“Education in Pursuit of
Supply Chain Leadership”
dp&c Chapter7
Chapter 7
Managing Supply Chain
Inventories
7-1
dp&c Chapter7
Learning Objectives
• Define inventory management
• Define inventory management objectives
• Describe what inventory management does
• Describe the different classes of inventory
• Identify the different levels of inventory management
• Review the characteristics of inventory in the supply chain
• Detail the strategic inventory management process
• Balance demand and supply objectives
7-2
dp&c Chapter7
Learning Objectives (cont.)
• Contrast the conflicting objectives of inventory
management among marketing/sales, finance, and
operations
• Understand inventory trade-off decisions
• Describe inventory and demand flows
• Define supply chain inventory and demand flows
• Describe inventory dynamics
• Understand how inventory provides value
• Determine whether inventory is an asset or a liability
• Assess the financial impact of inventory management
7-3
dp&c Chapter7
Chapter 7
Managing Supply Chain Inventories
Inventory
Inventory
Management
Basics
Management
Basics
7-4
dp&c Chapter7
Inventory Definitions
What is Inventory?
Those stocks or items used to support production,
supporting activities, and customer service
What is inventory management?
Inventory management is responsible for the maintenance
of the accurate and timely status of on-hand balances, on
order quantities, and the financial value of finished goods,
components and raw materials physically present at
inventory locations
7-5
dp&c Chapter7
Major Questions of Inventory Management
1
What is the optimal balance between inventory and
customer service?
2
What is the level of control an enterprise should
establish over its channel inventories?
3
Under what circumstances should control over
inventories be changed?
4
What is the optimum balance between inventory
investment and associated carrying costs?
5
What is the optimum balance between inventory
investment and replenishment costs?
6
What is the optimum balance between inventory
investment and transportation costs?
7-6
dp&c Chapter7
Magnitude of Inventory
Year
Nominal GDP
US$ Trillion
Values of all
Business
Inventory
(Billion)
Inventory
Inventory
Inventory as a
Carrying Costs
Carying Rate
% of GDP
(Billion)
2005
12.64
1,750
22.3%
390
3.1%
2007
14.03
2,015
24.1%
485
3.5%
2010
14.5
2,018
19.2%
387
2.7%
2011
15.08
2,182
19.1%
417
2.8%
2012
15.68
2,269
19.1%
434
2.8%
7-7
dp&c Chapter7
Inventory Management Objectives
The presence of inventory is the result of an
informed trade-off decision between the cost
of acquiring and stocking inventories and
the ability to meet or exceed a targeted level
of customer responsiveness
7-8
dp&c Chapter7
Inventory Management Objectives (cont.)
Serviceability
Inventory enables companies to serve
their customers without stockout
Cost Reduction
Reducing the cost of inventory without
reducing customer serviceability
Process
Efficiency
Inventory enables the efficient use of
equipment and workforce
Capital Budgets
Effective inventory management
enables firms to attain targeted return
on investment (ROI)
7-9
dp&c Chapter7
How Does Inventory Provide Value?
