cloudy222
Abhijeet Alte
Introduction
In financial parlance, inventory is defined as the sum of the value of raw materials, fuels and lubricants, spare parts, maintenance consumables, semi-processed materials and finished goods stock at any given point of time. The operational definition of inventory would be: the amount of raw materials, fuel and lubricants, spare parts and semi-processed material to be stocked for the smooth running of the plant. Since these resources are idle when kept in stores, inventory is defined as an idle resource of any kind having an economic value.
Inventories are maintained basically for the operational smoothness, which they can affect by uncoupling successive stages of production, whereas the monetary value of inventory serves as a guide to indicate the size of the investment made to achieve this operational convenience. The materials management department is expected to provide this operational convenience with a minimum possible investment in inventories. The objectives of inventory, operational and financial, needless to say, are conflicting. The materials department is accused of both stockouts as well as large investment in inventories. The solution lies in exercising a selective inventory control and application of inventory control techniques.
Inventory terminology
Inventory or stock is referred to in a variety of ways:
A Stock-keeping unit (SKU) is a separately identifiable class of item, which is complete in the sense that a customer in that form can utilize it.
Manufacturing, wholesale and retail inventory depends on the type of firm holding the inventory. These could be held in different forms for the same material. For example, wholesale in bulk form, and retail in packaged form.
During manufacturing, input inventory is raw material; an inventory in-between processing stage is referred to as work-in-process; and after the completion of manufacturing is called as finished goods inventory.
Transit or in-transit or pipeline inventory is inventory that either waiting or in the process of transportation. The speed of transportation and the point of time of ownership transfer of pipeline inventory determines the time of holding, and hence the cost of holding this inventory.
Seasonal stock refers to the material, which is purchased or manufactured in anticipation of seasonal demand.
Promotional stock is the additional stock kept ready for the increase in demand due to market promotions of products.
Speculative stock is the additional stock purchased as a hedge against the possibility of future increase in price of the material.
Dead stock is unused and / or obsolete stock, which cannot be sold.
In order to understand the concept of inventory terms are used for managing inventory at a logistical facility, let us first view the definitions:
Inventory level is the actual inventory quantity held at a logistical facility at a particular point of time.
Cycle inventory or base stock refers to the inventory quantity held in stock due to the replenishment time required in the ordering process.
Replenishment time or lead-time is the time elapsed between order placement and order receipt for an inventory item. In case inventory is to be replenished by manufacturing, this id the time elapsed between the work order issue for manufacturing and the completion of manufacturing.
Safety stock or buffer stock inventory is the inventory held due the differences in demand and supply rate of material at each stage in-between supplier, purchase, manufacture, distribution, and customer to avoid stock outs at each stage.
Average inventory is the calculated average of the inventory quantity held at a logistical facility over a period of time.
Reorder point is the pre-decided inventory level, which is reached by a falling inventory level during utilization of inventory, at which point an order is placed for replenishing the inventory in order to avoid a stock out.
Order quantity is the inventory quantity, which is ordered for replenishing depleting inventory.
Functions of Inventory
The necessity of holding inventory is due to the following functions of inventory:
Specialization:
A firm can either produce all the required variety products at a plant at one location, or, produce different products at separate plant locations. Locating separately will enable the firm to select the location of each different product manufacturing plant based on the particular requirements of that product, thus achieving specialization efficiencies like geographical facilities and economies of scale. This specialization approach creates inventory at diverse locations. Also, pipeline inventories are created due to transport linkages required between different manufacturing plants and with distribution warehouses.
Balancing supply and demand:
Demand depends upon the requirements of customers relating to time and quantity of products, and is not in the control of the producer. Supply, on the other hand is under the producer’s control, but has to be economized and also paced with the time and quantity requirements of customer demand. In order to ensure that customers are not dissatisfied when they demand the required quantity of products, it is necessary to have adequate inventory of products available at all times. This is the balancing inventory required due to the different rates of manufacturing and consumption. In case of seasonal products when production has to take place for a longer period of time in advance of the season, production throughout the year ensures lower investments in production capacities while increasing inventory. An example is the production of rainwear throughout the year for the sales which will occur only during the rainy season. Another example of balancing is seasonal production during raw material availability and year-round consumption, which also requires inventory. The example of this is seasonal availability of mango fruit and year-round consumption of mango –based products.
(3) Economies of scale:
Economies of scale are obtained by holding large inventories
a) While purchasing, ordering in large quantities provides cost economies and discounts; (b) transportation economies are obtained by transporting in larger quantities; and, (c) during manufacturing, producing in economic batch quantities lower costs.
(4) Overcoming uncertainty:
Safety stock of inventory is required to overcome uncertainty of customer demand on the one hand; and, purchasing, receiving, manufacturing, and order processing delays on the other. Either of these may result in shortages of products at the time of customer requirements if adequate safety stock of material is not provided for. If such material stock outs are not frequent occurrences, the customer may look elsewhere leading to a last order at the very least, or a lost customer. This uncertainty results in buffer stocks being created between (a) supplier and purchasing, (b) purchasing and production, (c) production and marketing, (d) marketing and distribution, (e) distribution and intermediary, (f) intermediary and customer, in order to avoid stock outs.
