INVENTORY MANAGEMENT

What are Inventories?

Inventories represent aggregate of those items which are either held for sale in the ordinary course of business or are in the process of production for sale (i.e. work in progress) or are yet t be utilized / consumed in the production of goods and services

Inventories can be in the form of

Raw materials Basic unfabricated materials which are yet to undergo the conversion process Finish parts When final output is made of sub assemblies ( Automobile manufacturing Work in progress Items are materials in partially completed condition of manufacture

Inventories can be in the form of

Finished goods Final products which are ready to be shipped Tools Supplies Materials used in running the plant but do not themselves go into the product. Oils, general office supplies, electric supplies Machinery spares

Direct Material
Direct materials are those materials which are directly identifiable and traceable as a part of the final product. It may be raw material like wood used in making tables and chairs, Component parts used in a product ,e.g., tyres and tubes in a car, Any material used in primary packing of the products, like cans for tinned food and drink. Materials cost constitutes a prime part of the total cost of production of manufacturing firms. There fore it becomes very important to have efficient control of materials. Materials control basically aims at efficient purchasing of materials, their efficient storing and efficient consumption.

Indirect material
Indirect material
Materials which are used to run the conversion system but do not themselves go into the product i.e. sewing mc oil

Materials can be classified as

Direct material
Materials which undergo the conversion process and are part of the out put product / service I.e. Fabric , buttons etc

Indirect material
Materials which are used to run the conversion system but do not themselves go into the product i.e. sewing mc oil

7 reasons to carry inventory

1.To economize on buying / manufacturing cost
Fixed ordering costs Cannot order on day to day basis A particular machine will have a fixed set up cost. Better to manufacture higher than demand to reduce cost Suppliers give quantity discounts if more units are purchased

7 reasons (contd..)
2.To keep pace with changing market conditions
Anticipated non-availability of supply in future or anticipated rise in price of supplies

3.To satisfy demand during period of replenishment

Supplies are not instantaneous Even work in progress goes through the conversion process with to come out Period of replenishment means the delay between ordering and arrival of goods

7 reasons (contd..)
4.To take care of contingencies (i.e. to prevent stockouts)
Stock out occurs when the rate of consumption is more than the estimated usage rate or when there is delay in delivery

5.To stabilize production

Incase of regular / seasonal products consumer demand is not regular. There are peaks and valleys Firms cannot alter their capacity based on these demand patterns Produce at uniform rate throughout the year so inventory will rise but once the demand peaks inventory will start to decline

7 reasons (contd..)
6. To prevent loss of sales
Finished goods inventory is maintained to match requirements of customers for immediate execution of orders

7.To satisfy other business constraints

Suppliers condition of minimum quantity Items where government regulations are there so it is better to procure those in bulk Seasonal availability

Types of inventories
Buffer / safety inventories : inventories to meet uncertainties of demand & supply
They are held for protecting against the fluctuations in demand and lead time

Anticipation inventories : Built up in advance for the season of large sales, a promotion programme or a plant shut down period Cycle (lot size) inventories : Built up as purchases are made in lots

Type of inventories (contd..)

Transportation inventories : Also known as pipeline inventories. Happens because of the transportation of inventory items to various distribution centers and customers Decoupling inventories : Inventories used to reduce the dependency of various stages of production system
Raw materials WIP Finished goods Spare parts

Objectives of scientific inventory control system

1. 2. 3. 4. 5. 6. 7. 8. Continuity of productive operations Effective use of capital Reduction of administrative workload Service to the customers Economy in purchasing Reduction of risk of loss Practical system Zero discrepancy between physical stock & book balance 9. Administrative simplicity

Inventory costs
1) 2) 3) 4) Inventory carrying cost Ordering cost (procurement cost) Set-up cost Stock-out costs

Inventory carrying cost

Cost of holding stocks
Capital cost: cost of borrowing capital (I.e. with interest rate) Storage cost: Cost of storage space, cost of maintenance and repairs, cost of storage facilities, cost of preservation, cost of record keeping & cost of periodic / annual stock verification Deterioration & obsolescence : Deterioration is the loss of functionality of stock where as obsolescence means the stock is of no longer needed Insurance cost

