
800 $6.70 $8,000
Mar 600 $6.70 $4,020 200 $6.00
10 200 $6.70 $2,540
Mar 800 $6.80 $5,440 200 $6.00
25 200 $6.70
800 $6.80 $7,980
$11,580
*Quarter cost of goods sold = $11,580; asset value = $7,980
Table 4 LIFO Inventory Valuation
Table 3 and Table 4 value the same inventory. Using FIFO, the cost of goods sold comes to
$$11,440 while the asset value is $8,120. The same valuation based on LIFO results in $11,580
cost of goods sold and an asset value of $7,980.
Transfer
The inventory that is moved from one location to another is usually transferred at cost value.
Generally it is relocated from storeroom to warehouse or between divisions. It may also be
moved because it requires repair.
Standard Cost
In a standard cost system, a single value is selected for an inventory item, generally based on an
average of historical costs or anticipated costs. The difference between the standard cost and the
actual cost would be recorded as a variance from standard. This technique consistently reports
the inventory asset and the cost of goods sold. The standard cost is generally updated annually.
Actual Cost
This method is rarely used, although some government contracts may require it. It is also
occasionally required where lot traceability is also important for reasons such as safety or

Unit 2
warranty cover. For example, actual cost may be suitable in the purchase of meat products in the
UK and Ireland where it is now important that meat can be traced back to the farm of origin.
Actual cost involves implementing a form of lot control so that materials withdrawn from
inventory can be traced directly to a specific purchase order or production run. This can be
complex and cumbersome to manage.
Project Cost
In shipbuilding, large engineering construction projects, and public accounting firms, for
example, project cost is used. This is an accounting method that sets valuations for each project.
Each project is unique and is costed separately.
Process Cost
Costs are collected according to time period and averaged over all the units produced during the
time period in question. This gives a reasonably accurate indicator of the cost of processing per
product. The system is used with either actual or standard costs in manufacturing companies that
produce a large number of identical units.
Comparison of Costs
The most effective way of illustrating the differences between the
various costing methods is to input the same data to each method and
comparing the results.
Table 5 below displays the results of using various costing methods on
the same inventory item. FrescaFruits Ltd are working on costings for
the 3rd quarter of the year. They buy grapes in small units with a
standard cost of $12.50 dollars per piece.
At the end of the 2nd quarter the unit cost was $10. The inventory level at the end of the 2nd
quarter is 0. The requirement for grapes in the 3rd quarter is expected to be 70 units per month, a
total of 210 units. The cost of the item is rising, and is expected to be $16 in October.
The record of purchases for the 3rd quarter is as follows:
July $10 100 units
August $12 100 units
September $14 100 units
Costing Method Inventory Value Cost of Goods Sold

Actual Cost $1,080.00 $900.00
Replacement Cost $1,440.00 $3,360.00
Standard Cost $1,125.00 $2,625.00
Average Cost $1,080.00 $2,520.00
FIFO $1,260.00 $2,340.00
LIFO $900.00 $2,700
Table 5 Comparison of Costing Methods

Unit 2
Data Integrity and Inventory Accuracy
MRP, capacity requirements planning, process flow scheduling, enterprise resource planning,
advanced planning and scheduling, all rely on the data that is input. When inaccuracies are
introduced into these systems, the calculations of the systems themselves will be inaccurate. As
the Master Production Schedule, bills of material, inventory levels, work center data, and process
information are all inputs into MRP, the accuracy and integrity of these data will be directly
impact on the effectiveness of the resulting MRP.
The maintenance of accurate data requires strict discipline within and between all departments of
an organization. Not only must the data be maintained in an accurate and timely manner, but the
system must be such that the finding and fixing of inaccuracies is encouraged, rather than
ignored.
Definition and Purpose of Inventory Accuracy

In accounting, the only measure of inventory accuracy that matters is the dollar value. The
planning department is concerned with maintaining an acceptable percentage of inventory
accuracy. However, production demands absolute count accuracy. The most stringent
requirement is the count accuracy required from production. If this is correct, the other forms of
inventory accuracy (percentage and dollar accuracy) will also be correct.
The aim of any company should be to ensure 100% inventory accuracy on
all items at all times, using inventory accuracy logic that supports this aim
and ensuring that any inaccuracies made are recorded and corrected
immediately.
Perpetual inventory systems record the balance of inventory on hand at each
stock location. Due to mistakes and failures of security, transaction
processing, and recording of inventory location, it is easy for the physical
inventory balance and the recorded balance to become out of sync. One way
to alleviate this is to support inventory record systems with physical counts.
Another way of dealing with potential inaccuracies is to design the system
so that inaccuracies are impossible.
For example, when designing software to maintain inventory records, checks
and filters should be used to ensure that the system user does not unknowingly
enter a wrong figure. Types and sizes of inventory items should be available to
choose from a list rather than input by the operator.
Cost of Inaccuracy
Some of the consequences of inaccurate inventory records include:
Shortages Missed schedules
Excess production Low productivity
Lost sales High inventory levels
High levels of obsolescence Excess freight costs
Excessive expediting