Classification of Inventories
Production inventories
They represent raw materials, parts and components that are used in the process of production. Production inventories include
Standard industrial items purchased from outside (also called bought outs)
Non-standard items (purchased items)
Special items manufactured in the factory itself (also called works made parts or piece parts.
(2) MRO inventories
They refer to the maintenance; repairs and operation supplies, which are consumed during process of, manufacture but do not become a part of the product.
(3)In-process inventories
They represent items in the semi-finished condition (i.e. items in the partially completed stage)
(4)Goods-In-Transit
They represent such materials, which have been paid for but have not yet been received by the stores.
Risks of Holding Inventory
The holding of inventory creates the following risks for a firm
The investments committed to a particular inventory combination are not available for alternative uses for the benefit of the firm. The risks in these case is due to the interest cost incurred on this inventory until the investment is recovered, as also the opportunity cost of profit which might have been made in alternative investment
The inventory may be pilfered or lost
The inventory may become absolute and/ or useless
Determination of inventory is another risk for holding inventory.
Inventory Cost
In operating an inventory system manager should consider only those costs that vary directly with the operating doctrine in deciding when and how much to recorder; cost independent of the operating doctrine are irrelevant. Basically, there are five types of relevant costs.
Cost of the item.
Cost of procuring the item.
Cost of carrying the item in inventory.
Cost associated with being out of stock when units are demanded but are unavailable (stock outs).
Cost associated with data gathering and control procedures for the inventory system.
Often these five costs are combined in one way or another, but let’s discuss them separately before we consider combinations.
(1)Cost of Item
The cost, or value, of the item is usually its purchase price: the amount paid to the supplier for the item. In some instances, however, transportation, receiving, or inspection costs, for example, may be included as part of the cost of the item. If the cost of the item per unit is constant for all quantities ordered, the total cost of items purchased during the planning horizon is irrelevant to the operating doctrine. If the unit cost varies with the quantity ordered, a price reduction called a quantity discount, this cost is relevant.
If the facility manufactures the item, the cost of the item is its direct manufacturing cost. Again, constant unit cost mean total costs are irrelevant.
(2) Procurement Costs
Procurement costs are the placing a purchase order or the setup costs if the item is manufactured at the facility. These costs vary directly with each purchase order placed. Procurement costs include costs of postage, telephone calls to the vendor, labor costs in purchasing and accounting, receiving costs, computer time for record keeping, and purchase order supplies.
(3) Carrying Costs
Carrying or holding casts are the costs of maintaining the inventory warehouse and protecting the inventoried items. Typical costs are insurance, security, warehouse rental, heat, lights taxes, and losses due to pilferage spoilage, or breakage. The cost of typing up capital inventory is also considered a carrying cost.
(4) Stockout Cost
Stock out cost, associated with demand when stocks have been, takes the form of lost sales or backorder costs. When sales are lost because of stockouts, the firm loses both the profit margin on unmade sale and its customer’s good will. If customers take their business elsewhere, future profit margins may also be lost. When customers agree to come back after inventories have been replenished, they make backorders. Backorder costs include loss of good will and money paid to reorder goods and notify customers when goods arrive. As the next example shows, stockouts can and do occur in the service industries.
(5) Cost of operating the information processing system
Whether by hand or by computer, someone must update records as stock levels change, for system in which inventory levels are not recorded daily, the cost is primarily incurred in obtaining accurate physical counts of inventories. Frequently, these operating costs are more fixed than variable over a wide quantity range. Therefore since fixed costs are not relevant to the operating doctrine, we will not consider them further.
(6) Cost tradeoffs
Our objective in the inventory control is to find the minimum cost operating doctrine over some planning horizon; these costs can be expressed in a general cost equation:
Total
Annual = cost of the items + procurement costs + carrying Costs + stock out cost
Relevant cycle stocks lost sales
Cost Buffer stocks Backorders
Fundamental approaches to managing Inventory
Traditional Inventory management has been deciding how much to order? And when to order? But challenges of today require inventory managers to find answer to the question ‘where’ to stock the material as this greatly influences customer satisfaction level. High level of inventory indicates higher customer satisfaction level, but cost of high inventory is obviously high. Hence the modern challenge is high customer satisfaction at minimum inventory
Reactive Approaches
Fixed Order Quantity Approach: ‘Q’ model
The above approach also called Q model signifies that the order quantity can be fixed at a level depending on demand, value and inventory related costs. A stock level called Re Order Level [ROL] is fixed, which triggers ordering. Re Order Level is the lead-time consumption or product of lead-time and demand rate during lead-time. When we follow this approach order quantity is fixed by calculating EOQ and ROL is fixed by calculating lead-time consumption. Inventory cycles can be conceptualized by looking at the figure given below and drawn in the class.
Constant monitoring is the main disadvantage of this model
Salient Features of the above approach
Widely used technique
Requires constant monitoring of stock levels
Suitable for high value and critical items
Limited by the assumptions made – cost of in transit inventory, volume transportation rates, use of private carriage, etc
Economic Order quantity
The order quantity depends upon the cost of the inventory items, the rate and nature of demand (whether constant or fluctuating), the replenishment time, and the inventory carrying costs and ordering costs for the inventory items.
The EOQ can be calculated with the help of a mathematical formula. Following assumptions are implied in the calculation:
Constant or uniform demand- although the EOQ model assumes constant demand, demand may vary from day to day. If demand is not known in advance- the model must be modified through the inclusion of safe stock.
