Part 3 : Acquisition and Production Support.
Ch.7 Inventory Management.
Edited by Dr. Seung Hyun Lee (Ph.D., CPL)
IEMS Research Center,
E-mail : lkangsan@iems.co.kr
Inventory Management.
[Other Resource]
Definition of Inventory.
․ Those stocks or items used to support production, supporting activities, and
customer service. Demand for inventory may be dependent or independent.
Inventory functions are hedge, cycle, anticipation, fluctuation, transportation, and
service parts.
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Inventory Management.
[Other Resource]
General in Inventory Management..
Category
Policies
․ ABC Category (percent by category).
․ Accounting-related (raw material and components, work in process and
Inventory
Policies.
finished goods ; various classification)
․ Turns-related (operating, business, and financial)
․ Inventory-related (operating, excess, surplus, inactive, obsolete).
․ Target-related (days supply, investment, turns, customer service level,
inventory accuracy level.)
․ Order-related (order quantity constraints and modifiers)
Inventory
․ Forecasting-related (alpha and beta factors)
Planning.
․ Safety-stock-related (safety stock customer service %, alpha factor, number
of standard deviations "=" 100% safety stock customer service %)
Inventory
Control
․ Cycle-counting-related (accuracy targets, acceptable deviations)
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Demand Characteristics.
Independent Demand.
․ The demand for an item that is unrelated to the demand for other items.
․ Examples.
1. Demand for finished goods.
2. Parts required for destructive testing.
3. Service parts requirements.
Dependent Demand.
․ Demand that is directly related to or derived from the bill of material structure for
other items or end products. Such demands are therefore calculated and need not
and should not be forecast.
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Inventory Policies.
[Other Resource]
Functions of Inventory.
Lot size stock The cycle stock is one of the most active components that depletes
gradually as customer orders are received and is replenished cyclically when
supplier orders are received.
Safety stock Fluctuation stock is a cushion of protection against uncertainty in the
demand or in the replenishment lead time.
Anticipation stock. Additional inventory above basic pipeline stock to cover projected
trends of increasing sales, planned sales promotion programs, seasonal fluctuations,
plant shutdowns, and vacations.
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Inventory Policies.
[Other Resource]
Functions of Inventory.
Hedge stock. A form of inventory buildup to buffer against some event that may not
happen. Hedge inventory planning involves speculation related to potential labor
strikes, price increases, unsettled governments, and events that could severely
impair a company's strategic initiatives. Risk and consequences are unusually high,
and top management approval is often required.
Transportation stock. (Pipeline stock, In transit inventory) Inventory that is in transit
between locations.
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Inventory Policies.
[Other Resource]
Types of Inventory.
Raw Materials. Raw materials are input goods intended for combination and/or
conversion through the manufacturing process into semi-finished or finished goods.
In-process Goods or Work-In-Process(WIP) These are goods in the process of being
manufactured and are only partially completed.
Finished Goods. These represents the completed conversion of raw materials and
components the final product.
Maintenance, Repair, and Operating Supplies (MRO). These inventories include
parts, supplies, and materials used in or consumed by routine maintenance and
repair of operating equipment.
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Inventory Policies.
[Other Resource]
Inventory Turnover Ratio.
․ Inventory turnover ratios represent how effectively inventories are being used.
Inventory Turnover ratio =
Cost of Goods Sold
Average Inventory
Inventory Turns Deviation from Target =
(Actual Turns - Target Turns)
Target Turns
× 100
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Inventory Policies.
[Other Resource]
ABC Classification.
․ ABC analysis is a very useful and relatively simple method for classifying and
analyzing inventory based on annual usage value (annual demand × unit cost). It
is based on Pareto's low which is sometime referred to as the 90/10 rule, the
80/20 rule.
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Inventory Policies.
[Other Resource]
Inventory Cost : Inventory Carrying Cost.
․ The cost of holding inventory, usually defined as a percentage of the dollar value
of inventory per unit of time (generally one year). Carrying cost depends mainly on
the cost of capital invested as well as such cost of maintaining inventory as taxes
and insurance, obsolescence, spoilage, and space occupied.
․ The cost of carrying inventory vary from 10% to 35% annually, depending on type
of industry. Carrying cost is ultimately a policy variable reflecting the opportunity
cost of alternative uses for funds invested in inventory.
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Inventory Policies.
[Other Resource]
Inventory Cost : Inventory Carrying Cost.
Opportunity costs. Typically the largest portion of the carrying costs. The cost of
capital represents the rate of return that the company could earn from its best
investment opportunities.
Storage facility costs. Storage must accomodate the entire order when it first arrives,
not just the average Inventory level. Other operating costs include heat, power, and
other utilities.
Insurance and taxes. Business pay taxes on inventory. Although insurance premiums
may be relatively minor, they are based on inventory level, which is a direct result
of ordering and stocking policies.
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Inventory Policies.
[Other Resource]
Inventory Cost : Inventory Carrying Cost.
Counting, transporting, and handling costs. Activities, such as cycle counting and
material handling, may be necessary to ensure that records accurately reflect
physical inventories.
