INVENTORY MANAGEMENT,
LEAN AND FINANCE
John Carrico
What is inventory?


Inventory is anything that is purchased and held
(stored) prior to use/need
product on-hand, current asset that has been
acquired by cash (or payables) and is yet to be
consumed
Inventory Distribution Management
3


Physical inventory is the actual counting of supplies and
comparing the amount on hand with the amount on the financial
statement
Inventory can be counted two ways:
 Periodic counting


Done at regular intervals (usually 6 or 12 months)
Cycle counting



Continuously selecting subgroups to count
Typically 10% of stock per month
May be critical or volatile items
Inventory Distribution Management
4

Inventory control should:
 Provide monetary savings
 Improve service levels
 Improve internal operations
 Review supply utilization
 Reduce waste
 Fully utilize MMIS capabilities
Inventory Distribution Management
5

Inventory Valuation
 Last in, First out (LIFO)
 Cost is defined as the newest (most recently received) item is used
to define product cost.
 First in, First out (FIFO)
 Cost is defined as the oldest item in the inventory (conservative,
understates the inventory)
 Average costing inventory

Method where a weighted average cost is computed.
Your valuation methodology may be the source of your never being “right on” at
inventory count time
Types of Inventory
6
Official- On the Hospital financial books as an ASSET.
Perpetual
Always reflects actual on-hand quantitycomputer
Periodic
Periodically updated based on a count
Unofficial- Already expensed.
Consignment Housed in the facility, owned by the
vendor, purchased when used. Is not included in
inventory turn calculations.
Inventory Ground Rules
7

Impact of Consignment on our performance
 Consignment stock is not counted as our inventory and is not
included in turns.
 The more items you consign, the higher your expected level of
performance (turns) of your owned inventory.
 However, while you do not retain ownership of the product, you
are still responsible for the loss or damage-how many of you
have letters of understanding with your vendors?
Managing Inventory
8

Why Manage Inventories?
 Reduce
 Free
Costs-carrying costs
Up Space
 Have
Supplies Available
Managing Inventory
9
Controlling Inventory
Techniques you can use to
monitor and reduce inventories
Inventory Distribution Management
10


Successful Inventory Control is achieving balance between
stock on-hand and organizational need
Basic components to assist inventory management are:
 Order quantity
 Lead time
 Safety stock
“Normal” Departmental Inventory
(% of total hospital supply inventory)
OR
General Stores
15.8%
Drugs/Meds
12.3%
CS/SPD
CCU
Lab
0%
48%
23.8%
9%
6.3%
10%
20%
30%
40%
50%
Note: All other individual departments are less than 5% of total supply inventory
Source: VCS Supply Chain Database
11
Inventory Control Techniques
12
Inventory Turnover Rate
Turnover =
Total $ Issued
Average Inventory Value
(or ending value)
Inventory Control Techniques
13
Higher
Balance Order and Inventory Costs
Order Cost
15 – 18
Turns
Cost
Sweet
Spot
Lower
Less
Order Frequency
Inventory Levels
More
Inventory Management
14 Inventory Turn Calculation Worksheet
$20,000,000 State your annual purchases
$2,500,000 State value of inventory
16% State percent carrying cost of inventory
Turns
Owned
Inventory
Annual Cost for
Holding Inventory
Inventory Reduction One Time Cash Flow
Holding Cost
Savings
Days On Hand
(DOH)
8
$2,500,000
$400,000
$0
$0
33
4
5
6
7
8
9
10
11
12
24
$5,000,000
$4,000,000
$3,333,333
$2,857,143
$2,500,000
$2,222,222
$2,000,000
$1,818,182
$1,666,667
$833,333
$800,000
$640,000
$533,333
$457,143
$400,000
$355,556
$320,000
$290,909
$266,667
$133,333
$0
$0
$0
$0
$0
$277,778
$500,000
$681,818
$833,333
$1,666,667
$0
$0
$0
$0
$0
$44,444
$80,000
$109,091
$133,333
$266,667
65
52
44
37
33
29
26
24
22
11
Yellow Squares indicate where you should key in your hosptial values
Inventory Costs
15

Inventory Carrying Costs-what does it cost you to maintain
your inventory?