Constant unit price- the EOQ model assumes that the purchase price per unit of material will remain unaltered irrespective of the order offered by the suppliers to include variable costs resulting from quantity discounts, the total costs in the EOQ model could be redefined.
Constant carrying costs- unit carrying costs may very substantially as the size of the inventory rises, perhaps decreasing because of economies of scale or storage efficiency or increasing as storage space runs out and new warehouses have to be rented.
Constant ordering cost- this assumption is generally valid. However any violation in this respect can be accommodated by modifying the EOQ model in a manner similar to the one used for variable unit price.
Instantaneous delivery- if delivery is not instantaneous, which is generally the case; the original EOQ model must be modified through the inclusion of a safe stock.
Independent orders- if multiple orders result in cost saving by reducing paper work and the transportation cost, the original EOQ model must be further modified. While this modification is somewhat complicated, special EOQ models have been developed to deal with it.
These assumptions have been pointed out to illustrate the limitations of the basic EOQ model and the ways in which it can be easily modified to compensate for them.
Fixed Order Interval Approach: ‘P’ model
The time between two successive orders [order interval], T is fixed and the maximum stock that can be stored, S is also fixed as pre-requisites for this approach. The inventory level is not monitored as in ‘Q’ model continuously but checked in intervals of T fixed as a policy decision. On the fixed day as per ‘T’ the stock is checked and the difference between current stock level and maximum sock ‘S’ is calculated. This difference is the order quantity, which will be ordered immediately. The order quantity arrives after the lead-time. Next inventory check will be only after the interval ‘T’.
Salient Features of the above approach
Widely used technique
Does not require constant monitoring of stock levels
Suitable for lower value and non critical items
Min-Max Approach – a modification to EOQ model
When we follow EOQ model, an order is released when ROL is reached. Here the assumption is stock depletion is at a specific rate ‘D’ during replenishment cycle. In reality when stock depletes in larger increments we may suddenly find that we are suddenly way below ROL. Min-Max Approach suggests that the actual order quantity should be the sum of EOQ and the difference between ROL and actual stock on hand at the time ROL occurs.
Just In Time
The time-based approach to inventory management came into focus when Toyota Motors Company came out with the concept of kanban in 1950. This lead to the dramatic reduction in WIP quantities tying the inventory closely to the demand from subsequent process or internal customer. Kanban is conceptually a two-bin system, a signal being raised to warrant replenishment.
JIT approach became a modern production system seeking to implant concept of stockless production. JIT embraced a variety of manufacturing concepts like reduced lot sizes, quick switch over [SMED], load leveling [response to tact time], group technology, statistical process control [control charts], preventive maintenance and quality circles.
QR, CR, AR, response-based techniques
Quick response
Information regarding retail sales is communicated by the retailer to the manufacturer via Electronic data Interface (EDI). The Manufacturer then decides upon the most effective and efficient replenishment response. The manufacturer then communicates the replenishment shipment schedule to the retailer to facilitate receipt. Thus, quick response is achieved by speedier technology-enabled information exchange.
Continuous replenishment strategy
Also known as vendor managed inventory. This approach eliminates the need for placing an order. Retail sales information is directly passed to the supplier, who takes the responsibility of replenishing the right variety of inventory at right time with advance shipping notification to the retailer
Automatic or profile Replenishment or AR
AR enables the supplier to anticipate the customers’ requirement in advance to make replenishment. The responsibility for inventory management is placed squarely on the supplier. There should be information flow between customer & supplier that makes inventory visibility possible. While this takes away the inventory management from the customer and gives it to the supplier, supplier gets the benefit of inventory visibility and more effective management to reduce total costs.
Planning approaches
Fair Share Allocation
Inventory planners decide to allocate an amount of inventory to a ware house based on the past consumption pattern of that particular facility from the available inventory volume at the source.
In the above example, in the plant warehouse the inventory is 600 units. If we decide to keep aside 100 units and allocate the balance, the allocation is done keeping the daily use performance pattern of the distribution centers. The methodology as given below.
Let A be the amount of inventory available for allocation.
Let I be the inventory in distribution center.
Let D be the daily demand,
Then a common day’s supply, DS, for distribution center inventories is,
A + ∑I
DS = --------------
∑D
500 + ∑50+100+75
DS = --------------------------
∑10+50+15
9.67days.
Now amount of inventory allocated to distribution center 1 is
[9.67 – 50/10]/10 = 4.67X10 = 46.7 units, say 47 units.
Similarly we can find allocations for distribution centers 2 & 3. We get 383 & 70 units. Fair share allocation method doesn’t take into account performance cycle times, EOQ & safety stock considerations.
Requirements Planning Approach
Requirements planning approach include materials or manufacturing requirement PlanNng or MRP, and DISTRIBUTION REQUIREMENTS PLANING or DRP. MRP controls inventory management from purchasing to Completion of manufacturing with delivery of finished goods to Plant Warehouse. DRP then takes over the inventory for distribution to the customers. MRP starts with MASTER PRODUCTION PLANNING (MPS) which details what, how much and when to manufacture based on forecasts and/or customer orders. On the basis of this end-product schedule, MRP prepares a schedule of raw Materials, Components and Sub-assemblies requirements to meet the MPS. DRP, on the other hand, starts with Customer Requirements for the end-product at diverse Geographical locations.
