meaning inventory-a physical resource that a firm holds in stock with the intent of selling it or...
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MEANING Inventory-A physical resource that a firm holds in
stock with the intent of selling it or transforming it into a more valuable state.
Inventory System- A set of policies and controls that monitors levels of inventory and determines what levels should be maintained, when stock should be replenished, and how large orders should be. It involves inventory planning and decision making with regard to the quantity and time of purchase, fixation of stock levels, maintenance of stores record and continuous stock taking.
THE INVENTORY DECISION In an Inventory control situation, there
are three basic questions to be answered. They are:-
1. How much to order?
2. When should the order be placed?
3. How much safety stock should be kept?
TYPES OF INVENTORIES
Types of Inventories
Direct Inventories
Raw Material
Work in Progress
Finished Goods
Indirect Inventories
Transit Inventories
Buffer Inventories
Lot Size Inventories
Decoupling Inventories
Seasonal Inventories
Fluctuation Inventories
Factors Affecting Inventory Control Policy
A. Characteristics of the manufacturing system:
1. Degree of Specialization and differentiation of the products at various stages.
2. Process capability and flexibility.
3. Production capacity and storage facility.
4. Quality requirements.
5. Nature of production system.
B. Amount of protection against storages:
1. Changes in size and frequency of orders.
2. Unpredictability of sales.
3. Physical and economic structure of distribution pattern.
4. Costs associated with failure to meet demand.
5. Accuracy, frequency and detail of demand forecasts.
6. Protection against breakdown or other interruptions in production.
Objectives of Inventory Control
1. A hedge against inflation.
2. Protection against fluctuation in demand.
3. Protection against fluctuation in supply.
4. To avoid stock outs and shortages.
5. Quantity discounts.
6. Optimum use of men, machines & materials.
7. Maintaining different level of stock.
8. Control of stock volume.
9. The decoupling function.
Scope of Inventory Control1. Formulation of policy.
2. Organization structure.
3. Determination of economic order quantity.
4. Determination of safety stock.
5. Determination of lead time.
6. Minimum material handling & storage cost.
7. Effectiveness towards running of store.
TOOLS & TECHNIQUES OF INVENTORY MANAGEMENT
1. DETERMINATION OF STOCK LEVELS
2.DETERMINATION OF SAFETY STOCKS
3. INVENTORY CONTROL SYSTEMS
4. ECONOMIC ORDER QUANTITY
5. PRODUCTION QUANTITY MODEL
6. QUANTITY DISCOUNTS
7. ABC ANALYSIS
8. JIT CONTROL SYSTEM
9. VED ANALYSIS
10. FNSD ANALYSIS
11. PREPETUAL INVENTORY SYSTEM
12. PRICE BREAKS APPROACH
13. OTHER MODELS OF INVENTORY CONTROL
1. Determination Of Stock Levels
Reorder Point Level of inventory at which a new order is placed.
R = dL
where
d = demand rate per periodL = lead time
Re-ordering level
It is the level of stock quantity between minimum and maximum level and material order was sent for getting fresh stock.
Formula : maximum usage of stock X maximum delivery period
Minimum level
It is the minimum balance, which must be maintained in hand at all times, so that there is no stoppage of production due to non availability of inventory.
Remember You must need re-order level for getting it.
Formula : Re-order level - ( Normal usage X average period )
Maximum level
It shows maximum quantity which should be in the stock, if we buy more, it means we are wasting money. Formula : re-order level X re-order quantity - ( minimum usage X minimum period )
Average Stock Level
This is the average of minimum and maximum level and it can be calculated by adding minimum level and maximum level and divided by 2.
formula : minimum level + maximum level / 2
Danger level
It is the level at which normal issues of the raw material inventory are stopped and emergency issues are only made.
