UNIT - III

OPERATIONS MANAGEMENT

INVENTORY MANAGEMENT

• WHAT IS INVENTORY ?

• WHAT ARE THE TYPES OF MANUFACTURING INVENTORY ?

• WHAT IS THE PURPOSE OF INVENTORY ANALYSIS ?

UNIT – III : INVENTORY MANAGEMENT

• Inventory – Is the stock of any item or raw materials used in an organization. An inventory system is the set of policies and controls that monitor levels of inventory and determine what levels should be maintained, when stock should be replenished.

• Types of manufacturing inventory - Manufacturing inventory generally refers to items that contribute to a firm’s product output. Manufacturing inventory is classified into Raw Materials, Component parts, Work-in-process, and Finished Products.

• The basic purpose of inventory analysis in manufacturing is to satisfy : (1) when items should be ordered and (2) how large the order should be

UNIT – III : INVENTORY MANAGEMENT

Purpose or objective of inventory1. To ensure uninterrupted production2. To meet variations in product demand3. To provide a safeguard in case of late delivery of raw

material by supplier4. To take advantage of economic purchase order size5. To reduce undesired accumulation of inventory thereby

to reduce blocking of capital

• TYPES OF INVENTORY : 1. CYCLE INVENTORY (Variation with Lot size)

2. ANTICIPATION INVENTORY

3. PIPELINE INVENTORY

4. SPECULATIVE INVENTORY

5. SURPLUS INVENTORY or SAFETY STOCK

UNIT III : INVENTORY MANAGEMENT

Types of inventory• Cycle inventory - The portion of total inventory that

varies directly with lot size. Determining how frequently to order and what quantity to be ordered is lot sizing.

• Safety stock - This is surplus inventory that protects against uncertainty in demand

• Anticipation inventory – Inventory used to absorb uneven rates of demand or supply

• Pipeline inventory - Inventory moving from point to point in the materials flow system. Materials move from supplier to plant and from one operation to other operation.

• Speculative inventory - Inventory that protects against some future event, e.g. labor strike

UNIT – III : INVENTORY MANAGEMENTTwo common measures to evaluate supply chain efficiency are :• Inventory turnover and Weeks of supply • Inventory turnover = • Cost of goods sold is the annual cost incurred by company to

produce the goods or services provided to customer; it is sometimes reffered to as cost of revenue. This does not include selling and administrative expenses of the company.

• Average aggregate inventory value is the total value of all items held in inventory for the firm valued at cost. It includes the raw material, work-in-process, finished goods, and distribution inventory considered owned by the company.

• Weeks of supply is a measure of how many weeks’ worth of inventory is available in the system at a particular point of time.

• Weeks of supply = ( ) x 52 weeks

UNIT – III : INVENTORY MANAGEMENT

Q1.Dell computer reported following information in its 2010 annual report(all amounts are expressed in millions) :1.Net revenue (fiscal year 2010) : $18,2432.Cost of revenue (fiscal year 2010) : $14,1373.Cost of production materials(fiscal year 2010) : $64234.Production materials on hand(25Jan.2010):$2345.Work-in-process & finished goods on hand : $39 (25 Jan.2010)6.Production materials – days of supply : 6 days(a)What is the inventory turnover?(b)What is weeks of supply?

UNIT – III : INVENTORY MANAGEMENT

SOLUTION

Inventory turnover = = = 51.78 Turns/year

Weeks of supply = ( ) x 52 weeks = x 52 = 1 week

• INVENTORY COST :- 1. HOLDING COST

2. SETUP COST

3. ORDERING COST

4. SHORTAGE COST

UNIT – III : INVENTORY MANAGEMENT

• INVENTORY COSTS :1.Holding (or carrying) costs - Includes cost of storage facilities, handling, insurance, breakage, depreciation, taxes, and opportunity cost of capital. 2.Set up cost - To make each different product, it is required to obtain necessary materials, arrange specific equipment set up, and to move out the previous stock of materials. The cost involved in completing these exercises is called set up cost.3.Ordering cost - These costs refer to the managerial and clerical costs to prepare and place the purchase order. Ordering costs include preparing bill of materials, floating enquiries, evaluation of vendor’s offers and the costs associated with maintaining the system required to track orders.

UNIT – III : INVENTORY MANAGEMENT

4.Shortage costs - When the stock of an item falls short, an order for that item either waits until the stock is replenished or it is cancelled. There is a trade-off between carrying stock to satisfy demand and the costs resulting from the stock out. This balance is difficult to obtain, because it may not be possible to estimate lost profits, the effects of lost customers, or lateness penalties. The assumed shortage cost is little more than a guess.Establishing the correct quantity to order on vendors involves a search for the minimum total cost resulting from the combined effects of four individual costs : holding costs, setup costs, ordering costs and shortage costs.

UNIT – III : INVENTORY MANAGEMENT

• INVENTORY MODELS 1.Fixed-order Quantity Models (also called Economic Order Quantity or EOQ Model, and Q-Model).2.Fixed Time Period Models (referred to as Periodic system, Periodic Review System, Fixed Order Interval System, and P-Model)

UNIT – III : INVENTORY MANAGEMENT

Difference between Q-Model & P-ModelFeature Q-Model (Fixed order

quantity model)P-Model (Fixed-Time period model)

Order Quantity Same amount ordered each time

Quantity varies each time order is placed

When to place order

When inventory level drops to reorder level

When review period arrives

Record keeping Each time a withdrawal or addition is made

Counted only at review period

Size of inventory Less than fixed-time period model

Larger than fixed-order quantity model

Time to maintain inventory

Higher due to perpetual record keeping

Less

UNIT – III : INVENTORY MANAGEMENT

• FIXED-ORDER QUANTITY MODEL • Fixed-order quantity model attempts to determine the specific

point, R at which an order will be placed, and the size of that order, Q.