MRP DRP
Guiding factor Guided by production schedules
Guided by customer demand
Control of the firm Under control of the firm
Not under control of the firm
Demand situation Operates in dependant demand situation Operates in independent demand situation
Area of operation and coordination Coordinates scheduling and integration of materials into finished goods Coordinates demand between outlets and supply sources
Stage
of
functioning Controls inventory until manufacturing and assembly is complete. Controls and coordinates inventory after manufacturing and assembly of finished goods
The figure below shows the areas of functioning of MRP and DRP. MRP plans the procurement of raw materials as per their requirements, right from the first stage till the final assembly.
After the goods have been manufactured, DRP plans the distribution of finished goods from the plant warehouse to the wholesalers and retailers till it reaches the customer.
The integrated model seeks to combine these two areas. Taking into consideration the requirements of both MRP and DRP, it provides integrated planning.
Adaptive Logic Approach
Certain situations may warrant the use of a reactive inventory approach; while others may find the planning approach to be appropriate. In actual practice one night find a system wherein different conditions exist at difference locations and times requiring the use of both the reactive and panning approaches under different conditions. For example, during the product lifecycle, it is necessary to push the products through the distribution channels during the introductory and growth phases, while allowing customers to pull the inventories through the increased distribution channels during the saturation/maturity phases.
Techniques Of Inventory Management
ABC ANALYSIS
ABC analysis underlines a very important principle “Vital few: trivial many”. Statistics reveal that just a handful of items account for bulk of the annual expenditure on materials. These few items, called ‘A’ items, therefore, hold the key to business. The other items, known as ‘B’ and ‘C’ items, are numerous in number but their contribution is less significant. ABC analysis thus tends to segregate all items into three categories: A, B, and C on the basis of their annual usage. The categorization so made enables one to pay the right amount of attention as merited by the items.
A-items: it is usually found the hardly 5-10% of the total items account for 70-75% of the total money spent on the materials. These items require detailed and rigid control and need to be stocked in smaller quantities. These items should be procured frequently, the quantity per occasion being small.
B-items: these items are generally 10-15% of the total items and represent 10-15% of the total expenditure on the materials. These are intermediate items. The control on these items need not be as detailed and as rigid as applied to C items.
C-items: these items are generally 70-80% of the total items and represent 5-10% of the total expenditure on the materials. The procurement policy of these items is exactly the reverse of A items. C items should be procured infrequently and in sufficient quantities. This enables the buyers to avail price discounts and reduce work load of the concerned departments.
Policies of Control for A, B and c Categories.
Any sound stock control system should ensure that the each item gets the right amount of attention at the right time. ABC analysis makes this possible with considerably less efforts due to its selective approach there are number of ways in which ABC classification can be made use of:
Degree of Control
Some one at the senior level should be made responsible for regular reviewing of these items. Up-to-date and accurate records should be maintain for these items. “B” items should be brought under normal control made possible by goods record keeping and periodic attention. Little control is required for “C” items.
Ordering Procedure
A items should be subject to frequent review to reduce unwarranted stockouts and possibilities of overstocking. A reasonable good analysis for order points is required for “B” items but the stocks may be reviewed less frequently. No such computations are necessary for “C” items. These should be bought in bulk.
Staggering of delivery schedules
Staggering of delivery schedules is one of the best strategies to reduce the inventory investment and ensure un-interrupted inflow of materials. Staggered deliveries tend to reduce cost of order writing but increase the cost of inspection and receiving. Annual contract with scheduled deliveries are desirable for “A” and “B” class of items. “C” class of items, however, should be purchased in bulk on single-order-basis.
Stock records
Details records of goods ordered, received, issued and goods on hand should be maintained for “A” category of items. No such detailed records are necessary for “C” items. Any routine method that ensures goods and accurate records is enough for “B” category of items.
Priority treatment
VIP treatment may be accorded to A items in all activities such a processing of purchases orders, receiving, inspection movement on the shop floor, etc., with an object to reduce lead time and average inventory. No such treatment is necessary for “B” items. No priority is assigned to “C” items.
Safety Stock
All items of consumption are equally important from production point of view. Safety stock should be less for “A” items. The possibility of stockouts can considerably be cut down by closer forecasting, frequent reviewing and more progressing. “C” items, on the contrary, should have sufficient safety stock to eliminate progressing and to reduce the probability of stockouts. A moderate policy is required for “B” items, safety stock being neither too high nor too low.
Value Analysis
To secure maximum benefits, it is essential to select those items for value analysis which offer the highest scope for cost reduction. The usage classification is a useful step in this direction. Only “A” and “B” items are selected for detailed value analysis and the former is given priority over the latter. “C” items should not be value analysed.
HML ANALYSIS:
H-M-L analysis is similar to ABC analysis except for the difference that instead of “usage value”, “price” criterion is used. The items under this analysis are classified into three groups that are called “high”, “medium” and “low”. To classify, the items are listed in the descending order of their unit price. The management for deciding three categories then fixes the cut-off-lines. For example, the management may decide that all items of unit price above Rs. 1000/-will of ‘H’ category, those with unit price between Rs. 100/- to Rs.1000/- will be of ‘M’ category and those having unit price below Rs. 100/- will be of ‘L’ category.
