INVENTORY MANAGEMENT

What are the costs of inventory? Production system converts raw materials into value added products of consumption. Among the input costs, material cost is predominant. Simply stated, materials required for production are procured and stored and consumed. This is to prevent any production interruption for want of raw materials. There are many other reasons why materials are required to be stocked like availability, seasonality, price, delays, to reduce dependency on Raw materials Suppliers plants. !ork in process "achines product line. #inished goods Plant, customers market. Protect against stock out situation and production interruption. $t is thus obvious that certain amounts of inventories % of raw materials, !$P #P are inevitable in production. !hen these inventories are in stock they represent locked up capital and carry interest or cost of capital. This apart they occupy valuable store space and cost is incurred in safety and security of such inventory. "oreover when there is a shortage of stock, an indirect cost is incurred as lost opportunity. Thus the costs involved in inventory are &rdering costs. 'arrying costs. Shortage costs. &rdering costs are costs associated with planning procurement. #orecasting demand selection of vendor bid invitation evaluation issuing purchase order. #ollow up transportation. Receipt $nspection (andling accounting auditing stocking "en are employed to attend to all these and each purchase order issued consumes direct and indirect labour hours. This cost per order is called &rdering 'ost. 'arrying costs are costs incurred in holding the inventory in storage. This depends on the nature, value, si)e, volume, time of storage, lighting, ventilation, security required for
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safe keeping of the inventory. This is called inventory carrying cost5holding cost shortage costs. The purpose spending money in carrying inventory and safe keeping is to ensure smooth production floor and output. $f for same reason this is not achieved, and a stock out situation docs arise, loss is incurred. Such stock out at raw material stage 5 !$P may cause temporary disruption in production incur man5machine idle time. Production loss capacity under2utilisation customer dissatisfaction Shortage of finished goods will be lost business, loss of profit, good will of customer and customer dissatisfaction. The ordering cost is directly proportional to the no. of orders placed. As the no. of orders is reduced, the volume of ordered quantity is proportionately high.$f the quantity is 1,000 the order quantity per order will be 1000, 600, /60, 100 etc for 1,/,7 or 10 orders. As the no. of orders increases, ordering costs increases. As the no. of orders reduced, the inventory increases, thus the carrying cost will increase shortage cost will decrease as the chances of stock out will be less. The ob8ective is to minimise the costs of ordering, carrying stock out. Basic Inventory Model $n .asic inventory model it is assumed that 9 the demand for an item is at a constant rate or uniform over a period and 9 the entire ordered quantity of material is received at a time. 9 This model is known as : system 9 fi;ed order quantity system or 9 continuous or perpetual review system. 9 &rder is placed as a predetermined point of time when the inventory reached the reorder level. Basic Inventory Model $n this model 1. *emand is known /. *emand is constant over time. <. -o shortage is allowed. 7. =ead time is also known 6. =ead time is constant. 4. The ordered quantity arrives at a time immediately. Basic Inventory Model Thus, to start with, the required quantity : is available. Since the demand or consumption is at a constant rate, over a period of time, : reduces in a right sloping line :1, :/, :< at time 1,/ < etc. !hen : reaches the predetermined reorder level, order is placed. !ith the lead time, as the inventory reaches )ero, stock is fully replenished for the ne;t cycle. Thus, we have a saw tooth model.
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$n this basic ,&: "odel> 9 &nly one product is involved. 9 Annual requirement is known 9 *emand rate is uniform constant. 9 There is no constraint % internal 5 e;ternal. 9 &nly ordering cost carrying cost are considered. 9 -o uncertainty. 9 =ead time is fi;ed constant. 9 &rder is delivered in a single lot. 9 :ty ordered is received in full. 9 -o :ty discount is considered. =et annual demand ? * @nit cost ? P &rdering cost ? 'o 'arrying cost per unit per year ? 'c ,conomic ordering :uantity ? : a. -o. of orders required ? *5: b. Total &rdering cost ? A*5:BC'o c. Total carrying cost ? A:5/BC'c d. Total cost of units per year ? *CP e. Total cost of inventory ? b Dc Dd ? EA*5:BC'oFDEA:5/BC'cF D*CP T'?EA*5:BC'oFDEA:5/BC'cF D*CP *ifferentiating w r t : ? dT'5d:? GEA2*5:/BC'oFDEA'c5/BF D0H 0 ? EA2*5:/BC'oFDEA'c5/BF EA*5:/BC'oF ? A'c5/B /C*C 'o 5'c ? :/ :? Sq. root of A/C*C 'o 5'c B -o. of orders ? *5: Time between orders ? :5* year * ? 6700 'o ? /60 'c ? <0 per unit pa #ind > a. ,&: b. -o. of orders 5 year c. Time between successive orders #ind > a. ,&: b. -o. of orders 5 year c. Time between successive orders
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Annual *emand * &rdering 'ost 'o 'arrying 'ost 'c @nit 'ost in Rs