Unit 2
Inventory Accuracy and Cycle Counts
Inventory accuracy can be improved by cycle-counting analysis. Once a level of 100% accuracy
has been achieved and sustained, the cost options and savings are analyzed. Cycle-counting is in
itself costly to implement. However, the trade off is that the costs of inaccurate records are
avoided.
ABC Classification and Inventory Analysis

ABC classification, based on Pareto’s principle or the 80/20 rule, assumes that 20% of the items
in a list will account for 80% of the significant measurement.
For example, in a shopping list, 80% of the cost will be due to only a few high-cost purchases
such as fillet steak, red wine, washing powder. Other items such as bread, milk, tins of beans,
pasta etc will be relatively low in cost.
While the exact percentages may vary, a useful general classification is to assume the following:
20% of all inventory items will be A class items and will
account for 80% of the total inventory value.
A further 30% of the inventory items will account for 15%
of the remaining cost. These items fall into the B category.
Finally, C items, although numerous (accounting for 50% of
all inventory items) will account for only 5% of the total
inventory value.
100%
95%
80%
Percentage of total value
A items B items C items
20% 50% 100%

Percentage of total number of items
Each class of inventory items will be treated differently. A items, the most significant from a
financial perspective, will be most tightly controlled. Minimal effort will be expended on
controlling inventories of C class items. The table below outlines uses of ABC classification.

Unit 2
Area of Use Benefit of ABC Classification
Cycle Counting Using ABC classification in cycle counting, A class items will be counted
Frequency more frequently than B or C class items
Customer Order quantity and safety stock levels are established according to the
Service criticality and cost of each item. Generally this is approached from a dollar
accuracy perspective. It may also be a recognition that A items take longer to
procure when an unplanned stockout occurs.
Engineering The engineering department may use ABC classification to identify items of
Priorities high cost or high usage and concentrate their efforts accordingly. There is
little point re-engineering products of little value or low usage.
Replenishment Inventory replenishment systems will vary according to the importance of
Systems the inventory items. For example, C class items may be controlled with a
simple two-bin system if they are not particularly bulky. This minimizes the
cost of control and replenishment and does not significantly increase
inventory carrying costs.
Investment As A class items form a larger investment in inventory, these items are
Decisions closely analyzed to ensure appropriate order quantities and safety stocks are
used. A class items are always the focus of attempts to improve inventory
turns as changes in the way A class items are procured and managed will
have the most significant effect on the overall inventory investment level.
ABC Classification Method

For each inventory item, yo u record its annual usage in units, the cost of a unit and the total
dollar usage for the year. You then calculate the cumulative usage in dollars, the cumulative
percentage dollars usage, and the cumulative percent of items. Next, you rank the part numbers
in order.
ABC Classification Steps
1. Find the annual demand in units for each item
2. Record the unit cost for each item
3. Calculate annual usage value of each item by multiplying the unit cost of the item by the
level of annual demand
4. Rank the annual usage values from highest to lowest
5. Calculate the cumulative annual usage value
6. Calculate, for each item, the percentage of the total cumulative usage value
7. Calculate the percentage of the total number of items
8. Evaluate relationships and assign categories
FrameIt Ltd provides a fairly broad product range from relatively few
inventory items (10 in total). However, as a means to minimize costs they are
now looking at ways to streamline their inventory investment without affecting
customer service levels. As a first step, the company uses ABC classification to
determine on which inventory items, the main effort should be expended.

Unit 2
The table on the following page shows the calculation of the annual dollar usage for each part
number, which is calculated by multiplying the annual unit usage rate by the unit cost in dollars.
Part Number Annual Unit Usage Unit Cost ($) Annual $ Usage
1 2200 2 4,400
2 1200 40 48,000
3 200 4 800
4 2600 1 2600
5 200 60 12,000
6 20 25 500
7 200 2 400
8 3000 2 6,000
9 400 2 800
10 1000 1 1,000
Total $76,500
Figure 2 Annual Usage Rate in $
The part numbers are ordered according to their annual dollar usage rate. The cumulative
percentage usage rate is calculated by firstly adding together the annual dollar usage rates at each
level in the part number ranking (see column 3 below), then converting each figure into a
percentage of the overall usage rate in dollars. Finally, the cumulative percentage of each item is
calculated in terms of the total number of items held in inventory.
In the table below, the part numbers have been ranked according to cumulative percentage dollar
usage rate and cumulative percentage of items. The top items are most significant and therefore
should be classified as A items. The items at the bottom of the list are B items.
Part Annual $ Cumulative $ Cumulative % $ Cumulative % of

