SYSPROInventory WorkshopPNG - Lae International Hotel Anand Subramaniam Manager Service Delivery – Asia Pacific Glen Skelton Principal Consultant – Asia Pacific
Agenda • Inventory Management Overview • Inventory Classification • Inventory Measures • Inventory Models • Inventory Controls • Inventory Cost • Economic Ordering Quantity • Economic Ordering Quantity using Discount Model • Minimum Quantity Calculation • Safety Stock • ABC Classification • Inventory Counting • Additional Approaches to Inventory Management
Overall Objective To achieve satisfactory levels of customer service whilst keeping inventory costs within reasonable bounds.
Current Trends / Managerial Issues • Inventory is no longer viewed as an asset • Product life cycles are becoming shorter increasing the likelihood of product obsolescence. • Inventory concealing other problems. • The high costs of inventory storage. • Firms are focusing on reducing setup and order costs, resulting in smaller economic order quantities. • Firms are working more closely with vendors to reduce product throughput times and lead times. • Recent emphasis is on increasing customer service and reducing inventory investment
Inventory Scenarios in a Firm The Importance of Inventory in other Functional Areas • Marketing uses inventory to provide strong customer service. • Manufacturing uses inventory to schedule longer production runs. • Finance wants inventory turnover ratios to be kept high so that risk of inventory loss is reduced and rate of return on assets kept competitively high.
What is Inventory? • Items that can be worked on to add value • Supplies typically consumed during operations • Raw materials and purchased parts • Partially completed goods, work-in-process • Finished goods inventories (manufacturing firms) or merchandise (retail stores) • Replacement parts, tools and supplies
What is an Inventory System? • Policies, procedures and controls for monitoring inventory levels and determines • What levels should be maintained. • When stock should be replenished. • How large orders should be.
Inventory Management Objectives • Maximise inventory turnover • Minimise damage and waste while in inventory • Minimise handling and storage • Minimise out of stock situations (stockouts) • Minimise the after “best before date” cases • Minimise engineering/design/customer changes • Minimise time from request to shipping • Minimise ordering costs from producer to stock • Minimise ‘interest’ costs of holding materials
Functions of Inventory • Smooth seasonal production requirements • Protect against stockouts • Hedge against price increases • To provide a stock of goods that will provide a “selection” for customers • To take advantage of quantity discounts • Flexibility in scheduling • Supply (lead-time) variability • Independence of operations • Variation in demand • Decouple production & distribution • permits constant production quantities
Inventory Terms • Lead time: time interval between ordering and receiving the order • Holding (carrying) costs: cost to carry an item in inventory for a length of time, usually a year • Ordering costs: costs of ordering and receiving inventory • Shortage costs: costs when demand exceeds supply • Independent demand - demand for item is independent of demand for any other item • Dependent demand - demand for item is dependent upon the demand for some other item
10 Ways to Reduce Inventory • Classify inventory into ABC categories • Reduce lead time • Reduce order quantity • Improve forecasting • Eliminate obsolete stock • Centralize inventory • Reduce number of SKUs • Reduce variation –match supply and demand • Vendor managed inventory (VMI) • Align performance metrics
Inventory . Process stage Number & Value Demand Type Other Raw Material WIP Finished Goods Maintenance Repair Overhaul A Items B Items C Items Independent Dependent Inventory Classification
Demand Types Independent Demand (not related to other items or final end-product) Dependent Demand (derived from component parts, sub-assemblies, raw materials, etc.) E(1)
Dependent demand - Work in progress - Components and raw materials Independent demand - finished goods - spare parts Demand/usage Demand/usage Time Time Independent / Dependent Demand
Pull Respond quickly Independent Demand Reactive Customer Demand Push Orderly Dependent Demand Proactive Inventory Replenishment Pull Vs. Push for Managing Inventory
Service Level / Inventory measures • Provide desired customer service level: • Percentage of orders shipped on schedule • Percentage of line items shipped on schedule • Percentage of dollar volume shipped on schedule • Idle time due to material and component shortages • Warehouse Productivity Measures: • Productivity ratio = Units handled per day divided by labor hours per day • Throughput = amount t of material moved through the system in a given time period • Minimize inventory related investments: • Inventory turnover • Weeks / days of supply
Inventory Turnover Inventory Turnover Product 1 Product 2 Cost of merchandise sold $15,620,127,000 $ 737,188,000 Inventories: Beginning of year $1,115,529,000 $478,467,000 End of year 1,067,837,000 571,669,000 Total $2,183,366,000 $1,050,136,000 Average $1,091,683,000 $525,068,000 Inventory turnover 14.3 times 1.4 times Measures the relationship between the volume of goods sold and the amount of inventory carried during the period.