Opportunity Costs-Invested Capital-Cost of Money
Cost of Space
Handling Charges-labor expense
Storage Costs
Utilities/Insurance
Data Processing
Shrinkage
• Pilferage/theft
• Obsolescence
• Spoilage
Inventory Control Techniques
16
Setting Levels
 Reorder points
 Reorder quantities
 Min/Max
 Economic Order Quantity (EOQ)
Inventory Distribution Management
17

Supply level calculations
 Maximum/minimum
 Economic order quantity
 The greater the order quantity, larger the inventory.
 The longer the lead time, the greater the inventory.
 The higher the safety stock, the greater the inventory.
Terminology
18

Order Cycle
Period of time elapsed between determining need and receipt of goods.
Usually expressed in days or weeks. Shows how many periods (days or
weeks) of stock are generally on-hand and how often the item is being
ordered.
•Lead Time
Period of time between placing an order and receipt of goods.
Terminology
19
Safety Stock
A level or quantity of inventory on-hand to reduce the
probability of a stock-out between time of order and time of
receipt of stock (lead time). This is a level (usually less than the
reorder point) that theoretically should never be needed or
used. It is “insurance.” It increases the cost of inventory and
that cost is weighed against the cost of a stock-out.

Terminology
20

Economic Order Quantity
Defined as a calculation of the most efficient maximum order quantities
consider factors such as lead times, carrying costs, ordering costs and
available space. A very basic EOQ formula follows:
EOQ = square root of (2(F*S)/(C*P)
F = fixed cost of placing and receiving an order
S = annual usage
C = carrying costs as a percentage of average inventory value
P = purchase price per unit
Inventory Control Techniques
21
Maintain Accuracy
 Control access to your inventory
 Locator system/location checks
 Cycle counting
 First in First Out (FIFO) philosophy
Inventory Distribution Management
22


Fill-Rate- percentage of items successfully supplied to end user
Total Annual Stocking Cost (TASC)

TASC = Annual Ordering Costs (AOC) + Annual Carrying Costs (ACC)

AOC = (D/Q)xS

ACC= (Q/2)xC

D = Average Annual Demand

Q = Order Quantity

S = Fixed Order Cost

C = Carrying Cost per Unit
Inventory Distribution Management
23


Economic Order Quantity (EOQ)

D = Ave. Annual Demand

S = Fixed Order Cost

C = Annual Carrying Cost
Total Material Cost (TMC)

TMC = TASC + D(AC)

TASC = (D/Q)xS + (Q/C)xC

D = Average Annual Demand

AC = Acquisition Cost
Inventory Distribution Management
24


Safety Stock (SS)

Z = Service Factor

R = Average Replenishment Time

S = Average Daily Demand

σr = Standard Deviation of Replenishment

σs = Standard Deviation of Daily Demand
Order Point (OP)

OP = EDDLT + Safety Stock

EDDLT = Expected Demand During Lead Time

EDDLT = R(S)

R = Average Replenishment Time

S = Average Daily Demand

OP = R(S) +
Integrated Enterprise Excellence
Utilize “Lean Organization” and “Standardization”
approaches focused on aggressively identifying and
eliminating waste while achieving 5Rs (Right Product,
Right Place, Right Quantity, Right Time, Right Price).
Driving Enhanced
Quality
Service
Technology
Which results in
–
–
–
–
Increased Patient Satisfaction
Greater Value for the Community
Improved Competitiveness
Increased Employee/Physician Satisfaction
Cost
Lean Organization
Definition:
Characteristics:
A systematic approach to the identification
and elimination of waste and non-value
added activities through continuous
improvement in all products and services
•
Equipment used synchronously to demand
• Utilizes people to their fullest capacity
• Simple, flexible, visible, & responsive
• Requires constant change
• Creates products/services with minimum
consumption of:
- Capital investment
- Floor space
- Materials
- Labor
- Time
- Distance
Definition of Waste
Understanding Waste
•Anything that doesn’t add value to the
process
• Identification and elimination of waste is
the central focus of a lean system.
• Anything that doesn’t help create
conformance to the customer’s
specifications
• It is dependent on the understanding
and involvement of all employees.
• Anything your customer would be
unwilling to pay (or need) you to do
• Successful implementation requires all
employees be trained to identify and
eliminate waste from their
work areas.
Waste exists in all work . . . . and
at all levels in the organization
8 Types of Waste