Number Usage Usage Usage Items
2 48,000 48,000 63% 10
5 12,000 60,000 78% 20

8 6,000 66,000 86% 30
1 4,400 70,400 92% 40

4 2,600 73,000 95% 50
10 1,000 74,000 97% 60
3 800 74,800 98% 70

9 800 75,600 99% 80
6 500 76,100 99% 90

7 400 76,500 100% 100
Figure 3 Cumulative % of Items

Unit 2
5. Using the table below, calculate the ABC classification for each of the 10
items listed, based on their annual dollar ($) usage. Record your results in the
empty table beneath.
Review Q
Item Annual unit

Number usage cost
in units
1 15000 50
2 140000 75
3 1500 50
4 55000 25
5 2000 25
6 110000 50
7 7500 25
8 45000 25
9 30000 75
10 4000 50
Part Annual Unit Annual $ Cumulative Percentage $ Rank ABC

Number unit Cost Usage $ usage usage Class
Usage
1
2
3
4
5
6
7
8
9
10
Total
Extending ABC Analysis

By including the number of units on hand for each inventory item and dividing the inventory on
hand into the annual usage (in units), the resulting figures show the amount of inventory on hand
as a percentage of the total year’s supply. When these figures are high, they should prompt
review of the inventory on-and to ensure there are valid reasons for maintaining such a high
stock.

Unit 2
Methods of Ensuring Inventory Accuracy
Counts of inventoried items and the cost of each item must be recorded accurately in order to
support production scheduling, customer service and the management of financial statements.
Cycle counting and periodic inventory counting are the two main methods of verifying the
accuracy of inventory records.
Periodic Inventory Audit

Periodic audits are large scale physical counts of all inventory in a plant. This type of audit
usually takes place annually and is primarily concerned with verifying the financial value of the
inventory. Periodic audits are disruptive to production and are expensive in terms of time and
administration. Accuracy is poor as many of those taking part in the exercise may be
inexperienced and error prone. Some items may be counted twice, others not at all.
Cycle Counting
Cycle counting is concerned with a specific set of inventory items and usually takes place daily,
or at the start and end of each production run. Each item is counted a specified number of times
per year depending on its importance. Cycle counting relies on trained and dedicated personnel.
The following table compares the characteristics of cycle counting with periodic counting
Timely detection and correction of problems
Finding and correcting causes of error
Little impact on production time
ABC classification is used to determine the frequency of the cycle count. The frequency should
increase as the value of the item and the number of transactions for that item increases.
Generally, A class items will be counted more frequently than B or C class items.
The following table compares the characteristics of cycle counting with periodic counting.
Cycle Counting Periodic Inventory Audit
Efficient use of a few experienced Inefficient use of many inexperienced

personnel throughout the year people in a short time once a year
Timely detection and correction of No correction of errors
problems
Fewer mistakes in item Many mistakes in identifying items
identification
Minimal loss of production time Shutdown of plant and warehouse may
be needed
Systematic inventory record Inventory accuracy is improved only
accuracy improvement once in the year
Reconciliation
When inventory audits (either cycle counting or periodic) have been completed, discrepancies
between the count and the inventory record for each item should be reviewed. Where

Unit 2
discrepancies occur, the item should be recounted if the variance is large, or the recorded value
should be changed.
Identifying Causes of Problems

One of the main objectives of cycle-counting is to identify the root causes of any errors,
especially recurring errors, and subsequently correct both the error and its cause. There are many
potential sources of error including:
Untrained personnel Carelessness
Inaccurate supplier receipts Poor document control
Poor form design Inadequate storage space
Inadequate security of inventory Inadequate identification of items
Options for Cycle Counting

It is important to have a system in place for triggering cycle count activity. The number of times
an item is counted may be in direct proportion to the importance of that item or it may be
triggered by some external event. Some examples of ways in which a cycle count for a particular
item may be triggered are:
ABC classification. As previously explained, A class items are counted most frequently.
After a set number of transactions. This allows cycle counting to occur more frequently
on items most often used. As many inaccuracies are due to inventory transactions, this
method is useful as there will only ever be a set number of transactions to check if an
error has occurred.
When a record indicates a zero balance, a count should verify that there is no inventory
available
Just before reordering the item in question, assuming that the inventory level will be low
and therefore quicker and easier to count.
When a replenishment lot is received. The lot should be counted anyway as part of the
receiving process, and the rest of the stock should be at its lowest level and easy to count.