ORDERING COST
Cost incurred to order and replenish and item
Paper work cost Postage cost Follow up cost Cost of visits to vendor plants Expediting cost Operating cost of the vehicles Inspection and testing tools Administrative costs

SET-UP COST
Cost that is incurred to replenish the stock of an item manufactured at the home plant It is also the cost of production stoppage to enable a machine or a group of machines to change over from one job to another Set up costs include
Idle time cost Cost of idle wages Work order cost Foregone profit

STOCKOUT COST
Represents the cost of going out of stock (i.e. loss incurred due to non availability of the item when it is required) Stock outs happen due to
Higher demand rate than calculated Delay in delivery Transportation delays Rejection in incoming consignment

Stock outs cause

Men & MC idle Loss of profit Extra cost incurred due to emergency actions ( like air freight) Penalty paid for delayed shipments Overtime Customer dissatisfaction Loss of business

How to control inventories?

Selective control : Means variation in method of control from item to item based on selective basis. The criterion for selective control can be cost of the item, criticality, lead time, consumption, procurement difficulties etc

Selective control classifications

1. 2. 3. 4. 5. 6. 7. 8. ABC analysis VED analysis FSN analysis HML analysis SDE analysis GOLF analysis SOS analysis XYS analysis

ABC analysis
Items are classified into A, B & C A-items : 5-10% of the total items account for 70 75% of the total money spent on materials Require detailed and rigid control Should be stocked in small quantities Should be procured frequently Better to go for a contract with staggered deliveries

ABC analysis (contd..)

B- items:

10- 15 % of the total items in quantity 10-15% in value Intermediate items Need not be controlled as rigid as A items
70- 80 % of the total items in quantity 5-10% in value Insignificant items Should be procured infrequently & sufficient quantities

C- items:

Steps to do ABC analysis

Prepare the list of items and estimate their annual consumption (units) Determine unit price of each item Multiply each annual consumption by its unit price to obtain annual consumption in Rupees Arrange items in the descending order of their annual usage starting with the highest annual usage down to the smallest annual usage Calculate annual usages and express the same as cumulative usage percentages. Also express the number of items into cumulative items percentages Graph cumulative annual usage percentages against cumulative item percentages and segregate the items into A,B & C Decide the policies of control for the three categories

Example of ABC analysis

Item Nitric acid Xyelene Drums Paraffin wax Biolac Methylene chloride Ethykl A Annual consumption 4000 600 2000 3500 50 6000 2400 Price 10 / lit 10 / kg 16 / no 1/ kg 8 / kg 6 / kg 5 / kg

D Sprit
Handrast Castor oil Camphor

4200
50 100 80

1 / lit
10 /kg 7 / kg 40 /kg

Eastergum
Butyle accetate Talc powder

50
350 800

8 / kg
6 /kg 0.25 / kg

Step 1 : calculate annual usage & rank

Item
Nitric acid Xyelene Drums

Annual consumption
4000 600 2000

Price
10 / lit 10 / kg 16 / no

Annual usage
40000 6000 32000

Rank
1 5 3

Paraffin wax
Biolac Methylene chloride Ethykl A D Sprit Handrast Castor oil Camphor Eastergum Butyle accetate Talc powder

3500
50 6000 2400 4200 50 100 80 50 350 800

1/ kg
8 / kg 6 / kg 5 / kg 1 / lit 10 /kg 7 / kg 40 /kg 8 / kg 6 /kg 0.25 / kg

3500
400 36000 12000 4200 500 700 320 400 2100 200

7
11 2 4 6 10 9 13 12 8 14

Step 2 : Revise the table and arrange items

Item
Nitric acid Methylene chloride Drums Ethykl A Xyelene D Sprit Paraffin wax Butyle accetate Castor oil Handrast Biolac Eastergum Camphor Talc powder

Annual usage (Rs)

