inventory management - pom and financial management
DESCRIPTION
Inventory management- MBA 2 A - PTU - POM and FMTRANSCRIPT
PRODUCTION AND OPERATIONS
MANAGEMENT
Chelliah Sriskandarajah
University of Texas at Dallas
Inventory Management
Inventory : A stock or store of goods.
Firms typically stock many items in inventory.
Many of the items a firm carries in inventoryrelate to the kind of business it engages in.
Examples :
1. Manufacturing firms carry supplies of rawmaterials, purchased parts, finished items, spareparts, tools,....
2. Department stores carry clothing, furniture,stationery, appliances,...
3. Hospitals stock drugs, surgical supplies, life-monitoring equipment, sheets, pillow cases,...
4. Supermarkets stock fresh and canned foods,packaged and frozen foods, household supplies,...
IBM Example : Approximately 1000 IBMproducts are currently in service, with installedunits numbering in excess of ten of millionsdollars.
IBM has more than 200,000 part numbers tosupport these services.
It is essential to maintain a service parts inven-tory system to support the product they sell andinstall.
IBM’s National Service Division (NSD) has de-veloped an extensive and sophisticated parts in-ventory management system (PIMS) to provideprompt and reliable customer service.
2 central warehouses, 21 field distribution cen-ters...
PIMS employed economic order quantity (EOQ)formulas to determine parts and replenishmentbatch sizes and to set service priority goals.
Inventory Management
Good inventory management is essential to thesuccessful operation of most organizations for anumber of reasons :
1. The amount of money inventory represents
2. The impact that inventories have on the dailyoperations of an organization.
We focus on management of independent items :finished goods, purchased parts, raw materials,etc.
We study :
1. Different functions of inventories
2. Requirements for effective inventorymanagement.
3. Objectives of inventory control
4. Techniques of determining how much toorder and when to order.
Dependent Demand : Demand for items ininventory that are subassemblies or componentparts to be used in the production of finishedgoods.
Independent demand : Demand for itemsthat are finished items.
The Nature and important ofinventories
Inventories are vital part of business
They are necessary for operations
They contribute to customer satisfaction.
A typical firm probably has about 30percent of its current capital assets andperhaps as much as 90 percent of itsworking capital invested in inventory.
Return on investment (ROI) :One widelyused measure of managerial performance.
ROI =Profit after taxes
total assets
Inventories may represent a significant portionof total assets.
A reduction of inventories can result in a signif-icant increase in ROI .
Different type of inventories :
1. Raw materials and purchased parts
2. Partially completed goodsWIP (Work-in-Process)
3. Finished-goods inventories (manufacturingfirms) Merchandise (retail stores).
4. Replacement parts, tools, and supplies.
5. Goods-in-transit to warehouses or customers.
Function of Inventory
1. To meet anticipated demand.
2. To smooth production requirements.
3. To decouple components of the production-distribution system.
4. To protect against stockouts.
5. To take advantage of order cycles.
6. To hedge against price increases or takeadvantage of quantity discounts.
7. To permit operations.
Objectives of Inventory Control :
Inadequate control of inventories can result inboth under- and overstocking of items.
Understocking results in missed deliveries, lostsales, dissatisfied customers, and productionbottlenecks.
Overstocking : ties up funds that might be moreproductive elsewhere.
Inventory management has two main concerns :
1. Level of customers service.
2. Cost of ordering and carrying inventories.
The overall objective of inventory managementis to achieve satisfactory levels of customer ser-vice while keeping inventory costs within rea-sonable bounds.
This means, the manager tries to achieve abalance in stocking.