Lowest cost for revenue value received
Improved channel efficiencies
Improved quality
Supply network simplification
Improved channel inventory information
7-10
dp&c Chapter7
Purpose of Inventory
Demand Buffer
Separate demand from supply
Demand
Uncertainty
Enable high customer service levels
regardless of variability in demand
Supply
Uncertainty
Provide for a steady flow of materials
and components regardless of variability
in supply
Lot-Size
Economies
Capitalize on short-term sales and
purchasing opportunities
Process
Flexibility
Increase production center operations
and scheduling by providing a buffer of
production inventories
7-11
dp&c Chapter7
Role of Inventory Management
Planning
Acquisition
Stockkeeping
Disposition
• Performing
order policy
receipt
Setting
inventory
Generating
purchase
orders
• Configuring
warehouse
storage
Setting inventory
order parameters
Generating
manufacturing
orders
•• Performing
stock putplanning
away
Selecting
Expeditinginventory
orders
• Maintaining
high inventory
techniques
Calculating costs
• accuracy
Performing inventory
planning
order audits
• Conducting
cycle counting
Forecasting
Performing order
performance
• Conducting
annualmaintenance
physical
Planning schedule
Disbursing
inventory
from stock to
reviews
•• Applying
techniques
Performing
performance
source
oflean
demand
Validating
order
receipt review
• Calculating
inventory
Purging damaged
andvalue
obsolete
• Assessing
inventoriesinventory performance
• Performing inventory balance
adjustments
7-12
dp&c Chapter7
Classes of Inventory
Raw Materials/Commodities
Work In Process (WIP)
Finished Goods
Distribution Channel
Maintenance, Repair, and Operating Supplies (MRO)
Service Parts
Damaged and Obsolete
7-13
dp&c Chapter7
Function of Inventory
Cycle (lot size)
Excess inventory caused by ordering or
producing in batches that exceed the demand
Safety
Planned excess inventory to cover unplanned
variations in demand and supply orders
Anticipation
Transportation
Hedge
Inventory purchased or built in advance of
demand, such as seasonality or promotions
Inventory that is in transit by ship, railcar,
pipeline, airplane, or truck from point of origin to
point of consumption
Inventory that is purchased to take advantage
of price and cost opportunities
7-14
dp&c Chapter7
Types of Supply Chain Inventory
Inventory Balance
Item level inventory is the balance
sufficient to satisfy projected
demand often driven by lot sizes
based on trade-offs between
carrying and ordering costs
Operating
Inventory
Time
Surplus inventory may have some
possibility of being used within 12-18
months but probably would not have
been stocked based on perfect
hindsight.
Excess
Inventory
Surplus
Inventory
Excess inventory encompasses
any item inventory which
exceeds the cycle inventory level
but still has a reasonable
chance of being used within the
planning time frame.
7-15
Inactive
Inventory
If the part remains in
inventory until there is no
longer any product or
service part demand, any
remaining balance will
become “obsolete”.
dp&c Chapter7
Chapter 7
Managing Supply Chain Inventories
Inventory
Components of
Management Basics
Inventory Decisions
7-16
dp&c Chapter7
Defining Cycle Inventory
Inventory
Expected demand
Q
The average amount of inventory on hand for
a product sufficient to satisfy demand during
Q / 2 the replenishment lead time.
Cycle
Inventory
T
Q = 250 units
T = 10 days
Cycle inventory = Q / 2 = 250 units / 2 = 125 units
7-17
dp&c Chapter7
Defining Safety Inventory
Inventory
Expected demand
Q
A quantity of stock planned to be in
inventory to protect against
Q/2
fluctuations
in demand or supply
Cycle
S
Inventory
Safety Stock
APICS Dictionary, 13th edition
T
Time
Q = 250 units
Q /2 = 250 units / 2 = 125 units
S = 125 units / 2 = 63 units
Q/2 + S = 313 units
7-18
dp&c Chapter7
Defining Seasonal Inventory
Inventory
5
Expected
demand
4
Inventory built up to smooth
production in anticipation of a peak
seasonal demand.