Risk of obsolescence due to engineering changes or spoilage. Spoilage, through
deterioration, loss, engineering change, or misuse, results in financial losses.
Risk of loss due to pilferage. Loss due to theft will vary greatly depending on the
nature of the products being stored and the degree of security that is enforced.
Hand tools, office supplies, and other items suitable for home use are frequently
pilfered.
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Inventory Policies.
[Other Resource]
Inventory Cost : Ordering Cost.
․ The cost of placing orders differ between orders placed by purchasing to outside
suppliers and orders placed in a factory for production of the needed product. This
cost parameter is usually expressed as the cost to place a single part in absolute
dollars.
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Inventory Policies.
[Other Resource]
Inventory Cost : Ordering Cost.
Production order costs.
․ Production control costs : Issuing and closing orders, scheduling, loading,
dispatching, and expediting.
․ Setup and teardown costs : Cost such as scrap costs, calibration costs, down time
costs, and lost sales associated with preparing the resource for the next product.
․ Lost capacity cost : The time taken to set up is lost, particularly important and
costly with bottleneck work centers.
Purchase order cost.
․ Order preparation, follow-up, expediting, receiving, authorizing payment, and the
accounting cost of receiving and paying the invoice.
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Inventory Policies.
[Other Resource]
Order Quantity and Inventory Cost.
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Inventory Planning.
[Other Resource]
SKU and Inventory Database Design.
․ SKU (Stock Keeping Unit) : An individual item in a specific inventory location.
․ Inventory Database Design.
- Item identification.
- Item description.
- Stock location.
- On-hand balances at each stock location.
- On-order information by due date.
- Reorder and safety stock information.
- Financial information.
- Usage.
- Classification information.
- Sourcing.
- Leadtime.
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Inventory Planning.
[Other Resource]
Storage Location Policies.
․ Fixed(preassigned) locations.
- Stock items are always in the same place.
- Weighted Items can be well managed.
- The location strategy is easy to understand.
- Bin locations can be assigned to facilitate the picking of materials.
- The problem of inadequate capacity
- Some bin space may be underused when stocks of a given item are low.
․ Random(floating) locations.
- Variations in stock quantities can be handled by storing material in more than a bin.
- Lot, or batch, identity can be maintained much more easily.
- Picking orders can be scheduled on a first in, first out basis.
- Bin location can be assigned to facilitate the picking of materials.
- Changes to the variety of items being stocked can be readily accommodated.
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Inventory Planning.
[Other Resource]
Storage Location Policies.
․ Zone locations.
- Zones could be assigned to hold certain kinds of items, depending on physical
characteristics or frequency of use.
- Then randomly located within zones.
․ Automated storage and retrieval systems (ASRS).
- Goods are put away and subsequently retrieved using robotic arms or other
kinds of automatic devices.
- Usually a human operator keys in an item number and a desired quantity.
- Computer directs the robotic mechanism for storing or retrieval of the item.
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Inventory Planning.
[Other Resource]
Other Inventory Records.
On-hand inventory balance. It represent quantities of goods that are physically
present in finished goods or component storerooms or warehouses.
Allocation. The allocation may be an assignment to specific order not yet released to
production or customer order.
Open-order or on-order. An order previously released to production or a vendor.
Lead Time. Lead time is generally defined as the elapsed time, expressed in days,
weeks, or otherwise, from the recognition of need for an item until it is ready for
use.
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Order Planning.
[Other Resource]
Economic Order Quantity.
․ A type of fixed order-quantity model that determine the amount of an item to be
purchased or manufactured at on time. The intent is to minimize the combined
costs of acquiring(ordering) and carrying inventory.
․ The EOQ formula.
EOQ
=
2A×S
C×i
․ Total cost = Annual carrying cost + Annual ordering cost.
TC =
Q
×C × i +
2
A
×S
Q
where
.
A = Annual Usage.
C = Cost of item.
S = Cost per order.
i = Annual cost to carry.
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Order Planning.
[Other Resource]
Economic Production Quantity.
․ This situation occurs when a company is both producer and user of an item or
when it spreads its deliveries over time.
․ The EPQ formula.
․ Total cost. TC
=
EPQ
2A×S
C×i
=
Q
d
×C × i
× 12
p
(
)
where
×
+
p
p-d
A
×S
Q
p = Production Rate.
d = Demand Rate.
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Order Planning.
[Other Resource]
Economic Production Quantity.
․ Example. The Great Southern Motor Co. manufactures electronic motors. One
particular motor has a known and constant demand rate of 2,000 units per year.
The fixed cost of the setup for each production run is $100, and the inventory
carrying cost is $2 per unit per year. The production rate is 8,000 unit per year.
Calculate the optimal economic lot size.
․ Solution.
EPQ =
2A×S
p
×
=
C×i
p-d
2(2,000)×(100)
8,000
×
2
8,000-2,000
=
516
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Order Planning.
[Other Resource]
Quantity Discount.
․ Quantity discounts for purchased items may be available, either directly from the
seller or through reduced transportation expenses. This complicates the order
quantity decision significantly if the normal EOQ calculation does not meet or
exceed the price-break quantity. The decision to take or pass put up the discount
offer is based on the minimum total cost.