HML analysis helps to -
Assess storage and security requirements
To keep control over consumption at the departmental head level
Determine the frequency of stock verification
To evolve buying policies to control purchase
To delegate authorities to different buyers to make petty cash purchase
VED ANALYSIS:
‘V’ stands for vital, ‘E’ for essential, ‘D’ for desirable. This classification is usually applied for spare parts to be stocked for maintenance of machines and equipments based on the criticality of the spare parts. The stocking policy is based on the criticality of the items. The vital spare parts are known as capital or insurance spares. The inventory policy is to keep at least one number of the vital spare irrespective of the long lead-time required for procurement. Essential spare parts are those whose non-availability may not adversely affect production. Such spare parts may be available from many sources within the country and the procurement lead time many not be long. Hence, a low inventory of essential spare parts is held. The desirable spare parts are those, which, if not available, can be manufactured by the maintenance department or may be procured from local suppliers and hence no stock is held usually.
S-D-E ANALYSIS:
S-D-E analysis is based on the problems of procurement namely:
Non-availability
Scarcity
Longer lead time
Geographical location of suppliers, and
Reliability of suppliers, etc.
S-D-E analysis classifies the items into three groups called “scarce”, “difficult” and “easy”. The information so developed is then used to decide purchasing strategies.
“Scare” classification comprise of items, which are in short supply, imported or canalized through government agencies. Such items are best to procure limited number of times a year in lieu of effort and expenditure involved in the procedure for import.
“Difficult” classification includes those items, which are available indigenously but are not easy to procure. Also items, which come from long distance and for which reliable sources do not exist, fall into this category. Even the items, which are difficult to manufacture and only one or two manufacturers are available belong to this group. Suppliers of such items require several weeks of advance notice.
“Easy” classification covers those items, which are readily available. Items produced to commercial standards, items where supply exceeds demand and others, which are locally available, fall into this group.
The purchase department employs S-D-E analysis:
To decide on the method of buying
To fix responsibility of buyers
GOLF ANALYSIS:
This stands for Government, Open Market, Local or Foreign source of supply. For many items, imports are canalized through Government agencies such as state trading corporation, minerals and metals trading corporation, Indian drugs and pharmaceutical etc.
For such items the buying firms cannot apply any inventory control techniques and hence to accept the quota allocated by the government. Open market category is those who form bulk of suppliers and procurement is rather easy. ‘L’ category includes those local suppliers from whom items can be purchased off-the-shelf on cash purchase basis. ‘F’ category indicates foreign suppliers since an elaborate import procedure is involved, it is better to buy imported items in bigger lots usually covering the annual requirements.
S-OS ANALYSIS
S-OS analysis is based on seasonality of the items and it classifies the items into two groups S (seasonal) and OS (off seasonal). The analysis identifies items which are:
Seasonal and are available only for a limited period. For example agriculture produce like raw mangoes, raw materials for cigarette and paper industries, etc. are available for a limited time and therefore such items procured to last the full year.
Seasonal but are available throughout the year. Their prices, however, are lower during the harvest time. The quantity of such items requires to be fixed after comparing the cost savings due to lower prices if purchased during season against higher cost of carrying inventories if purchased throughout the year.
Non-seasonal items whose quantity is decided on different considerations.
M-N-G ANALYSIS;
M-N-G analysis based on stock turn over rate and it classifies the items into M (moving items), N (non-moving items) and G (ghost items).
M (moving items) is those items, which are consumed from time to time. N (non-moving items) are those items, which are not consumed in the last one year. G (ghost items) is those items that had nil balance, both in the beginning and at the end of the last financial year and there were no transactions (receipt or issues) during the year.
Analysis mainly helps to identify non-existing items for which the store keeps bin-cards or waste computer memory or waste computer stationary while preparing stores ledger. Stores department even might have even ear-marked space for these non-existent items.
All pending/ open purchase orders (if any) of such items should be canceled.
F-S-N ANALYSIS;
F-S-N analysis is based on the consumption figures of the items. The items under this analysis are classified into three groups: F (fast moving), S (slow moving) and N (non-moving).
To conduct the analysis, the last date of receipt or the last date of issue whichever is later is taken into account and the period, usually in terms of number of months, that has elapsed since the last movement is recorded.
Such an analysis helps to identify:
Active items which require to be reviewed regularly
Surplus items whose stocks are higher than their rate of consumption; and
Non-moving items which are not being consumed
X-Y-Z ANALYSIS;
X-Y-Z analysis is based on value of the stocks on hand (i.e. inventory investment). Items whose inventory value are high are called as X items while those inventory value are low are called Z items. And Y items are those which have moderate inventory stocks.
Usually X-Y-Z analysis is used in conjunction with either ABC analysis or HML analysis.
XYZ analysis helps to identify a few items, which account for large amount of money in stock and take steps for their liquidation/retention.
XYZ when combined with FSN analysis helps to classify non-moving items into XN, YN, and ZN group and thereby identify a handful of non-moving items, which account for bulk of non-moving stock. These can be studied individually in details to take decision on their disposal or retention.
PECULIRITIES IN INDIA
All the well-known inventory control techniques have a basic assumption: “free availability of materials” as and when required in any quantity. This is however not true of Indian conditions. We operate in a seller’s market for most of the materials. There is a perpetual scarcity of key raw materials and the prices fluctuate widely. However, the techniques should not be discarded but used judiciously as a broad guideline, keeping in mind their limitations.