Seasonal
3
2
inventory
1
0
APICS
Dictionary, 13th edition
0
1
2
Quarter 1
3
4
5 6
7
Months
Quarter 2
8
Quarter 3
7-19
9
10 11 12
Quarter 4
dp&c Chapter7
Surplus/Obsolete Inventory
Charting Obsolete Inventory:
Quantity
25
20
15
SURPLUS
10
Demand
5
Time
Q1
Potential
Obsolescence
Q2
Q3
7-20
Q4
dp&c Chapter7
Chapter 7
Managing Supply Chain Inventories
Inventory
Management
Basics
Inventory Cost
7-21
dp&c Chapter7
Inventory Costs
Unit
Total production or purchasing cost for one
unit
Ordering
Cost incurred during reordering, such as
preparation, order creation, and put away
Carrying
Cost incurred when holding inventory in stock
over a period of time
Stockout
Costs associated with stockout, including lost
sales, backorder, expediting, and reordering
Transportation
Costs arising from transportation equipment
to move channel inventory
7-22
dp&c Chapter7
Unit Costs
Fundamental cost associated with inventory
Calculated differently for products that are manufactured
and products that are purchased
Key element is determining the costing unit of measure
Unit costs are often influenced by product lot sizes
Calculated using one five costing methods: standard, actual,
average, LIFO, and FIFO
Important for the calculation of other critical costs such as
the economic order quantity (EOQ)
7-23
dp&c Chapter7
Order Costs
Product planner and buyer costs
Supplies and operating expenses
Order generation costs
Setup and teardown costs
Lost capacity costs
Transportation costs
Receiving and put-away costs
Miscellaneous overheads
7-24
dp&c Chapter7
Inventory Carrying Cost Components
The cost of holding inventory, usually defined as a
percentage of the dollar value of inventory per unit of
time (generally one year)
Capital
Costs
Service
Costs
Risk
Costs
Storage
Costs
Inventory Carrying Costs
7-25
dp&c Chapter7
Exercise 7-1 Carrying Cost Calculation
Determined by combining the relevant expenses for each
of the four cost types and expressed as a percentage of
inventory value.
What would be the carrying cost detailed in this scenario?
Cost of capital
Insurance costs
Taxes
Damage and theft
Obsolescence
Equipment and handling
Carrying cost
13%
.7%
3%
1.3%
2%
6%
26%
Total carrying cost value = US$2,000,000 x 26% = $520,000
7-26
dp&c Chapter7
Stock Out Costs
Stockout Causes
Stockout Costs
Lost sales
Demand during the
replenishment lead
A stockout occurs when the
demand
for
Backorder
costs
time exceeded
a product,
component, or raw material
available
inventory
exceeds available inventory
Lost customers
Stocking, production,
and purchasing
problems caused
inventory shortages
Expediting
Additional
manufacturing and
purchasing costs
7-27
dp&c Chapter7
Transportation Costs
Fixed
Costs associated with the ownership of
transportation assets such as vehicles,
terminals, ports, pipelines, and docks
Variable
Costs that arise with the use of
transportation equipment such as fuel,
labor, and vehicle maintenance
Joint
Costs for transportation that are shared
by the shipper and carrier to perform a
certain transportation service
Common
Costs for equipment such as terminals
and rights-of-way spread overall
shippers using the service
7-28
dp&c Chapter7
Inventory Valuation
Standard cost
Uses the costs of an operation, or product
including direct material, direct labor, and
overhead charges to establish a cost standard
First in, first
out (FIFO)
Assumes that the oldest inventory (first in) is the
first to be used (first out)
Last in, first
out (LIFO)
Assumes that the most recent item receipt (last
in) is the first to be used or sold (first out)
Average cost
Uses the cost and quantity of a prior receipt and
combines and average it with the cost and
quantity of a new receipt
Actual cost
Uses a cost that is permanently linked to a
specific lot size quantity
7-29
dp&c Chapter7
Chapter 7
Managing Supply Chain Inventories
Inventory
Management
Basics
Inventory Control
7-30
dp&c Chapter7
Transaction Management
Accuracy is the Key!
WIP Scrap
WIP Issue
WIP
Receipt
Receipt
Put Away
Finished
Goods
Interbranch
Transfer
Pick Issue
Internal
Move
Adjustment
Shipment
Order
Returns
Inventory Record
7-31
dp&c Chapter7
3 P’s of Inventory Control
7-32
dp&c Chapter7
ABC Inventory Control
The classification of a group of items in decreasing order of
annual dollar volume (cost multiplied by projected volume) or
other criteria. This array is then split into three classes, called A,
B, and C. The A group usually represents 10 percent to 20
percent by number of items and 50 percent to 70 percent by
projected dollar volume. The next grouping, B, usually
represents about 20 percent of the items and about 20 percent
of the dollar volume. The C class contains 60 percent to 70
percent of the items and represents about 10 percent to 30
percent of the dollar volume. The ABC principle states that effort
and money can be saved through applying looser controls to the
low-dollar-volume class items than will be applied to high-dollar
volume class items.