Average selling period 25 days 283 days Inventory Management Efficiency Number of Days’ Sales in Inventory Product 1 Product 2 Average daily cost of merchandise sold: $15,620,127,000/365 $42,794,868 $737,188,000/365 $2,019,693 Ending inventory $1,067,837,000 $571,669,000 Average Selling Period = Ending Inventory / Average cost of merchandise sold
Inv. Comp. Inventory Days Rationale Cycle 20,000 72 Cycle time range of $40,000 In Transit 5,000 18 Transit delay Obsolescence/ 10,000 36 Obsolete and Damage damaged goods Speculative 5,000 18 Forward buy for discount Safety stock 10,000 36 To meet service requests. “Peeling the Inventory Onion” # of working days / year = 278
XYZ has annual cost of goods sold of $10,000,000. The average inventory value at any point in time is $384,615. Calculate inventory turnover and weeks/days of supply. (days 260) Inventory Measures Example • Inventory Turnover: 10,000,000= 26 Inv turns 384,615 • Weeks Supply: 384,615 = 2 weeks 10,000,000/52 • Days of Supply 384,615 = 10 days 10,000,000/260
Warehouse Productivity Metrics • Pounds or units per day • Employees per units / pound moved • Units / Pounds unloaded per hour • Units / Pounds picked per hour • Units / Pounds loaded per hour • Percentage of orders correctly filled • Productivity ratio = Units handled/day divided by labor hours/day • Throughput = amt of material moved through the system in a given time period
Inventory Models answers… Two main Inventory Questions: • How much to buy? • When is it time to buy? Also: • Which products to buy? • From whom?
Inventory Models • Fixed Order Quantity Models • Economic order quantity • Production order quantity • Quantity discount • Probabilistic Models • Fixed Order Period Models • Minimum Quantity • Min / Max Models • Safety Stock Help answer the inventory planning questions!
Inventory Models (Contd.) • Economic Order Quantity Model • Widely used, some math and is a fixed order model • Fixed Order Quantity Model • Set minimum level • Straight forward, inexpensive • Used ONLY • when there is stable customer demand • Order Point / Periodic Review Model • Orders submitted at regular intervals • Used ONLY when sales, lead times and product cost are stable
FOQ Models for Determining Order Quantity Fixed Order Quantity Models • Economic Order Quantity (EOQ or Q System) • An optimizing method used for determining order quantity and reorder points • Part of continuous review system which tracks on-hand inventory each time a withdrawal is made • Economic Production Quantity (EPQ) • A model that allows for incremental product delivery • Quantity Discount Model • Modifies the EOQ process to consider cases where quantity discounts are available
FOQ Vs. FTP System (Contd.) • Fixed Order Quantity Model • Event triggered (Example: running out of stock) • Fixed Time Period Model • Time triggered (Example: monthly sales call by sales representative)
Average Inventory Elements influencing Average Inventory • Average = OQ/2 + SS + IT • Where: • Average = average inventory level • OQ = average replenishment order quantity • SS = average safety stock level • IT = average in-transit inventory
Re-Order Point and Safety Stock When to Order • ROP = LT * DD + SS • Where: • ROP = reorder point • LT = replenishment lead time • DD = average daily demand • SS = safety stock
Fixed-Order-Quantity Model Total annual cost =Annual purchase cost + Annual ordering cost + Annual holding cost TC = Total Annual CostD = Annual demand in unitsC = Cost per unitQ = Quantity to be order (the optimum is termed the economic order quantity—EOQ)S = Setup or ordering costH = Annual holding cost per unit
Fixed-Order-Quantity Model (Contd) • Economic Order Quantity • The optimal quantity to order taking into consideration both the cost to carry inventory and the cost to order the item. • Minimizes total inventory cost D = Annual demand in unitsS = Setup or ordering costH = Annual holding cost per unit
Fixed-Order-Quantity Model (Contd) • Reorder Point • The point in time by which stock must be ordered to replenish inventory before a stockout occurs.
Fixed-Order-Quantity Model (Contd) • Fixed Order Quantity Model with Usage • Considers a supplier that will provide an order quantity over a period of time rather than all at once. d = the constant demand rate for the item in production p = production rate of the process (p - d) = inventory that accumulates each time period (Q/p) = number of time periods required to fill the order
Fixed-Order-Quantity Model (Contd) • Fixed Order Quantity Model with Usage (cont’d)
Inventory Controls • Level of customer service • Costs of ordering inventories • Cost of carrying inventories • Good personnel selection, training, and discipline • Tight control of incoming shipments • Effective control of all goods leaving the facility
Importance of Inventory Controls • Inventory is a significant asset and for many companies the largest asset. • Inventory is central to the main activity of merchandising and manufacturing companies. • Mistakes in determining inventory cost can cause critical errors in financial statements. • Inventory must be protected from external risks ( such as fire and theft) and internal fraud by employees.
Inventory Accuracy • Inaccurate inventory records can cause: • Lost sales • Disrupted operations • Poor customer service • Lower productivity • Planning errors and expediting • Two methods are available for checking record accuracy • Periodic counting - physical inventory • Cycle counting - daily counting of pre-specified items provides the following advantages: • Timely detection and correction of inaccurate records • Elimination of lost production time due to unexpected stock outs • Structured approach using employees trained in cycle counting
LIABILITIES Merchandise Inventory STOCK-HOLDERS’ EQUITY ASSETS Net Income Cost of Merchandise Sold COSTS & EXPENSES REVENUES Inventory Errors - Financial impact • If merchandise inventory is overstated • Cost of merchandise sold is . . understated • Gross profit and net income are . . overstated • Total stockholders’ equity is . . overstated
Inventory Costs What costs do we experience because we carry inventory?