Unit 2
Inventory Policy
Inventory policies must strike a balance between the conflicting objectives required by Sales
(high customer service), Operations (efficient plant operation), and finance (lowest overall
inventory investment). All inventory policies should therefore aim to maximize customer service
with minimal plant costs and inventory investment while maintaining operational efficiency.
Customer Service Objectives

Objectives for achieving customer service vary from company to company. They include
delivery on time, buffering against uncertain demand and provision of sufficient variety to meet
customer needs. As many of these objectives increase the pressure to maintain larger inventories,
they are in direct conflict with the objectives of inventory management. All customers require
from their suppliers the following:
High quality
Flexibility in terms of volume, specification and delivery dates
High service levels
Committed lead times
Reliability in meeting targets
Low cost
Production planning and scheduling has an influence on all of these elements of customer
service. Most companies gauge their customer service levels through performance measures such
as percentage measures and absolute measures as shown in the table below.
Percentage Measures Absolute Value Measures
% of orders shipped on schedule Order days out of stock

% line items shipped on schedule Line items out of stock
% total units shipped on schedule Total item days out of stock
% dollar volume shipped on schedule Dollar volume days out of stock
% profit volume shipped on schedule Idle time due to material and
component shortages
% operating days in stock
% ordering days in stock
Measuring Customer Service Internally

Most measurements of customer service are internal rather than from the customer. These are
therefore indicators of customer service rather than true measures of customer satisfaction.
Internal measurements may cover uncertainty of demand or supply, product mix or variety,
orders, line items, total units or dollar volume delivered on time.
Uncertainty
Inventories are held due to uncertainty in either the demand for finished goods or the
replenishment of raw materials and components. Forecasting is an inexact science which
generally includes variations from the norm: resulting in a level of uncertainty. By maintaining
Unit 2
inventories, a company ensures that delivery is possible even when demand exceeds
expectations. Transportation, quality problems, excessive scrap and supplier lead time factors
contribute to the level of uncertainty. Safety stock protects against fluctuating demand or supply.
Variety
As well as uncertainty about the timing of demand for goods there is usually uncertainty about
which goods are required. When a product is available in a range of options, colors, or flavours,
the precise breakdown of demand for each of these options may be difficult to predict. It may be
necessary to maintain inventories of each different product configuration. This will result in
greater expense in terms of tying up capital, particularly where money must be borrowed to
facilitate extra inventory, and inventory carrying costs. Company objectives are generally clear
that inventory levels should be as low as possible to avoid such costs.
Orders Shipped
For an order to be considered on schedule, all line items on that order must be shipped before the
due date. Using this measurement assumes that all orders are equally important. For example, if
1 order out of 100 orders is late, the orders shipped measurement will be 99% However, if the
one late order accounted for 20% of the value of the total orders shipped then the 1% error is
much more significant than the order shipped measurement suggests.
Line Items Shipped on Schedule
This measurement recognizes that some orders may contain a greater number of items than
others. However, it still does not take into account the dollar value of the orders; neither does it
measure how late an order is.
Total Units Shippe d on Schedule
This measurement deals with the number of units shipped on schedule but again does not
recognize dollar volume or the length of delay in delivery.
Dollar Volume Shipped on Schedule
Generally, the dollar volume of an order will be readily available and recorded on the order
documentation. This is a more complete measure of the value of the order to the company and to
the customer. But if some large orders consist mainly of materials that have been bought by the
company and sold to the customer with little added value, it may still distort the value of the
order as the actual profit margin on such an order would be minimal.

Unit 2
Summary
This lesson covered safety stock techniques, the importance of inventory valuation, data and
inventory accuracy, ABC analysis, cycle counting, and inventory policies are examined The
main aim of this lesson was to review all factors that are potential inputs or affect inputs to
Material Requirements Planning (MRP) and review techniques to ensure the accuracy of suc h
inputs.
You should be able to:
Describe safety-stock processes
Identify ways in which safety stock processes support customer service strategies
Identify the purpose of inventory valuation
Calculate safety stocks to support a required level of customer service using the table of
safety factors
State the effect of inventory valuation on inventory investment
Describe inventory accuracy methodologies used to maintain and improve part-count and
inventory valuation accuracy
Distinguish between various customer services measurements
Further Reading
Introduction to Materials Management,
JR Tony Arnold, CFPIM, CIRM and Stephen Chapman CFPIM
5th edition, 2004, Prentice Hall
APICS Dictionary
10th edition, 2002
Manufacturing Planning and Control Systems,

Vollmann, T.E.; W.L. Berry; and D.C. Whybark
5th edition, 2004, McGraw-Hill
Production & Inventory Management,

Fogarty, Donald W. CFPIM; Blackstone, John H. JR. CFPIM; and
Hoffmann, Thomas R. CFPIM
2nd edition, 1991, South-Western Publishing Co., Cincinnati, Ohio

Unit 2
Review
The following questions are designed to test your recall of the material covered in
lesson 2. The answers are available in the appendix of this workbook.
6. Which is the most accurate description of cycle counting?