/7000 160 /0J 60

16000 1/6 /0J 36

=et annual demand ? * @nit cost ? P &rdering cost ? 'o 'arrying cost per unit per year ? 'c Shortage cost ? 's ,conomic ordering :uantity ? : Basic Inventory Model with shorta e : ? Sr of A/C*C'o5'cBCEA'sD'cB5'sF :1 ? Sr of A/C*C'o5'cBCE's5A'sD'cBF :/ ? :2:1 'ycle time T ? :5* $nventory period T1?:15* Shortage period T/?:/5* *?3,/00 'c?6005unit5year 'o?1,600 per order 's?/,000 5 unit5year #ind> 1. &rdering :uantity /. "a;. inventory <. "a;. shortage quantity 7. 'ycle time 6. $nventory period 4. Shortage period *?3,/00 'c?6005unit5year 'o?1,600 per order 's?/,000 5 unit5year 1. &rdering :uantity ?: : ? Sqr of A/C*C'o5'cBCEA'sD'cB5'sF : ? S:R E/C3,/00C1,600C5600FCEA/,000D600B5/,000F ?Sqr 7</00C1./6 ?/<< *?3,/00 'c?6005unit5year 'o?1,600 per order
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's?/,000 5 unit5year /. "a;. inventory ? :1 :1 ? Sr of A/C*C'o5'cBCE's5A'sD'cBF :1 ? S:R EA/C3,/00C1,6005600BFCE/,0005A/,000D600BF ? Sqr 7</00C0.I ?1I4 *?3,/00 'c?6005unit5year 'o?1,600 per order 's?/,000 5 unit5year <. "a;. shortage quantity ? :/ :/ ? : % :1 ? /<<21I4?73 *?3,/00 'c?6005unit5year 'o?1,600 per order 's?/,000 5 unit5year 7. 'ycle Time ? t t ? :5* ? A/<<53/00BC<46 ?11.I1 days *?3,/00 'c?6005unit5year 'o?1,600 per order 's?/,000 5 unit5year 6. $nventory period ? t1 t1 ? :15* ? A1I453/00BC<46 ?K.7< days *?3,/00 'c?6005unit5year 'o?1,600 per order 's?/,000 5 unit5year 4. Shortage period ? t/ t/ ? t2 t1 ? 11.I12K.7<?/.<Idays .asic Production "odel =et annual demand ? * Production rate ? Pr Set up cost ? 'o 'arrying cost per unit per year ? 'c 'ost of production per unit ? ' ,conomic .atch :uantity ? ,.: ? : =et annual demand ? * Production rate ? Pr Set up cost ? 'o
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'arrying cost per unit per year ? 'c 'ost of production per unit ? ' ,conomic .atch :uantity ? ,.: ? : ,.:? Sqr A/C*C'oB5E'cCA12*5PrBF T1 ? :5Pr T/ ? :C A12*5PrB5* 'ycle time ? T1DT/ =et annual demand ? * ? <4000 Production rate ? Pr ? 3/000 Set up cost ? 'o ? /60 'arrying cost per unit per year ? 'c ? /65unit ,conomic .atch :uantity ? ,.: ? : ,.:? Sqr A/C*C'oB5E'cCA12*5PrBF ? Sqr A/C<4000C/60B5E/6A12<400053/000BF ? 1/00 T1? :5Pr?A1/0053/000BC<46?4.0Idays T/ ? E:CA12*5PrBF5*?A4005<4000BC<46?4.0I days 'ycle time T ? 1/days ,&: helps to decide how much to order in the most economical way. $t is equally important to know when the place the order. $n the basic ,&: model an important assumption is made that the consumption5demand is at a uniform rate during the period and that replenishment is instantaneous. This does not reflect the real life situation. #luctuations in consumption due to other factors and delays in supplies in shipping, transporting, wrong order si)e, shipped quantity etc., (ence, in order to encounter this fluctuation, a few precautions are taken>2 9 =ead Time required for an order to materialise. 9 To meet some delays in supplies, a reserve stock. 9 A safety stock to meet unforeseen circumstances 9 (ence over and above the ,&:, three layers of stocks % .uffer, Reserve Safety stocks are built. 9 9 9 9 9 Any stock held costs money to carry. The time the stock recedes to buffer level, the outer limit by which P.& is to be released is called the R&= the system is said to have reached the reorder point. $t is known as continuous Review system or : system. $n this model also a basic assumption is made that the lead time remains constant. This obviously increases the carrying cost and other risks of obsolescence and perishability.
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INVENTORY MANAGEMENT