40000 36000 32000 12000 6000 4200 3500 2100 700 500 400 400 320 200

Cumulative annual usage (Rs)

40000 76000 1,08,000 1,20,000 1,26,000 1 ,30,200 1,33,700 1,35,800 1,36,500 1,37,000 1,37,400 1,37,800 1,38,120 1,38,320

Cumulative usage (%)

28.9 54.9 78.07 86.75 91.09 94.12 96.65 98.17 98.68 99.04 99.33 99.62 99.85 100

Category
A A A B C C C C C C C C C C

Policies of control for A, B & C category items

Degree of control
A items : Direct control of senior management as they form bulk of the cost B items : normal control C items : little control

Ordering procedure
A items : Accurate order quantities & subjected to periodic reviews B items : Reasonable good analysis C items : no such computations

Staggering of delivery schedule

A & B items : staggering deliveries with contract C items : best to purchase in one bulk purchase

Policies of control for A, B & C category items

Stock records
A items : Detail records of goods ordered, received, issued & goods on hand B items : Good & accurate records C items : No detailed records

Priority treatment
VIP treatment for A , Normal treatment for B & C lower level personnel

Safety stock
Stock kept in excess to safeguard against shortages Less safety stock for A : Moderate for B

Policies of control for A, B & C category items

Price discounts
A & B decide between discounts & carrying cost

Store layout
A items : should be easily accessible B items: further back C items : at the back

Physical stock-tacking
Check A items more often

Value analysis
C items not to be value analyzed

VED analysis
Based on criticality : Vital, Essential & desirable Vital: items without which the production will come to halt. Reasons to classify a item as vital are
Non availability can cause serious production losses Lead time for procurement is large It is a non standard item and is procured to buyers design The source of supply is only one and located far off

Essential : items whose stock-out costs are high Desirable : items which do not cause production loss or stock out

VED analysis (procedure)

Identify the factors to be considered
Lead time, effect on production, nature of items & sources of supply

Assign points/ weightages to the factors Divide each factor into first , second & third degree
First degree is assigned equal points to the weightage of the factor: second degree twice the weightage & third degree thrice the weightage

Prepare categorization plan Evaluate the items one by one Place the items into V,E or D category depending on the points scored

Typical VED analysis categorization plan

Factor Stock out cost in the event of non availability (30) Lead time for procurement (30) Nature of the item (20) First degree Below Rs. X (30) Second degree Between Rs. X to Y (60) 4-8 weeks (60) Standard items produced to suppliers design (40) Outstation (40) Third degree Above Rs.Y (90)

1-4 weeks (30) Produced to commercial items or off the shelf availability (20) Local (20)

Over 8 weeks (90) Produced to buyers design (60)

Sources of supply (20)

Import (60)

How to analyze a single item?

Factor Stock out cost in the event of non availability (30) Lead time for procurement (30) Nature of the item (20) 1-4 weeks (30) Produced to commercial items or off the shelf availability (20) Outstation (40) First degree Second degree Between Rs. X to Y (60) Third degree

Sources of supply (20)

Total points for this item is 150

After analyzing each item against all the factors using the categorization plan classify all the items based on the points scored
Points 100-160 161-230 231-300 Classification Desirable Essential Vital

FSN analysis
Based on consumption figures of the items F : Fast moving S : Slow moving N : Non moving Helps to identify
Active items which need to be reviewed regularly Surplus items whose stocks are higher than their rate of consumption Non moving items disposal

HML analysis
Same as ABC H : high value, M : medium value & L : low value

SDE analysis
Based on problems in procurement
Non-availability Scarcity Longer lead time Geographical location of suppliers Reliability of suppliers

S: Scarce: imported items in short supply: better to procure once a year D: Difficult : Indigenously available items but not easy to procure E: Easy : Readily available items & locally available

Other analysis
GOLF : (Government. Ordinary, local & foreign) S-OS (Seasonal of seasonal) XYZ (Based on value of stocks in hand)
X : Inventory values are high Z: Low inventory value Y : Moderate inventory stocks