The Indian industry tends to stress a lot on production and machine utilization-this focus of attention in the context of scarcity of materials leads to hoarding of stocks. The inflation that prevails in the country prompts hoarding
In view of the shortage of foreign exchange, strict import procedures are enforced. The time taken for import clearance is high and the inventory of imported materials is therefore usually very high.
In its initial stage of industrial development, the country relied solely on foreign collaboration. Machinery and spare parts ware readily imported. The lack of technological knowledge made the country rely on the collaborators for the estimation of the requirements of spare parts. This stock of spares is abnormally high. It is extremely evident that these spares are useless and should be written off; however, for financial reasons they continue to exist on inventory records.
Inventory control systems are built on the foundation laid by materials management techniques such as ABC-VED analysis, standardization and codification. Setting up an inventory control system without the pre-use of these techniques is like building a castle in the air. The importance of ABC-VED analysis is brought out in the light of the inability to measures precise costs on the basis of which inventory levels could be set Standardization and codification help in variety reduction and make inventory control purposeful.
Inventories, built to act as a cushion between supply and demand, serve the following needs: it is sufficient to take care of the requirements of demand till the next supply arrives, it is sufficient to take care of probable delays in supply as well as probable variations in demand.
The problems that to be tackled are: the determination of the level of inventory for placing a replenishment order, the quantity to be ordered, the amount of delay in supplies and the amount of variations in demand which the inventory should be able to withstand. The problems can be resolved by the cost implications. Costs, which are relevant for consideration, are discussed in the following paragraphs.
Relevant Costs
Basically there are four costs relevant for consideration in developing an inventory model. These are: (1) the cost of placing a replenishment order, (2) the cost of carrying inventory, (3) the cost of under stocking, and (4) the cost of overstocking. The cost of ordering and the inventory carrying cost are viewed as the supply side costs and help in the determination of the quantity to be ordered for each replenishment. The understocking and overstocking costs are viewed as the demand side costs and help in the determination the amount of variations in demand and the delay in supplies, which the inventory should withstand.
Cost of ordering
Every time an order is placed for stock replenishment, certain are involved, and, for most practical purposes, it can be assumed that the cost per order is constant. The ordering cost—C o may very, dependent upon the type of items: raw materials like steel against production components like casting. However, it is assumed that an estimate Co can be obtained for a given range of items. This cost of ordering, Co includes:
Paper work costs, typing and dispatching an order.
Follow-up costs – the follow-up required to ensure timely suppliers- includes the travel cost for purchase follow-up, telephone, telex and postal bills.
Costs involved in receiving the order, inspection, checking and handing to the stores.
Any set up cost of machines if charged by the supplier, either directly indicated in quotations or assessed through quotations for various quantities.
The salaries and wages to the purchase department. This is relevant for consideration if the purchase function is carried out at same level with the existing staff. If the level of purchasing activity decreases significantly, obviously a proportional amount of personnel will be transferred to other departments.
If the level of purchasing increases, the extra load will be tackled by paying overtime to existing staff or by recruiting new personnel. This additional cost can be viewed as the marginal cost of orders. The ordering cost in a typical Indian firm is around Rs. 100 per order, but experience shows that this cost varies considerably depending upon the efficiency of the purchasing department
Some firms operate on the basis of “receipt cost” particularly when dealing with staggered delivers. The mathematical models can be suitably modified to get the “economic receipt quantity” instead of “economic order quantity’.
Cost of Inventory Carrying
This cost Cc is measured as a percentage of the unit cost of the item. This measure, therefore, gives a basis for estimating what it actually costs a firm to carry stock. This cost includes: 1) interest on capital, (2) insurance and tax charges, (3) storage costs-any labour, excluding handing of receipts of new orders-the costs of provision of storage area and facilities like bins, racks, etc… (4) allowance for deterioration or spoilage, (5) Salaries of stores staff, and (6) obsolescence. The inventory carrying cost varies and in a typical Indian industry is about 30 percent. A major portion of this is accounted for by he interest on capital, which depends on the fiscal policies of the government. A few firms differentiate the costs as fixed and variable. In the analysis of and use of mathematical formula, only the variable costs of ordering should be considered as the fixed costs will be constant irrespective of the number of orders placed or the inventory carried
Understocking Cost
This cost, Ku is the cost incurred when an item is out of stock. It includes the cost of lost production during the period of stock out and extra cost per unit, which might have to be paid for an emergency purchase.
Overstocking Cost
This cost K o is the inventory carrying (which is calculated per year) for a specific period of time. The time varies in different contexts- it could be the lead time of procurement or the entire life-time of a machine. In the case of one-time purchases, overstocking cost would be: purchase price-scrap price.
Based on the above costs several scientific models have been developed and these are discussed separately for consumables and for spares in the following chapters. The need for using these models in India has been stressed by various committees. For example, the report of the committee* on public undertakings mentions: “For proper inventory control, it is essential to adopt the scientific practices and techniques that have been developed in this regard”.
Spare parts management
Spare parts management is an important section of any system and a part that needs much planning and organization. The right parts much be ready when need to prevent the process to stop and the project to be slowed down to much. On the other hand, too many spare parts will mean a both unpractical and expensive situation.
Spare Parts Management Indicators
There is a saying: “What you can’t measure, you can’t improve”. The saying
are not necessarily always true, but it is interesting, because I think a
derivative of the saying is true: “What you measure, is usually what you
get”.
