Lecture 21 - Inventory Fundamentals. The contents of this chapter include all of the following: Inventory fundamentals, aggregate inventory management, how company use their inventory, objectives of inventory management, relevant inventory cost, inventory function, types of inventory, material flow, functions of inventory, inventory cost, inventory turns.
Lecture 21 Inventory Fundamentals Books • Introduction to Materials Management, Sixth Edition, J. R. Tony Arnold, P.E., CFPIM, CIRM, Fleming College, Emeritus, Stephen N. Chapman, Ph.D., CFPIM, North Carolina State University, Lloyd M. Clive, P.E., CFPIM, Fleming College • Operations Management for Competitive Advantage, 11th Edition, by Chase, Jacobs, and Aquilano, 2005, N.Y.: McGrawHill/Irwin • Operations Management, 11/E, Jay Heizer, Texas Lutheran University, Barry Render, Graduate School of Business, Rollins College, Prentice Hall Objectives • • • • • • • • • • • Inventory Fundamentals Aggregate inventory management How company use their inventory Objectives of Inventory management Relevant inventory cost Inventory function Types of inventory Material Flow Functions of inventory Inventory cost Inventory turns Amazon.com Amazon.com started as a “virtual” retailer – no inventory, no warehouses, no overhead; just computers taking orders to be filled by others ỵ Growth has forced Amazon.com to become a world leader in warehousing and inventory management ỵ Amazon.com Each order is assigned by computer to the closest distribution center that has the product(s) A “flow meister” at each distribution center assigns work crews Lights indicate products that are to be picked and the light is reset Items are placed in crates on a conveyor. Bar code scanners scan each item 15 times to virtually eliminate errors Amazon.com Crates arrive at central point where items are boxed and labeled with new bar code Gift wrapping is done by hand at 30 packages per hour Completed boxes are packed, taped, weighed and labeled before leaving warehouse in a truck Order arrives at customer within a week Inventory Fundamentals • What is inventory? – Materials and supplies that a business or institution carries either for sale or to provide inputs or supplies to the production process – Those stocks or items used to support production (raw materials and workinprocess items), supporting activities (maintenance, repair, and operating supplies), and customer service (finished goods and spare parts) APICS Dictionary Inventory Fundamentals • Can production be planned without managing inventory? – since inventory either results from production or supports it, the two cannot be managed separately separately and must be coordinated • • • Production planning is concerned with overall inventory Master planning is concerned with end items Material requirements planning is concerned with component parts and raw material Aggregate Inventory Management • Aggregate inventory management is concerned with managing inventories according to their classifications (raw material, workinprocess, finished goods, etc.) and the function they perform. It is financially oriented and is concerned with the costs and benefits of carrying the classifications of inventories Aggregate Inventory Management • Aggregate inventory management involves – Flow and kind of inventory needed – Supply and demand patterns – Functions inventory performs – Objectives of inventory management – Costs associated with inventory Item Inventory Management • Management must establish decision rules about individual inventory items: – Importance of inventory items – How they are to be controlled – How much to order at one time – When to place an order Functions of Inventories • Purposes of inventory (continued) – Lotsize inventory to purchase or manufacture in quantities greater than needed immediately – Purpose to take advantage of quantity discounts, to reduce shipping, clerical, and setup costs, and in cases where it is impossible to make or purchase items at the same rate they will be used or sold Functions of Inventories • Purposes of inventory (continued) – Transportation inventory to cover the time needed to move goods from one location to another (sometimes called pipeline inventory) – Hedge inventory to protect against price fluctuations Inventory Objectives • Inventories must be coordinated to meet three conflicting objectives: – Maximize customer service – Lowcost plant operation – Minimum inventory investment Inventory Costs • Costs used for inventory management decisions – Item costs – Carrying costs – Ordering costs – Stockout costs – Capacityrelated costs Inventory Costs • Item costs – Item costs include the cost of the item and all costs to get the item into the facility: • product • transportation • customs duties • insurance • direct material, direct labor, and factory overhead Inventory Carrying Costs • Carrying costs – Carrying cost include all costs caused by the amount of inventory carried. Three categories used are: • Capital costs – • Storage costs – • money tied up in inventory space, personnel, and equipment Risk costs – Obsolescence, damage, pilferage, insurance, and deterioration Inventory Carrying Costs • • The annual carrying costs depend on the average inventory carried. The more that is ordered at one time, the higher the average inventory. The annual cost of carrying inventory can be decreased by ordering less at one time Inventory Ordering Costs • Ordering costs include the costs of placing an order with a factory or outside supplier – Categories included in ordering cost are: • • • Production control costs Setup and teardown costs Lost capacity costs – • Every time an order is placed on a work center, the time taken to set up is lost as productive output time. It is particularity important with bottleneck operations Purchase order costs Inventory Ordering Costs • • • The annual ordering cost depends on the number of orders placed in a year The annual cost of ordering can be reduced by decreasing the cost of placing an order and by reducing the number of orders placed The number of orders per year can be reduced by ordering more at any one time Inventory Costs • Stockout costs – If demand during lead time exceeds the forecast and available inventory, we can expect a stockout. Possible costs of a stockout include: • Backorder costs • Lost sales costs • Lost customer costs Inventory Costs • Capacityrelated costs – These costs are those of changing production levels. They include: • Overtime / slack time • Hiring • Layoff • Training • Shift premiums Inventory Turns • Inventory turns: a measure of how effectively inventories are being used. The ratio of Annual Cost of Goods Sold divided by average inventory in dollars Inventory Turns Example Example from Page 238 What will be the inventory turns ratio if the annual cost of goods sold is $24 million and the average inventory is $6 million? Inventory turns = Annual COGS / Avg. inv. $ = $24 million / $6 million = 4 Inventory Turns Example What would be the reduction in inventory if inventory turns were increased to 12? Avg. inv. $ = Annual COGS / Inventory Turns = $24 million / 12 = $2 million Reduction = $6 million $2 million = $4 million If the carrying cost is 25%, what will the savings be? Savings = $4 million X 25% = $1 million! End of Lecture 21 ... Aggregate? ?Inventory? ?Management • Aggregate? ?inventory? ?management? ?involves – Flow? ?and? ?kind? ?of? ?inventory? ?needed – Supply? ?and? ?demand patterns – Functions? ?inventory? ?performs – Objectives? ?of? ?inventory? ?management. .. • • Inventory? ?Fundamentals Aggregate? ?inventory? ?management How company use their? ?inventory Objectives? ?of? ?Inventory? ?management Relevant? ?inventory? ?cost Inventory? ?function Types? ?of? ?inventory Material? ?Flow... time 5% Run time Output Inventory? ?Management How inventory items can be classified þ How accurate inventory records can be maintained þ Inventory? ?and? ?the Flow? ?of? ?Materials • Inventory? ?can be classified according to the following