A. Annual physical counts of all inventory in a plant
B. Each inventory item is counted a specified number of times per year depending on its
importance. Often, cycle counts take place daily
C. Monthly physical counts of all inventory items in a group
D. Each week a different inventory item is counted and reconciled
7. When the value of orders varies significantly but the cost of individual line items does
not, which of the following may be an appropriate measure of customer service?
A. % on-time orders
B. % line items shipped on schedule
C. % Total items shipped on schedule
D. % Dollar volume shipped on schedule
8. What is the main purpose of inventory valuation?

A. To establish the asset value of the company.
B. To give an insight into inventory management efficiency
C. To calculate the expenses of the company
D. To keep the total inventory value on the balance sheet close to the current market value
9. Which is the most accurate description of FIFO costing?

A. Uses most recent item costs to calculate cost of goods sold and assumes that most
recently arrived items will be used first
B. Sets a value for an inventory item based on an average of historical costs or anticipated
costs and uses this to calculate cost of goods sold and inventory value
C. Relies on lot control to ensure that materials withdrawn from inve ntory can be traced
directly to a specific purchase order or production run
D. Assumes the oldest items are used first. Uses least recent cost values to calculate the cost
of goods sold and sets inventory values close to current market rates

Unit 2
What’s Next?
Lesson 2 a variety of techniques for customer service and inventory management. At this point
you have completed two of the 9 lessons in the Detailed Scheduling and Planning unit.
You should review your work before progressing to the next lesson which is:
Detailed Scheduling and Planning – Lesson 3 Materials Planning Information
Requirements

Unit 2
Appendix

Unit 2
Answers to Review Questions
1. B, C, and D
Demand is unlikely to exceed supply as items with dependent demand are required solely for the
production of a parent item. Instead, safety stock may be held to guard against delivery delays, or
ensure there is sufficient material available should production yields decrease.
2. C
Although option A is a possible answer, there is no evidence that the necessary data is easily
available. It is possible to measure the percentage of orders shipped on schedule. However, as
order sizes vary greatly this could be misleading. For example if there is a 99% success rate but
the one order that was delayed accounts for 10% of total sales volume, then customer service is
actually lower than the measurement. It is better to measure the percentage of line items shipped
on schedule. As the costs and margins of all line items are similar there is no need to go to the
extra effort of calculating the profit on each line item.
3. B
Safety stock should be set at a level that is appropriate, given the demand variability and the
desired level of customer service. Both MAD and standard deviation are measures of demand
variability and can be used to calculate appropriate safety stock levels. However, the safety stock
level is not necessarily equal to the MAD or the standard deviation and is more likely to be a
multiple of the standard deviation.
4. D
To support a customer service level of 98% the safety stock level should be equal to the amount
of standard deviation multiplied by 2.05.
5. ABC Classification
Part Annual Unit Annual $ Cumulative Percentage $ Rank ABC
Number unit Usage Cost Usage $ usage usage Class
2 140000 $75 10,500,000 10,500,000 47.70% 1 A
6 110000 $50 5,500,000 16,000,000 72.69% 2 A
9 30000 $75 2,250,000 18,250,000 82.91% 3 B
4 55000 $25 1,375,000 19,625,000 89.15% 4 B
8 45000 $25 1,125,000 20,750,000 94.26% 5 B
1 15000 $50 750,000 21,500,000 97.67% 6 C
10 4000 $50 200,000 21,700,000 98.58% 7 C
7 7500 $25 187,500 21,887,500 99.43% 8 C
3 1500 $50 75,000 21,962,500 99.77% 9 C
5 2000 $25 50,000 22,012,500 100.00% 10 C
Total $22,012,500

Unit 2
6. B
Cycle counting is concerned with a specific set of inventory items and usually takes place daily,
or at the start and end of each production run. Each item is counted a specified number of times
per year depending on its importance. When inventory audits (either cycle counting or periodic)
have been completed, discrepancies between the count and the inve ntory record for each item
should be reviewed. Where discrepancies occur, the item should be recounted if the variance is
large, or the recorded value should be changed. The number of times an item is counted may be
in direct proportion to the importance of that item, for example, its ABC classification or it may
be triggered by some external event such as a reorder of the item or a set number of item
transactions.
Periodic audits are large scale physical counts of all inventory in a plant. This type of audit
usually takes place annually and is primarily concerned with verifying the financial value of the
inventory.
7. C
When all line items are of a similar value it is a waste of effort to calculate the dollar volume.
However, as the value of orders varies significantly it is not sufficient to measure only the % of
orders or line items shipped on schedule. For example, if 1 line item out of 100 is delayed, the %
line items shipped on schedule will be 99% whether that line item was for 10 units or 200 units.
In this case, the percentage of total units shipped on schedule provides the most accurate picture.
8. A
Inventory valuation is important as it establishes the asset value of the company. It also enables
average inventory value, and therefore inventory tur ns, to be calculated. This gives a company a
good picture of how efficiently they are using their inventories. Note that MRO inventories are
not included when calculating inventory turns.
9. D
FIFO assumes that the oldest inventory items are issued for use first. As the cost of the inventory
items changes over time, this would keep the total inventory value on the balance sheet close to
the current market value. It would also result in the cost of goods sold equating to the least recent
cost values. LIFO assigns the cost of goods sold based on the most recent cost of the inventory
item. It assumes that the most recently arrived inventory items are the first to be issued for use.
The standard cost system, sets a single value for an inventory item, generally based on an
average of historical costs or anticipated costs, and uses that value in all calculations. The actual
cost method uses lot control to trace the actual cost of each material. It is cumbersome and rarely
used unless when required by regulations, such as in the tracing of the origin of meat products.