Reducing Inventory Value
It is common for plants to have a lot of focus on reducing inventory value.
Inventory value is one of those numbers that acts like salt in a wound for
corporate accountants. No, it doesn’t matter if it’s high or low, it always
hurt to look at the number. Most of the time we don’t know if the number is
too high or too low, we just know we want the number to be lower.
Cost of Keeping Spare Parts and Materials.
The cost for keeping inventory is usually an estimated number, often called
“inventory interest” (or similar), that varies from 10-40% depending on
company accounting rules. The cost included storeroom, storeroom personnel,
depreciation, etc. If you have a spare parts and materials inventory value
of 10 Million, it costs the company 1-4 Millions (10-40%) a year to keep
that spare parts and materials inventory.
The Problem
Since it is common that inventory value is the only number the plant really
cares about, it tends to get reduced. But, anyone can reduce inventory value
very easily, IF it’s the only thing that matters. I can tell you to scrap
all spare parts right now bringing your spare parts and materials inventory
to zero. But the consequences will be devastating to production since we
don’t have any spare parts.
Measure a “Counterweight”
Spare parts inventory value is important, but to effectively reduce spare
parts inventory value, the “counterweight” has to be measured as well. The
counterweight to inventory value can be “stock-outs” for example (times we
get the spare part needed divided by total request for spare parts). When
stock outs go over around 4-5%, you will start seeing signs of people not
trusting the storeroom. These signs are spare parts in supervisor’s office,
satellite stores, spare parts in crafts peoples toolboxes etc.
In financial parlance, inventory is defined as the sum of the value of raw materials, fuels and lubricants, spare parts, maintenance consumables, semi-processed materials and finished goods stock at any given point of time. The operational definition of inventory would be: the amount of raw materials, fuel and lubricants, spare parts and semi-processed material to be stocked for the smooth running of the plant. Since these resources are idle when kept in stores, inventory is defined as an idle resource of any kind having an economic value.
Inventories are maintained basically for the operational smoothness, which they can affect by uncoupling successive stages of production, whereas the monetary value of inventory serves as a guide to indicate the size of the investment made to achieve this operational convenience. The materials management department is expected to provide this operational convenience with a minimum possible investment in inventories. The objectives of inventory, operational and financial, needless to say, are conflicting. The materials department is accused of both stockouts as well as large investment in inventories. The solution lies in exercising a selective inventory control and application of inventory control techniques.
Inventory terminology
Inventory or stock is referred to in a variety of ways:
A Stock-keeping unit (SKU) is a separately identifiable class of item, which is complete in the sense that a customer in that form can utilize it.
Manufacturing, wholesale and retail inventory depends on the type of firm holding the inventory. These could be held in different forms for the same material. For example, wholesale in bulk form, and retail in packaged form.
During manufacturing, input inventory is raw material; an inventory in-between processing stage is referred to as work-in-process; and after the completion of manufacturing is called as finished goods inventory.
Transit or in-transit or pipeline inventory is inventory that either waiting or in the process of transportation. The speed of transportation and the point of time of ownership transfer of pipeline inventory determines the time of holding, and hence the cost of holding this inventory.
Seasonal stock refers to the material, which is purchased or manufactured in anticipation of seasonal demand.
Promotional stock is the additional stock kept ready for the increase in demand due to market promotions of products.
Speculative stock is the additional stock purchased as a hedge against the possibility of future increase in price of the material.
Dead stock is unused and / or obsolete stock, which cannot be sold.
In order to understand the concept of inventory terms are used for managing inventory at a logistical facility, let us first view the definitions:
Inventory level is the actual inventory quantity held at a logistical facility at a particular point of time.
Cycle inventory or base stock refers to the inventory quantity held in stock due to the replenishment time required in the ordering process.
Replenishment time or lead-time is the time elapsed between order placement and order receipt for an inventory item. In case inventory is to be replenished by manufacturing, this id the time elapsed between the work order issue for manufacturing and the completion of manufacturing.
Safety stock or buffer stock inventory is the inventory held due the differences in demand and supply rate of material at each stage in-between supplier, purchase, manufacture, distribution, and customer to avoid stock outs at each stage.
Average inventory is the calculated average of the inventory quantity held at a logistical facility over a period of time.
Reorder point is the pre-decided inventory level, which is reached by a falling inventory level during utilization of inventory, at which point an order is placed for replenishing the inventory in order to avoid a stock out.
Order quantity is the inventory quantity, which is ordered for replenishing depleting inventory.
Functions of Inventory
The necessity of holding inventory is due to the following functions of inventory:
Specialization:
A firm can either produce all the required variety products at a plant at one location, or, produce different products at separate plant locations. Locating separately will enable the firm to select the location of each different product manufacturing plant based on the particular requirements of that product, thus achieving specialization efficiencies like geographical facilities and economies of scale. This specialization approach creates inventory at diverse locations. Also, pipeline inventories are created due to transport linkages required between different manufacturing plants and with distribution warehouses.