Two fundamental decisions are to be made :
1. Timing of the order.
2. Size of the order.
Performance measures used to judge the effec-tiveness of inventory management :
1. Customer satisfaction : the number andquantity of backorders, customer complaints.
2. Inventory turnover =annual cost of sold goods
average inventory investment
3. Days of inventory : the expected number ofdays of sales that can be supplied from existinginventory.
Requirements for Effective InventoryManagement
1. A system to keep track of the inventory onhand and on order.
2. A reliable forecast of demand that includesan indication of possible forecast error.
3. Knowledge of lead times and lead timevariability.
4. Reasonable estimates of inventory holdingcosts, ordering costs, and shortage costs.
5. A classification systems for inventory items.
Inventory Counting Systems
1. Periodic system
2. Continuous (perpetual) system
3. Two-bin system
Universal product code : Bar code printedon a label that has information about the itemsto which it is attached.
Demand Forecasts and Lead Time In-formation :
Inventories are used satisfy demand. Therfore,it is essential to have reliable estimates of theamount and timing of demand.
Lead time : Time interval between orderingand receiving the order.
Cost Information
Holding (carrying) cost:
Physically holding item in storage.
• interest
• insurance
• taxes
• depreciation
• obsolescence
• deterioration
• spoilage
• breakage
• warehouse costs (heat, light, rent, security)
• Holding cost also include opportunity costshaving funds tied up in inventory.
Ordering cost:
Cost ordering and receiving inventory.
• determine how much needed, typing upinvoices.
• inspecting goods for quality and quantity.
• moving to storage.
• cost of machine setup
Shortage costs :
• Opportunity cost for not making a sale.
• loss of customer goodwill.
• lateness charges.
• cost of loss production.
Classification Systems :
A-B-C approach : Classifying inventory ac-cording to some measure of importance, and al-locating control efforts accordingly.
Cycle counting : A physical count of itemsin inventory.
How Much to Order :
Economic Order Quantity : The ordersize that minimizes total cost.
Economic Order Quantity Models:
1. The economic order quantity model.
2. The economic order quantity model withnoninstantaneous delivery.
3. The quantity discount model.
Basic Economic Order quantity Model
EOQ
Assumptions:
1. Only one product is involved.
2. Annual demand requirements are known.
3. Demand is spread evenly throughout the yearso that the demand rate is reasonably constant
4. Lead time does not vary.
5. Each order is received in a single delivery.
6. There are no quantity discounts.
Notations:
D = Demand, usually in units per year.
S = Ordering cost.
H = Holding (carrying) cost per unit per unitperiod (year).
r = Holding (carrying) cost per dollar per unitperiod (year).
P = Unit price (or cost C).
H = rP .
TC = Total cost (per year) associated with car-rying and ordering inventory when Q units areordered.
TC = Annual carrying cost+Annual ordering cost
Annual carrying cost =Q
2H
Annual ordering cost =D
QS
TC =Q
2H +
D
QS
TC =Q
2H +
D
QS
Optimal order quantity
Qo =
√
2DS
H
Length of order cycle =Qo
D
The economic order quantity model withnoninstantaneous delivery
D = Demand, usually in units per year.
S = Ordering cost.
H = Holding (carrying) cost per unit per unitperiod (year).
p = Production or delivery rate.
u = usage (demand) rate.
Imax = Maximum inventory.
TC = Total cost (per year) associated with car-rying and setup cost whenQ units are produced.
TC = Annual carrying cost + Annual setup cost
Annual carrying cost =Imax
2H
Annual setup cost =D
QS
TC =Imax
2H +
D
QS
Iaverage =Imax
2
TC =Imax
2H +
D
QS
Optimal run quantity
Qo =
√
2DS
H
√
p
p − u
Cycle time =Qo
u
Run time =Qo
p
Imax =Qo
p(p − u)
The quantity discount model
TC = Total cost (per year) associated withcarrying, ordering and purchasing cost.
TC = Annual carrying cost+Annual ordering cost
+Purchasing cost
TC =Q
2H +
D
QS + PD
Reference
Production/Operations Management by William J. Steven-
son, Seventh Edition, Irwin/McGraw-Hill, 2002.