Transportation
Inventory
Movement
Waiting
Over Production
Over Processing
Defects
People skills/potential
Lean Tool Box
Pull
Systems
Standardized
Operations
Reduction
of
Variation
Transportation/
Logistics
Small
Lots
Machine
Process
Capability
Level
Scheduling
Supplier
Development
Lean
Organization
Plant, Machine
& Office Layout
Error
Proofing
Containerization/
packaging
Quick
Set-up
Lead Time
Reduction
Workplace
Organization &
Visual Controls
Employee / Process
Control
Planned
Maintenance
Lean Organization
A Four Step Focus
• Step One - Understand what waste is
• Step Two - Use appropriate waste elimination tool
to eliminate specific waste(s) identified
• Step Three - Brainstorm to develop a vision so as
to create a plan
• Step Four - Aggressive implementation of plans.
Do it now!!!!
Finance
3 Financial Statements
 Income Statement
 Cash Flow Statement
 Balance Sheet
Income Statement



Displays revenues and expenses
Clearly states net profit or loss
Also called “statement of revenue and expense”
Sample Income Statement
Sales Revenue
Cost of Goods Sold
$1,000,000
Direct Material
($150,000)
Direct Labor
($100,000)
Overhead
($150,000)
Total Cost of Goods Sold
Gross Profit
Operating Expense
Office Supplies
Salaries
Utilities
Total Operating Expense
Net Income
($400,000)
$600,000
($50,000)
($225,000)
($25,000)
($300,000)
$300,000
Balance Sheet

Summarizes assets, liabilities, and shareholder
equity or net assets (non-profit)
Assets = Liabilities + Shareholder Equity
Both sides of equation must “balance” out

http://www.investopedia.com/video/play/introduction-balance-sheet#axzz1cjqs0ph6


Balance Sheet
11/11/2011
ASSETS
Current Assets
Cash
Accounts receivable
(less doubtful accounts)
Inventory
Temporary investment
Prepaid expenses
Total Current Assets
$62,950
60,880
62,150
2,650
$188,630
Fixed Assets
Long-term investments
Land
Buildings
Long-term Liabilities
Mortgage
Other long-term liabilities
Total Long-Term Liabilities
(less accumulated depreciation)
Plant and equipment
150,000
(less accumulated depreciation)
Furniture and fixtures
(56,870)
15,570
(less accumulated depreciation)
Total Net Fixed Assets
TOTAL ASSETS
LIABILITIES
Current Liabilities
Accounts payable
Short-term notes
Current portion of long-term notes
Interest payable
Taxes payable
Accrued payroll
Total Current Liabilities
$22,420
1,800
6,000
1,140
$31,360
$30,000
$30,000
Shareholders' Equity
Capital stock
$110,000
(4,720)
$103,980
Retained earnings
Total Shareholders' Equity
121,250
$231,250
$292,610
TOTAL LIABILITIES & EQUITY
$292,610
Cash Flow Statement

Records all cash movement
 Inflows
from operations and investments
 Outflows for business expenses and investments

http://www.investopedia.com/video/play/what-is-cash-flow#axzz1cjqs0ph6
Cash Flow Statement
Beginning Cash Position
Cash Flow from Operating Activities
Net Income
Depreciation Expense
Net Change in Accounts Receivable
Net Change in Account Payable
Total Adjustments to Operating Income
Net Cash Flow Provided by Operating Activities
Cash Flows from Investing Activities
Purchase of New Computers
Purchase of Assembly Line Machines
Decommissioning Fund Contributions
Net Cash Used in Investing Activities
Net Cash Flows from Financing Activities
Increase in Short Term Debt
Redemption of Long Term Debt
Issuance of Common Stock
Cash Dividends on Common Stock
Net Cash Provided by (Used in) Financing Activities
$6,000,000
$8,000,000
$4,000,000
($2,000,000)
$1,000,000
$3,000,000
$11,000,000
($1,500,000)
($2,000,000)
($500,000)
($4,000,000)
$500,000
($3,000,000)
$250,000
($2,000,000)
($4,250,000)
Net Increase / Decrease in Cash and Cash Equivalents
$2,750,000
Cash and Cash Equivalents at the End of the Period
$8,750,000