Unit 2
Glossary
Term Definition
ABC Classification The grouping of items in a list in order depending on their importance.
First, the items are measured against the critical criteria (for example dollar
volume) and listed in descending order. The top group of items (usually
around 20%) are classed as A items and account for around 50-70% of the
critical measurement. The next 30% or so of items are B items and are
responsible for around 20% of the critical measurement. The rest are C
items and are of least value in terms of the critical measurement.
ABC classification is used to focus management on the most important
items. It is usually applied to inventories, purchasing and sales.
Actual cost The labor, material, and associated overhead costs that are charged against
a job s it moves through the production process
Anticipation Additional inventory above the baseline stock to cover projected sales
inventory increases, planned sales promotions, seasonality, plant shutdowns and
vacations
Backorder A customer order or commitment to a customer that has not been fulfilled
by the promised date due to inventory stockout.
Bias A consistent deviation from the average, either too high or too low. Bias is
an undesirable trait in forecasts
Buffer A quantity of material waiting for further processing. This may be raw
material, partially completed material in stores, or a work backlog that is
purposely maintained beside a work center.
Carrying cost Cost or carrying inventory. This is defined usually as a percentage of the
monetary value of the inventory per unit of time (usually a year). Carrying
cost depends on the cost of capital invested and on costs of maintaining the
inventory, paying tax on it, insuring it, spoilage, storage space, and
obsolescence.
Consignment A shipment that is handled by a common carrier or the process of a
supplier placing goods at a customer location without receiving payment
for the goods until after they are used or sold
Constraint An element or factor that prevents a system from achieving a higher level
of performance with respect to its goal. Constraints can be physical, such
as a machine center or lack of material, or managerial, as defined in
policies or procedures.
Cumulative lead The longest planned length of time needed to complete a particular
time activity. It may be calculated in MRP by reviewing the lead time for each
BOM path below the item. The longest BOM path is equal to the
cumulative lead time
Customer service A measure of a company’s ability to delivery the right product at the right

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time to the right place of the required quality and in the desired quantities.
In other words, customer service is the ability of a company to meet the
needs of its customers.
Customer service A measurement of delivery of finished goods performance, usually a
level or ratio percentage such as the number of items or dollars shipped on schedule
during a specified time period, compared to the total that should have been
shipped. In a make-to-order environment it may be measured by the
number of jobs or dollars shipped in a particular period compared with the
total number required.
Cycle The interval of time during which a system or process, periodically returns
to similar initial conditions. It is also the interval of time during which an
event or set of events is completed
Cycle counting An inventory accuracy audit technique. Each inventory item is allocated a
cycle count frequency, usually more frequent for high value or fast moving
items. Each item is counted in isolation at regular intervals throughout the
year as often as specified for each item. Many items may be counted very
working day. Cycle counting is used to identify items in error. This may
lead to research, identification, and elimination of the causes of the errors.
Demand A need for a particular product or component which could come from a
customer order, forecast of market requirements, interplant requirement, or
a request from a branch warehouse for a service part
Demand The need for a product of component. Demand may be generated from
customer orders, forecasts, or internal requests.
Dependent demand Demand for an item that is wholly influenced by demand for another item.
For example, in the manufacture of computer monitors, the demand for the
plastic monitor case will be entirely dependent on the demand for
monitors.
Distribution The activities associated with the movement of material, usually finished
goods or service parts from production plant to the customer. Distribution
incorporates functions such as transportation, warehousing, inventory
control, material handling, order administration, location analysis,
packaging, data processing, and communications networks.
Economic order Reducing setup time and inventory to the point where it is economical to
quantity (EOQ) produce in batches of one.
Excess inventory Inventory that exceeds the minimum amount required to achieve a desired
throughput rate, or inventory over and above the minimum amount needed
to ensure desired due date performance
Expedite To speed up production orders or purchase orders that are required in a
shorter time than the usual lead time.
First-in-first-out A calculation of inventory value that assumes, for the purposes of
(FIFO) valuation, that the oldest inventory will be used first.
Finished goods or A product sold as a completed item or repair part. This term refers to any
end items item that is subject to a customer order or sales forecast