APICS Dictionary
7-33
dp&c Chapter7
ABC Inventory Distribution
Unit Cost
Annual
Usage
Cumulative
% Usage
Annual Dollar
Usage
Cummulate %
Dollar Usage
1-100
1-500
2-300
$.0074
$.0203
$.0800
5,750,000
1,265,000
110,000
63.9
78.0
79.2
$42,550.00
$25,679.50
$8,800.00
41.3
66.2
74.7
A
A
A
1-200
2-100
2-600
1-300
$.0800
$1.0173
$.0200
$1.1438
105,00
7,500
115,000
1,500
80.4
80.4
81.7
81.7
$8,400.00
$7,629.75
$2,300.00
$1,715.70
82.9
90.3
92.5
94.2
B
B
B
B
1-400
3-100
3-200
2-700
4-100
5-100
4-200
3-300
4-300
6-100
7-100
6-500
5-500
4-700
5-600
2-800
4-900
5-900
6-900
$3.1999
$.0125
$.0300
$.0200
$.0799
$4.5438
$.3000
$.0100
$.3000
$.0050
$.2000
$.0200
$.0200
$.0010
$.0000
$.0000
$.0000
$.0000
$.0000
500
110,000
25,300
25,300
500
70
1,000
25,300
600
25,300
126
1,000
500
525
0
0
0
0
1,419,400
81.7
83.0
83.2
83.5
83.5
83.5
83.5
83.8
83.8
84.1
84.1
84.1
84.1
84.1
84.1
84.1
84.1
84.1
99.9
$1,599.95
$1,375.00
$759.00
$506.00
$439.95
$318.06
$300.00
$253.00
$100.00
$126.50
$25.30
$20.00
$10.00
$0.52
$0.00
$0.00
$0.00
$0.00
$0.00
96.8
97.1
97.8
98.3
98.8
99.1
99.4
99.6
99.8
99.9
99.9
99.9
99.9
100
100
100
100
100
100
C
C
C
C
C
C
C
C
C
C
C
C
C
C
C
C
C
C
C
Item
Totals
8,991,491.50
ABC
Classification
$102,988.23
7-34
dp&c Chapter7
ABC Inventory Stratification
5%
15%
80%
Percent
Of Value
A
B
20%
30%
Percentage of Products
7-35
C
50%
dp&c Chapter7
Year-End (Periodic) Physical Inventory
• The focus is on financial reporting
• Factories and warehouses will often need
to be closed down during the count
A physical inventory taken at some
•What
Since there is pressure to complete the
recurring
intervalor(e.g.,
monthly,
is
a
year-end
periodic
physical
physical as soon as possible, inaccuracies
quarterly,
or annual physical inventory)
inevitably occurinventory?
• Nonoperations people often participate in
the counting, causing further inaccuracies
•APICS
The Dictionary,
accuracy13th
of the
new balances begins
edition
to deteriorate steadily as each day moves
away from the count date
7-36
dp&c Chapter7
Cycle Counting – Definition
An inventory accuracy audit technique where inventory is
counted on a cyclic schedule rather than once a year. A
cycle inventory count is usually taken on a regular,
defined basis (often more frequently for high-value or
fast-moving items and less frequently for low-value or
slow-moving items). Most effective cycle counting
systems require the counting of a certain number of items
every workday with each item counted at a prescribed
frequency. The key purpose of cycle counting is to identify
items in error, thus triggering research, identification, and
elimination of the cause of the errors.
