SCM 303 Chapter 7 (Pages 234-243) Managing Inventories

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Supply Chain Management and Inventory Management

A major emphasis over the past two decades has been placed on reducing the amount of inventory There are many who argue that having inventory is bad Their reasoning is based on the financial implications of holding inventory

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Types of Inventory Raw materials/Component Parts

Work-in-process
Finished goods Maintenance, repair, and operating supplies (MRO) Transit Inventory
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So, Why Carry Inventory?

Balance Supply and Demand Seasonality

Production Processes
Provide Buffer against Uncertainty/Variability in Supply and/or Demand (Buffer/Safety Stock)

Basic Economics of Buying

Geographic Specialization

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Financial Implications of Inventory Inventory represents investment by the firm

It is an asset on the firms balance sheet Companies typically desire to keep their investment in assets as low as possible

Maintaining inventory costs money on an ongoing basis.

Thus, inventory also causes expenses to be incurred These expenses show up on the firms income statement

However, not having inventory when customers want it results in negative financial consequences as well
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Inventory Holding/Carrying Cost

Cost of capital (opportunity cost) Cost of owning and maintaining storage space Taxes Insurance Costs of obsolescence and loss Costs of material handling, tracking, and management

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INVENTORY HOLDING COST

ELEMENT Cost of Capital Taxes Storage /handling/mgt.

AVERAGE PERCENT OF COST 15.0 1.0 2.0

PERCENT RANGE 8.0 30.0 0.5 2.0 2.0 6.0

Insurance
Obsolescence Total

0.5
1.2 19.7

1.0 4.0
0.5 8.0 11.0 50.0

Percentage is annual percent of average inventory value

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Inventory Carrying Cost

Suppose average inventory for a firm is $3,500,00. The company has determined that its inventory carrying cost is 25%. What is the annual expense of holding inventory? The company is able to reduce inventory to an average of $2,750,000? What is the savings associated with this reduction?

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OTHER COSTS RELATED TO INVENTORY

Ordering Costs
Preparation Transmittal Receiving Payment processing

Stockout Costs

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Measures of Inventory Performance

Inventory turnover Days of Supply Service level

Discussed in more detail in Chapter 9, but should understand the basic concept of a stockout

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Calculating Inventory Turnover

Inventory turnover =
Inventory turnover =

Net Sales Average inventory at retail

Cost of goods sold Average inventory at cost Sales in Units Average inventory in Units

Inventory turnover =

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Table 7-1: Example Inventory Levels, Turnover, and Carrying Cost (Fiscal Year 2011, $ figures in millions) *Inventory Carrying Cost calculation assumes a 20% annual rate.

Company

Cost of Goods

Beginning Inventory

Ending Inventory

Average Inventory

Inventory Carrying Cost* $5,665.70 743.40 1,181.80 1,395.60

Inventory Turnover

Boeing Deere Ford HewlettPackard

$55,867.00 22,034.40 113,345.00 97,529.00

$24,317.00 3,063.00 5,917.00 6,466.00

$32,240.00 4,371.00 5,901.00 7,490.00

$28,278.50 3,717.00 5,909.00 6,978.00

1.98 5.93 19.18 13.98

Kellogg
Procter & Gamble Target Wal-Mart Hyatt Hotels Starwood
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7,750.00
40,768.00 48,306.00 335,127.00 2,957.00 4,994.00

1,056.00
7,379.00 7,596.00 36,318.00 100.00 802.00

1,132.00
6,384.00 7,918.00 40,714.00 87.00 812.00

1,094.00
6,881.50 7,757.00 38,516.00 93.50 807.00

218.80
1,376.30 1,551.40 7,703.20 18.70 161.40

7.08
5.92 6.23 8.70 31.63 6.19

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Turnover

Advantages of high turn over:

Fresh inventory from high sales Reduced risk or mark down from obsolescence Reduced total carrying costs Lower asset investment and higher productivity

Dangers of high turnover:

Stockouts may mean lower sales Increased costs from missing quantity requirements Increased ordering costs
Turn over
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Turn over
713

Days of Supply

How many days of demand into the future can we satisfy from inventory on hand?
Current Inventory/expected rate of daily demand Suppose a firm currently has a total of $8,000 inventory of an item. It expects demand to average $200 per day. What is the days of supply of the item?
$8,000/$200 = 40 days

If the firm consistently maintains an average of 40 days of supply, what inventory turnover rate will it have for the year?
360 days/40days = 9 turns/year (It is convention to think of a year as 360 days for this calculation just because its simpler arithmetic than thinking about 365 days).

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Problems to work

Note: This is NOT a graded homework assignment, but you can expect that knowing how to work these will be useful on the exam!! Work problems 1-4 at the end of Chapter 7.

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