• Inventory position is defined as :Inventory position = Inventory on hand + Inventory on order – Backordered quantity • Assumptions for developing Q-Model• Demand for the product is constant and uniform throughout

the period• Lead Time (Time from ordering to receive) is constant• Price per unit of product is constant• Ordering cost or setup costs are constant• Inventory holding cost is based on average inventory

UNIT – III : INVENTORY MANAGEMENT

• All demands for the product will be satisfied (No backorders are allowed).

• Total = Annual + Annual + Annual

Annual cost purchasing cost ordering cost holding cost TC = DC + + H TC = Total annual cost, S=Setup cost/Ordering cost D = Annual demand R=Reorder pointC=Cost/Unit L=Lead TimeQ= Quantity to be H=Annual holding or storage cost ordered, EOQ per unit of average inventory

UNIT – III : INVENTORY MANAGEMENT

• The second step in model development is to find out the optimum order quantity, QOPT at which the total cost is minimal.

• Using calculus, we take the derivative of total cost with respect to Q and set this equal to zero.

TC = DC + S + H = 0 + ( ) + = 0 QOPT = )

TC = (D/QOPT ).S + (QOPT /2).H

Reorder point, R = D.LD = Average daily demand (constant)L = Lead Time in days (constant)

UNIT – III : INVENTORY MANAGEMENT

Q1.Synergy Incorporation requires 1000 Units of product-A per annum. The firm purchases each unit of A for Rs.100 and spends Rs.500 on each order. The inventory carrying cost of item is 25% of the unit price. Determine the EOQ and total annual cost associated with the item A. [I.P.University]Q2.A two wheeler manufacturing company uses large quantities of a component made of steel. Although these are production items, the demand is continuous. The annual demand for the component is 2500 boxes. The company procures the item from a supplier at the rate of Rs.750 per box.The company estimates the cost of carrying inventory to be 18% per unit per annum and the cost of ordering as Rs.1080 per order. The company works for 250 days in a year. How should the company design an inventory control system for this item? What is the overall cost of the plan?

Solution #1. QOPT = )

Given, D = 1000 Units C = Rs.100 / Unit S = Rs. 500 / order H = 25% of Rs.100 = Rs.25 Therefore, QOPT = ) = 200 Units

TC = S + H = x 500 + x 25 = Rs.5000/-

Solution #2. Given : D = 2500 Boxes/year d= No. of working days = 250 Unit cost of item, C = Rs.750 Inventory carrying cost, H = 18% of Rs.750 = Rs.135/unit/year Ordering cost, S = Rs.1080 /orderThe average daily demand = 2500/250 = 10 Boxes Economic order quantity, QOPT = )

= ) = 200 boxes Number of orders to be placed = D/ QOPT = 2500/200=12.5 =13(Say)

Time between orders = QOPT /D = 200/2500 = 0.08 year

= 0.08 x 250 = 20 days Total cost of plan = TC = S + H = (2500/200)x1080 + (200/2)x135 = Rs.27,000/-

#3.Alpha industry estimates that it will sell 12000 units of its product for the forthcoming year. The purchase price per unit is Rs.50. The ordering cost is Rs.100 per order and the inventory carrying cost per unit per year is 20% of purchase price per unit. Find :(a) The Economic order quantity(b) Number of orders per year(c) Time between successive order

Solution :Given :D = 12000 units/year S = Rs.100 per order H = 20% of Rs.50 = Rs.10/Unit/Year C = Rs.50 per Unit (a) Qopt = √[(2DS)/H] = √[(2 x12000 x 100)/10] = 490 unit approx.

(b) No. of orders / year = D /QOPT = 12000/490 = 24.49

(c) Time between successive orders = Qopt /D = 490/12000

= 0.04 year = 0.48 Month

• SELECTIVE CONTROL OF INVENTORY 1. ABC ANALYSIS

• ABC CLASSIFICATION OF INVENTORIES IS BASED ON COST (OR VALUE ) OF THE ITEMS CONSUMED.

• VERY HIGH VALUE ITEMS ARE “A-CLASS” ITEMS WHICH REQUIRES TIGHTER CONTROL

• MEDIUM VALUE ITEMS ARE CATEGORISED AS “B-CLASS” ITEMS

• LOW VALUE ITEMS ARE CATEGORISED AS “C-CLASS” ITEMS

2. XYZ ANALYSIS

• XYZ ANALYSIS IS DONE ON THE BASIS OF UNIT COST OF ITEM

• HIGH UNIT COST ITEMS ARE CONSIDERED AS “X-COST” ITEM

• MEDIUM UNIT COST ITEMS ARE CONSIDERED AS “Y-COST” ITEMS

• LOW UNIT COST ITEMS ARE CONSIDERED AS “Z-COST” ITEMS

3. FSN CLASSIFICATION

• FSN CLASSIFICATION IS DONE ON THE BASIS OF MOVEMENT OF INVENTORY

• FAST-MOVING INVENTORY

• SLOW-MOVING INVENTORY

• NON-MOVING INVENTORY

4.VED CLASSIFICATION • VED CLASSIFICATION IS DONE TO DETERMINE THE

CRITICALITY OF THE ITEM. THIS CLASSIFICATION IS DONE IN CASE OF MAINTENANCE ITEMS

• CLASSIFIED IN FOLLOWING THREE WAYS :-

• VITAL ITEMS

• ESSENTIAL ITEMS

• DESIRABLE