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Fixed order À lot sizing technique in MRP or inventory management that will always
quantity cause an order to be generated for a fixed quantity or multiples of that
fixed quantity, if net requirements for the period are higher than the fixed
order quantity.
Hedge inventory An amount of inventory built up to guard against a particular event that
may or may not occur. Hedge inventories are the result of speculation
related to potential strikes, price increases, government unrest, or other
external events that could severely impair a company’s strategic initiatives.
Inactive inventory Stock that is in excess of consumption within a defined period of time or
stocks of items that have not been used within a defined time frame.
Independent Demand for an item that does not depend on the order of other items.
demand Demand for finished goods, parts required for destructive testing, and
service parts are examples of independent demand.
Independent The demand for an item that is derived from customer orders, forecasts, or
demand internal requirements, and is not dependent on the demand for other items.
Inventory Stocks or items used to support production (raw materials and WIP items),
supporting activities (MRO supplies), and customer service (Finished
goods and spare parts). Demand for inventory may be dependent or
independent. Inventory functions are anticipation, hedge, cycle (lot size),
fluctuation (safety, buffer, or reserve), transportation (pipeline), and
service parts.
In the theory of constraints, inventory refers to items purchased for resale
and includes finished goods, WIP and raw materials. In this approach,
inventory is always valued at purchase price and includes no value-added
costs, whereas traditionally, direct labor and overhead costs were attributed
to the items as they went through the productio n process.
Inventory turns The number of times that an inventory turns over during a year. This is
calculated by dividing the average inventory level into the annual cost of
sales. For example, an average inventory of $600,000 divided into an
average cost of sales of 1,800,000 means that inventory turned over 3
times during the year.
Kanban A JIT production method that uses standard lot sizes. Material is pulled to
the work center according to demand. A Kanban is a card, billboard or
sign. When a work station requires material it sends some form of sign,
such as an empty container, up the chain.
Lead time The amount of time required to perform an operation. In logistics, it is the
time between identifying the need for an order and the receipt of that order.
Components of lead time may include order preparation time, queue time,
processing time, move time, receiving, and inspection time.
Last-in-first-out A calculation of inventory value that assumes the most recent material
(LIFO) received will be the first to be used. LIFO does not relate to the physical
use of goods. It is required solely for accounting purposes.
Lot-for-lot A lot sizing technique that generates planned orders in quantities equal to
the net requirements in each period.
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Maintenance, Items used to support operations and maintenance, including for example
repair, and maintenance supplies, spare parts, consumables used during manufacturing
operating supplies and supporting operations.
(MRO)
Manufacturing The framework in which a manufacturing strategy is developed and
environment implemented. It includes external environmental forces, corporate strategy,
business unit strategy, product selection, process technology, and
management competency. It is often used to refer to whether a company is
make-to-stock, make-to-order, or assemble-to-order.
Material A set of techniques that use bill of material information, inventory data,
requirements and the master production schedule to calculate requirements for materials.
planning (MRP) MRP recommends replenishment orders and order dates for materials and
helps to reschedule open orders when due dates and need dates are not in
line. MRP takes the items listed on the MPS and determines the quantity of
all components and materials required to make those items and the dates
by which those materials are required. It explodes the bill of material for
each item, takes into account inventory on hand or on order and offsets the
net requirements by the lead time for each item.
Mean absolute A figure calculated by averaging the sum of the absolute values of each
deviation (MAD) deviation of an actual from an expected figure. This can be used to track
the accuracy of a forecast.
Normal distribution A commonly known statistical distribution pattern where most events are
close to a ‘mean’ and only occasional events stray far from that mean.
Obsolete inventory Inventory that is out of date or no longer required in the manufacturing
process, or made worthless due to the appearance of a better or more
economical alternative
Open order A manufacturing or purchase order that has been released or an unfilled
customer order
Opportunity cost The return on capital that would have resulted had the capital been
available for some purpose other than what it has been used for
Order point or A predefined inventory level, which if it is higher than the stock on hand
reorder point and stock on order combined, will trigger an action to replenish the stock.
Order Quantity or The amount of an item that is ordered from a supplier or from the plant or
Lot size is issued as a standard quantity to the production process.
Period order A lot-sizing technique which equates the lot size to the net requirements
quantity for a specified number of periods in the future. The number of periods to
order is variable. The order size should equalize the holding costs and
ordering costs for the time interval
Periodic inventory A physical count of all inventory undertaken either monthly, quarterly or
audit annually.
Periodic review A fixed reorder cycle inventory model
Periodic review This is also called fixed reorder cycle inventory model. It is a form of
system independent demand item management in which an order has a fixed