Since the demand rate and lead time are known, the R&= is the inventory which meets this demand during the lead time. This is also known as .uffer Stock. R&= ? A-ormal or Ave. demand rateB ; AAve. =ead timeB (owever when either the demand rate or lead time is not certain, the demand may vary under normal distribution or poisson distribution or the lead time is e;tended, the probability of ma;. e;tension of lead time is P;, then e;tra stock called the safety stock is required. Safety Stock ? GAAve.demand rateB ; A"a;. e;tn.of lead timeBH ; GProbability of that tensionH ? A ; P; Thus, R&= ? Safety stock D Reserve Stock D .uffer stock. !lassification " !odification of stoc#$ 9 $nventory represents a significant portion of current assets 9 $nventories or stock are different in 9 kind, 9 nature, 9 si)e, 9 form, 9 value, 9 weight, 9 volume, 9 usage, 9 requirement etc. 9 $t is necessary to study each item of stock 9 Take appropriate action to store. 9 Since large number of items is to be stored at a time, it is important to classify them 9 Stock in such a manner that they are easily accessible and identifiable. !lassification of stoc# 9 Systematic grouping of similar items of varying si)es e;> 9 nuts bolts, 9 fasteners, 9 rivets, 9 gears. Nat%re of %sa e & 9 Raw materials, 9 components, 9 consumable,
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9 spare, 9 tools, 9 !$P, 9 (ardware Nat%re of ite' & 9 Laseous, 9 liquid, 9 solid, 9 paste, 9 inflammable, 9 requiring temp. 'ontrol. Val%e of ite's & 9 highly valuable, 9 scarce resource, common item. !riticality of ite's & availa(ility) 9 lead time, 9 imported etc., Move'ent of ite's & 9 #ast, 9 medium 9 slow. By so%rce & 9 .ought out 5 9 manufactured in house. 9 Ta; and costing structure will very !odification of ite's* 9 $n a manufacturing unit hundreds5thousand of items will be stocked and consumed. 9 $n order to stock the items in a scientific manner to avoid many problems of handling, items are codified by numbers. 9 They are not simple seriali)ed no. but group of numerals and alphabets each conveying some information useful in handling and locating. Such codes also become locational addresses. +ifferent #inds of codes are %sed to denote AaB Source of supply. AbB =ocation of supplier. Ac B"a8or aggregate 5 group to which the part belongs. AdB "a8or subassembly in which the item is used. AeB Specific part no which is unique for the item read with the group sub assembly id. AfB The A.' 5 M,* classification AgB Any special condition to use the item.
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The code may be = . ' " 06 0K 13/ This will mean =eyland 'lass item from Type source of "edium moving Transmission group Lear bo; assembly $tem issued in unique no 2 13/ Technique Purpose

2= 2. 2' 2" 2 06 2 0K

1. A . ' 1. 'lassification by consumption value. /. N O P /. $nventory Malue of items. <. M , * <. 'lassification by criticality of items. 7. # S 7. 'onsumption rate. 6. ( " = 6. @nit rate of items. 4. S * , 4. Availability in market. 3. S &S 3. Seasonal items. I. L & = # I. $tem by source. ,ses of !lassification of ite's* 1. 'ontrol5Review /. Authority to sanction. <. &rdering frequency. 7. R&=, safety buffer stock levels. 6. &rder quantity. 4. 'ontrol on issue for consumption. 3. Accuracy in material planning. I. =ead time required5 to be allowed. K. -o. of sources. 10. *egree of follow up. 11. $nspection waste control. 1/. Malue Analysis for cost reduction. 1<. #orecasting 17. &bsolescence 5 surplus control. "aterials Requirement Planning called "RP determines the schedule and quantities for each item required for a product. "RP takes the output from the "SP"aster Schedule of the Production Plan. Then it combines the "SP with inventory record information to know the stock on hand and in pipeline and the product structure records to arrive at the requirement of each item when. The ob8ective of "RP is to get the right materials to the right place at the right time. (owever, "RP does not take into account capacity in calculating the production lot si)e. The capacity may e;ceed resulting in longer production time. (ence, closed
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loop "RP was developed which ensures feed back from capacity planning module. This is the first component of "RP $$ % "anufacturing Resource Planning. Production Plan Rough cut 'apacity Plan "aster Production Schedule "RP 'apacity Requirement Planning Requirement Schedule "RP class * ' . A 'overage 'omputing only. Probably inv. Records one poor. Mery few outputs used used for inv. &rdering but not for scheduling. capacity planning shop floor controls mainly a PP' tool. 'losed loop is working full "RP $$.

$nputs to "RP are "aster production schedule. .ill of materials. $nventory status file. &utput of "RP Timing :uantity of sub assemblies, parts raw materials required. "RP @sesPlan Purchase. Plan Production Action. =ot si)ing>2 =ot for =ot ,&: "inimum cost per period. Period order :ty. Approach. =east unit cost approach. =east Total cost. Part Period .alancing.

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