APICS Dictionary, 13th edition
7-37
dp&c Chapter7
Cycle Counting Methods
Item
are counted
based on their usage
Cycle
counting
advantages:
ABC
frequency
• Timely detection and correction of
inventory control
problems
(root
Items are
grouped
andcause)
counted in a
Zone
zone time
• Minimal or specific
no loss storage
of production
• High level of counting accuracy
Location
A predetermined number of locations
• Focus on the
items
arecritical
checked
in aproviding
period the
Audit
most profitability to the organization
A cycle acount
is triggered
by the
• Ability to establish
continuous
inventory
Special
occurrence of
an item transaction
accuracy
improvement
program
Counts
event
7-38
dp&c Chapter7
Chapter 7
Managing Supply Chain Inventories
Inventory
Performance
Management
Basics
Measurement
7-39
dp&c Chapter7
How Does Inventory Provide Value?
Lowest cost for revenue value received
Improved channel efficiencies
Improved quality
Supply network simplification
Improved channel inventory information
7-40
dp&c Chapter7
Inventory – Asset or Liability?
Balance Sheet
Assets (US$M)
Cash
Receivables
Inventory
Total Current Assets
Property
Plant
Equipment
Total Fixed Assets
Total Assets
$
$
$
$
$
$
$
$
$
Liabilities (US$M)
10
20
200
230
20
100
50
170
400
Current Liabilities
Accounts Payable
Long Term Debt
Total Liabilities
$
$
$
$
30
20
250
300
Comon Stock
Retained Earnings
Total Stockholders' Equity
Total Liabilities + Equity
$
$
$
$
90
10
100
400
Inventory as Percent of Total Assets
50%
7-41
dp&c Chapter7
Inventory – Asset or Liability?
Income Statement - Profit and Loss (US$M)
Sales Revenue
Direct Labor
Direct Material
Factory Overhead
Cost of Goods Sold
Gross Profit
General and Administrative Expenses
Pre-Tax Income
Taxes
Net Income
$
$
$
$
$
$
$
$
$
$
400
30
60
30
120
280
160
120
60
60
ROA Calculation
Net Income
Total Assets
Return on Assets
$
$
7-42
60
400
15.0%
dp&c Chapter7
Exercise 7.2 Return on Asset (ROA)
Calculation
$120 COGS
$160 Exp
$ 60 Tax
Total Costs (TC)
$ 340
Net Income
Sales (S)
$400
(NI = S - TC)
$60 = $400 - $340
Return on
Asset
Fixed Assets (FA)
$170
Cash (C)
$10
Accounts
Receivable (AR)
$20
(ROA = NI / TA)
$60/$400 = 15%
Total Assets
(FA + C + AR + I = TA)
$170 + $10 + $20 + $200 =
400
Inventory (I)
$200
7-43
dp&c Chapter7
Inventory Values, Turns, and Ratios
•
Balance sheet and income statement values
•
Calculating the average inventory investment
Formula:
Beginning inventory + ending inventory
Inventory turnover = Cost of goods
/ average
= Average
Inventory
inventory. 2
•
Answer:
Inventory turnover
US$120M / US$30M = 4 turns.
Cost of Goods Sold
= Inventory Turns
Average Inventory
7-44
dp&c Chapter7
Inventory Values, Turns, and Ratios (cont.)
•
Inventory to total current assets
Total Current Assets
= Ratio
Average Inventory
•
Inventory to total assets
Total Assets
= Ratio
Average Inventory
•
Days of supply
Inventory on hand
= Days of supply
Average daily usage
7-45
dp&c Chapter7
Inventory Values, Turns, and Ratios (cont.)
•
Inventory to net working capital
Total Current Assets
= Ratio
Average Inventory
•
Cash-to-cash cycle
Cash-to-cash cycle = days’ supply of inventory + accounts
receivable days – accounts payable days
Or
Cash-to-cash cycle = days’ supply of inventory + days of sales
outstanding – days of payables outstanding
7-46
dp&c Chapter7
“Education in Pursuit of
Supply Chain Leadership”
dp&c Chapter7
Chapter 7
End of Session
7-47
dp&c Chapter7