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Order Planning.
[Other Resource]
Periodic Review System.
․ Time-based systems are designed so that each inventoried item is reviewed and
reorders are placed after a predetermined time interval. Orders are placed for each
item equal to the difference between current inventory level and a predetermined
maximum.
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Order Planning.
[Other Resource]
Periodic Review/Reorder Point Combination System.
․ The reorder triggers that when the quantity on hand drops below the reorder point
prior to the review period, an order is placed immediately. Otherwise, orders are
placed up to the target level at the time of the review as in the normal periodic
review method. This method would only be feasible where perpetual inventory data
are maintained.
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Order Planning.
[Other Resource]
Optional Replenishment System.
․ The optional replenishment system is a periodic review system where only those
items with an on-hand balance below a predetermined level (the reorder point) are
ordered. It is also sometimes referred to as a Min-Max system or as an (s, S)
system (where s represents the order point, and S represents the target inventory
level).
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Order Planning.
[Other Resource]
Two-bin System.
․ A continuous review system is the two-bin system, which sets aside two
containers, or bins, to hold to total inventory of an item. Items are withdrawn from
the first bin until it is empty, at which point it is time to reorder the quantity that
will again fill the bin. The second bin contains enough stock to satisfy demand
until the order replenishment.
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Safety Stock.
[Other Resource]
Definition of Safety Stock.
․ A quantity of stock planned to be in inventory to protect against fluctuations in
demand or supply. Two main factors for considering safety stock.
1. Customer service level.
2. Demand variability (uncertainty).
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Safety Stock.
[Other Resource]
Calculation of Safety Stock.
․ Safety Stock = Safety Factor × Standard Deviation.
(Lead time = Forecast interval)
․ Safety Stock = Safety Factor × Standard Deviation ×
(
Lead Time Interval
Forecast Inverval
)
β
(Lead time ≠ Forecast interval)
where β ranges between 0 and 1,
typically in the range of 0.5 - 0.7
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Inventory Control.
[Other Resource]
Periodic Inventory Audit.
․ Inefficient use of many inexperienced people in a short, hectic period once a year.
․ No correction of cause of errors.
․ Many mistake in item identification.
․ Plant and warehouse shutdown for inventory audit.
․ One-time improvement of record accuracy.
Cycle Counting.
․ Efficient use of a few experienced people continuously throughout the year.
․ Timely detection and correction of causes of errors.
․ Fewer mistakes in item identification.
․ Minimal loss of production time.
․ Systematic improvement of record accuracy.
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■ Performance Check.
1. Inventory that is on hand but reserved for some specific use is
A. Reserve stock.
B. Anticipated stock.
C. Allocated stock.
D. Buffer stock.
2. Which of the following would MOST likely be subject to dependent demand ?
A. Plastic molding compound.
B. Little red wagons.
C. Janitorial supplies.
D. Electronic spare parts.
3. You determine inventory turnover by which of the following formulas ?
A. Average inventory divided by total assets.
B. Cost of goods sold divided by average inventory.
C. Average inventory divided by stockholder's equity.
D. Sales divided by cost of sales.
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■ Performance Check.
4. Which of the following is NOT a benefit of a random location system ?
A. Less space required.
B. Maintain batch identity.
C. Most-used items always nearby.
D. Overflow stock handled routinely.
5. Which of the following is NOT a reason that inventories becomes obsolete ?
A. Engineering changes.
B. Spoilage.
C. Age.
D. Pilferage.
6. Which of the following inventory types MOST likely requires safety stock ?
A. Finished goods.
B. Work in process.
C. Raw materials.
D. Semifinished assemblies.
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■ Performance Check.
7. ABC classification of inventory is a means to categorize materials in terms of which
of the following ?
A. Function.
B. Type.
C. Storage requirements.
D. Annual usage value.
8. Which of the following is a primary objective of cycle counting ?
A. Reduce the number of storeroom personnel.
B. Identify and fix the cause of errors.
C. Make the data processing task easier.
D. Eliminate the annual physical inventory.
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■ Performance Check.
9. Which of the following is a valid reason to order a quantity other than that suggested
by the EOQ formula, given that all other conditions for use of the formula are met ?
Ⅰ. Inadequate shelf space.
Ⅱ. Item subject to spoilage.
Ⅲ. Cost of the item.
A. Ⅱ
B. Ⅰ, Ⅱ
C. Ⅱ, Ⅲ
D. Ⅰ, Ⅱ, Ⅲ
10. The inventory carry-cost rate include which of the following elements ?
Ⅰ. Obsolescence.
Ⅱ. Taxes and insurance.
Ⅲ. Cost of capital.
Ⅳ. Quality inspection.
A) Ⅰ, Ⅱ
B) Ⅲ, Ⅳ
C) Ⅰ, Ⅱ, Ⅲ
D) Ⅰ, Ⅱ, Ⅲ, Ⅳ
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■ Performance Check.
Solutions
1
2
3
4
5
6
7
8
9
10
C
A
B
C
D
A
D
B
B
C
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