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quantity. The reorder point will be large enough to cover the maximum
expected demand during the replenishment lead time.
Process cost A system of cost accounting that collects cost by time period and
calculates the average for all units produced during that time period.
Procurement A fussiness function of planning, purchasing, inventory control, traffic,
receiving, incoming inspection, and salvage operations
Product group A number of similar products. Generally they are grouped according to the
process or materials required to make them
Project cost A method of costing used in project-based industries. Each assignment is
costed as a standalone project without reference to other assignments.
Raw material Purchased items or extracted materials that are converted via the
manufacturing process into components and produc ts.
reconciliation Comparison of physical inventory figures with perpetual inventory records
followed by appropriate adjustments to correct the records.
Reserve Material on hand or on order that is assigned to specific future production
or customer orders
Safety stock This is a quantity of stock that is planned for inventory to protect against
fluctuations in demand or supply. In the context of master production
scheduling, the additional inventory and capacity planned as protection
against forecast errors and short term changes in the backlog.
Overplanning can be used to create safety stock. Safety stock is also
known as buffer or reserve stock.
Scheduled receipt An open order with an assigned due date
Scrap Material outside specifications for which rework is not possible or
practical
Seasonality A pattern of demand that repeats from year to year (or other identified
season) where some periods have very high demand compared to others
Service level A desired measure (usually a percentage) of satisfying demand through
inventory or by the current production schedule in time to satisfy the
customers’ requested delivery dates and quantities. In a make-to-stock
environment, level of service is sometimes the percentage of orders picked
complete from stock upon receipt of customer order.
Service parts Parts (modules, components or elements) that are planned to be used
without modification to replace an original part
Shelf life The amount of time an item may be stored before becoming unusable.
Spare parts or These are modules, components or elements that may be used without
service parts modification to replace an original part
Standard cost An accounting system that determines cost by using set cost units for
estimating the cost of an order. The standard cost is regularly compared
against actual costs.
Stock Items in inventory or stored products / service parts ready for sale, as

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distinguished from stores that hold components and raw materials
Stockout A lack of required materials components or finished goods.

Time period safety An amount of safety stock that covers requirements for a set period of
stock time.
Time-phased order Similar to MRP planning logic for independent demand items, where gross
point (TPOP) requirements come from a forecast. The TPOP may be used to plan
distribution center inventories and repair parts. The TPOP approach uses
time periods, allowing for lumpy withdrawal instead of average demand.
Tracking signal A signal used to highlight when the forecasting method is inaccurate. It is
usually the ratio of the cumulative sum of deviations between forecast and
actual values compared to the mean absolute deviation (MAD)
Two -bin system A type of fixed order system in which inventory is carried in tow bins. A
replenishment quantity is ordered when the first bin is empty. During the
replenishment lead time, material is used from the second bin. When the
material is received, the second bin, which contains a quantity to cover
demand during the lead time plus some safety stock, is refilled and the
excess is put into the working bin. AT this time, stock is drawn from the
first bin until it is empty again. The bins may be metaphorical only.
Unit cost Total labor, material, and overhead cost for one unit of production.
Visual review A simple inventory control system which involves looking at the amount
system of inventory on hand before reordering. It is used for low value items
Work-in-process A product or products in various stages of completion throughout the plant.
(WIP) This includes all material from raw material that has been released for
processing, up to completely processed material that is awaiting final
inspection and approval as finished goods.
Yield The amount of usable output from a process as compared to its input. This
is usually expressed as a percentage of the input.

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Detailed Scheduling and Planning

The Leading Edge Training Institute Limited

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Measuring Customer Service

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Absolute Value Measurements

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Delivery Performance and Backorders

Selecting Customer Service Measurements

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Customer Service Objectives

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Customer Service and Order Quantities

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Mean Absolute Deviation (MAD) and Standard Deviation

Sum of squared deviations

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Week Actual Sales Forecast Deviation Deviation2

So in this example, the Standard Deviation = 533.3

Implications of Forecast Bias

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3. To support a particular level of customer service, it is important to ensure

Using Variability Metrics

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Figure 1 Standard Deviation and Customer Service

Table of Safety Factors

Desired Service Level (%) Standard Deviation Safety MAD Safety

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Lead Time Deviation

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Time Period Safety stock = 20 units

Fixed Safety Stock

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Safety Stock Analysis

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Purpose of Inventory Valuation

Cost of Goods Sold

Types of Inventory Valuation

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Higher cost of goods sold Decreased earnings before taxe s

The following table is an example of LIFO valuation

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Costing Method Inventory Value Cost of Goods Sold

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Definition and Purpose of Inventory Accuracy

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ABC Classification and Inventory Analysis

A items B items C items

20% 50% 100%

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ABC Classification Method

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Part Annual $ Cumulative $ Cumulative % $ Cumulative % of

5 12,000 60,000 78% 20

1 4,400 70,400 92% 40

10 1,000 74,000 97% 60

3 800 74,800 98% 70

6 500 76,100 99% 90

Figure 3 Cumulative % of Items

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Item Annual unit

Part Annual Unit Annual $ Cumulative Percentage $ Rank ABC

Extending ABC Analysis