formula :
average consumption X lead time for emergency purchases
2. Determination of Safety Stocks
Safety stockbuffer added to on hand inventory during lead
timeStockout
an inventory shortageService level
probability that the inventory available during lead time will meet demand
Reorder Point With Variable Demand
R = dL + zd L
where
d = average daily demandL = lead timed = the standard deviation of daily demand
z = number of standard deviationscorresponding to the service levelprobability
zd L = safety stock
Reorder Point for a Service Level
Probability of meeting demand during lead time = service level
Probability of a stockout
R
Safety stock
dLDemand
zd L
Reorder Point for Variable Demand
The carpet store wants a reorder point with a 95% service level and a 5% stockout probability
d = 30 yards per dayL = 10 daysd = 5 yards per day
For a 95% service level, z = 1.65
R = dL + z d L
= 30(10) + (1.65)(5)( 10)
= 326.1 yards
Safety stock = z d L
= (1.65)(5)( 10)
= 26.1 yards
3. Inventory Control Systems
Continuous system (fixed-order-quantity or Q Systems)
constant amount ordered when inventory declines to predetermined level
Periodic system (fixed-time-period or P Systems)
order placed for variable amount after fixed passage of time
Fixed Order Quantity System or Q Systems – In reorder level system, a replenishment order fixed size (Q) is placed when the stock level falls to the fixed reorder level (R). Thus a fixed quantity is ordered at various interval of time.
Periodic Review System or P System – In periodic review system, the inventory levels are reviewed at fixed points of time, when the quantity to be ordered is decided. By this method variable quantities are ordered at fixed time intervals
4. ECONOMIC ORDER QUANTITY (EOQ)
Economic order quantity is the size of the lot to be purchased which is economically viable. This the quantity of materials which can be purchased at minimum costs.
ASSUMPTIONS Demand rate D is constant, recurring, and known Amount in inventory is known at all times Ordering (setup) cost S per order is fixed Lead time L is constant and known. Unit cost C is constant (no quantity discounts) Annual carrying cost is i time the average RUPEE value of
the inventory No stock outs allowed. Material is ordered or produced in a lot or batch and the lot is
received all at once
EOQ Inventory Order CycleDemand rate
0 TimeLead time
Lead time
Order Placed
Order Placed
Order Received
Order Received
Inve
nto
ry
Lev
el
Reorder point, R
Order qty, Q
As Q increases, average inventory level increases, but number of orders placed decreases
ave = Q/2
EOQ Cost ModelCo - cost of placing order D - annual demand
Cc - annual per-unit carrying cost Q - order quantity
Annual ordering cost =CoD
Q
Annual carrying cost =CcQ
2
Total cost = +CoD
Q
CcQ
2
EOQ Cost Model
TC = +CoD
Q
CcQ
2
= +CoD
Q2
Cc
2
TC
Q
0 = +C0D
Q2
Cc
2
Qopt =2CoD
Cc
Deriving Qopt Proving equality of costs at optimal point
=CoD
Q
CcQ
2
Q2 =2CoD
Cc
Qopt =2CoD
Cc
EOQ Cost Model (cont.)
Order Quantity, Q
Annual cost ($) Total Cost
Carrying Cost =CcQ
2
Slope = 0
Minimum total cost
Optimal order Qopt
Ordering Cost =CoD
Q
EOQ Example
Cc = $0.75 per yard Co = $150 D = 10,000 yards
Qopt =2CoD
Cc
Qopt =2(150)(10,000)
(0.75)
Qopt = 2,000 yards
TCmin = +CoD
Q
CcQ
2
TCmin = +(150)(10,000)
2,000
(0.75)(2,000)
2
TCmin = $750 + $750 = $1,500
Orders per year = D/Qopt
= 10,000/2,000
= 5 orders/year
Order cycle time = 311 days/(D/Qopt)
= 311/5
= 62.2 store days
5. Production Quantity Model An inventory system in which an order is
received gradually, as inventory is simultaneously being depleted
AKA non-instantaneous receipt modelassumption that Q is received all at once is
relaxed p - daily rate at which an order is received
over time, a.k.a. production rate d - daily rate at which inventory is
demanded
Production Quantity Model (cont.)
Q(1-d/p)
Inventorylevel
(1-d/p)Q2
Time0
Orderreceipt period
Beginorder
receipt
Endorder
receipt
Maximuminventory level
Averageinventory level
Production Quantity Model (cont.)
p = production rate d = demand rate
Maximum inventory level = Q - d
= Q 1 -
Qp
dp
Average inventory level = 1 -Q2
dp
TC = + 1 -dp
CoD
Q
CcQ
2
Qopt =2CoD
Cc 1 - dp
Production Quantity Model: Example
Cc = $0.75 per yard Co = $150 D = 10,000 yards
d = 10,000/311 = 32.2 yards per day p = 150 yards per day
Qopt = = = 2,256.8 yards
2CoD
Cc 1 - dp
2(150)(10,000)
0.75 1 - 32.2150
TC = + 1 - = $1,329dp
CoD
Q
CcQ
2
Production run = = = 15.05 days per orderQp
2,256.8150
Production Quantity Model: Example (cont.)
Number of production runs = = = 4.43 runs/yearDQ
10,0002,256.8
Maximum inventory level = Q 1 - = 2,256.8 1 -
= 1,772 yards
dp
32.2150
6. QUANTITY DISCOUNTS
Price per unit decreases as order quantity increases
TC = + + PDCoD
Q
CcQ
2
where
P = per unit price of the itemD = annual demand
Quantity Discount Model (cont.)
Qopt
Carrying cost
Ordering cost
Inve
ntor
y co
st (
$)
Q(d1 ) = 100 Q(d2 ) = 200
TC (d2 = $6 )
TC (d1 = $8 )
TC = ($10 ) ORDER SIZE PRICE0 - 99 $10100 – 199 8 (d1)200+ 6 (d2)
Quantity Discount: Example
QUANTITY PRICE
1 - 49 $1,400
50 - 89 1,100
90+ 900
Co = $2,500
Cc = $190 per computer
D = 200
Qopt = = = 72.5 PCs2CoD
Cc
2(2500)(200)190
TC = + + PD = $233,784 CoD
Qopt
CcQopt
2
For Q = 72.5
TC = + + PD = $194,105CoD
Q
CcQ
2
For Q = 90
7. ABC ANALYSIS The materials are divided in to a number of categories
for adopting a selective approach for material control.
Classification of items as a, b, or c
Purpose: set priorities for management attention. ‘A’ items: 20% of the items contributes, 80% value ‘B’ items: 30 % of Items contributes , 15% Value ‘C’ items: 50 % of Items contributes , 5% value Three classes is arbitrary; could be any number. Percents are approximate.
ABC ANALYSIS EXAMPLE
10 20 30 40 50 60 70 80 90 100
Percentage of items
Per
cen
tag
e o
f d
oll
ar v
alu
e
100 —
90 —
80 —
70 —
60 —
50 —
40 —
30 —
20 —
10 —
0 —
+Class C
Class A
+Class B
ABC Classification
Class A5 – 15 % of units70 – 80 % of value
Class B30 % of units15 % of value
Class C50 – 60 % of units 5 – 10 % of value
8. JIT CONTROL SYSTEM
Just in Time purchasing is the purchase of material in such a way that delivery of purchased items is assured before their use or demand.
9. VED Analysis
VED – Vital, Essential, Desirable – analysis is used primarily for control of spare parts. The spare, parts can be divided into three categories – vital, essential or desirable – keeping in view the critically to production.
10. FNSD Analysis
FNSD analysis divides the items into four categories in the descending order of their usage rate as follows:
‘F’ means Fast moving items ‘N’ means normal moving items ‘S’ means slow moving items ‘D’ means dead stock.
11. Perpetual Inventory System Perpetual Inventory is a system of records maintained
by the controlling department, which reflects the physical movement of stocks and their current balance. It aims at devising the system of records by which the receipts and issues of stores may be recorded immediately at the time of each transaction and the balance may be brought out so as to show the up-to-date position.
The records used for perpetual inventory are:
(i) Bin Cards;
(ii) Store Ledger Accounts or Stores Record cards;
(iii) The forms and documents used for receipt, issue and transfer of materials.