Balancing supply and demand:
Demand depends upon the requirements of customers relating to time and quantity of products, and is not in the control of the producer. Supply, on the other hand is under the producer’s control, but has to be economized and also paced with the time and quantity requirements of customer demand. In order to ensure that customers are not dissatisfied when they demand the required quantity of products, it is necessary to have adequate inventory of products available at all times. This is the balancing inventory required due to the different rates of manufacturing and consumption. In case of seasonal products when production has to take place for a longer period of time in advance of the season, production throughout the year ensures lower investments in production capacities while increasing inventory. An example is the production of rainwear throughout the year for the sales which will occur only during the rainy season. Another example of balancing is seasonal production during raw material availability and year-round consumption, which also requires inventory. The example of this is seasonal availability of mango fruit and year-round consumption of mango –based products.
(3) Economies of scale:
Economies of scale are obtained by holding large inventories
a) While purchasing, ordering in large quantities provides cost economies and discounts; (b) transportation economies are obtained by transporting in larger quantities; and, (c) during manufacturing, producing in economic batch quantities lower costs.(4) Overcoming uncertainty:
Safety stock of inventory is required to overcome uncertainty of customer demand on the one hand; and, purchasing, receiving, manufacturing, and order processing delays on the other. Either of these may result in shortages of products at the time of customer requirements if adequate safety stock of material is not provided for. If such material stock outs are not frequent occurrences, the customer may look elsewhere leading to a last order at the very least, or a lost customer. This uncertainty results in buffer stocks being created between (a) supplier and purchasing, (b) purchasing and production, (c) production and marketing, (d) marketing and distribution, (e) distribution and intermediary, (f) intermediary and customer, in order to avoid stock outs.
Classification of Inventories
Production inventories
They represent raw materials, parts and components that are used in the process of production. Production inventories include
Standard industrial items purchased from outside (also called bought outs)
Non-standard items (purchased items)
Special items manufactured in the factory itself (also called works made parts or piece parts.
(2) MRO inventories
They refer to the maintenance; repairs and operation supplies, which are consumed during process of, manufacture but do not become a part of the product.
(3)In-process inventories
They represent items in the semi-finished condition (i.e. items in the partially completed stage)
(4)Goods-In-Transit
They represent such materials, which have been paid for but have not yet been received by the stores.
Risks of Holding Inventory
The holding of inventory creates the following risks for a firm
The investments committed to a particular inventory combination are not available for alternative uses for the benefit of the firm. The risks in these case is due to the interest cost incurred on this inventory until the investment is recovered, as also the opportunity cost of profit which might have been made in alternative investment
The inventory may be pilfered or lost
The inventory may become absolute and/ or useless
Determination of inventory is another risk for holding inventory.
Inventory Cost
In operating an inventory system manager should consider only those costs that vary directly with the operating doctrine in deciding when and how much to recorder; cost independent of the operating doctrine are irrelevant. Basically, there are five types of relevant costs.
Cost of the item.
Cost of procuring the item.
Cost of carrying the item in inventory.
Cost associated with being out of stock when units are demanded but are unavailable (stock outs).
Cost associated with data gathering and control procedures for the inventory system.
Often these five costs are combined in one way or another, but let’s discuss them separately before we consider combinations.
(1)Cost of Item
The cost, or value, of the item is usually its purchase price: the amount paid to the supplier for the item. In some instances, however, transportation, receiving, or inspection costs, for example, may be included as part of the cost of the item. If the cost of the item per unit is constant for all quantities ordered, the total cost of items purchased during the planning horizon is irrelevant to the operating doctrine. If the unit cost varies with the quantity ordered, a price reduction called a quantity discount, this cost is relevant.
If the facility manufactures the item, the cost of the item is its direct manufacturing cost. Again, constant unit cost mean total costs are irrelevant.
(2) Procurement Costs
Procurement costs are the placing a purchase order or the setup costs if the item is manufactured at the facility. These costs vary directly with each purchase order placed. Procurement costs include costs of postage, telephone calls to the vendor, labor costs in purchasing and accounting, receiving costs, computer time for record keeping, and purchase order supplies.
(3) Carrying Costs
Carrying or holding casts are the costs of maintaining the inventory warehouse and protecting the inventoried items. Typical costs are insurance, security, warehouse rental, heat, lights taxes, and losses due to pilferage spoilage, or breakage. The cost of typing up capital inventory is also considered a carrying cost.
(4) Stockout Cost
Stock out cost, associated with demand when stocks have been, takes the form of lost sales or backorder costs. When sales are lost because of stockouts, the firm loses both the profit margin on unmade sale and its customer’s good will. If customers take their business elsewhere, future profit margins may also be lost. When customers agree to come back after inventories have been replenished, they make backorders. Backorder costs include loss of good will and money paid to reorder goods and notify customers when goods arrive. As the next example shows, stockouts can and do occur in the service industries.
(5) Cost of operating the information processing system
Whether by hand or by computer, someone must update records as stock levels change, for system in which inventory levels are not recorded daily, the cost is primarily incurred in obtaining accurate physical counts of inventories. Frequently, these operating costs are more fixed than variable over a wide quantity range. Therefore since fixed costs are not relevant to the operating doctrine, we will not consider them further.
(6) Cost tradeoffs
Our objective in the inventory control is to find the minimum cost operating doctrine over some planning horizon; these costs can be expressed in a general cost equation:
Total
Annual = cost of the items + procurement costs + carrying Costs + stock out cost
Relevant cycle stocks lost sales
Cost Buffer stocks Backorders
Fundamental approaches to managing Inventory
Traditional Inventory management has been deciding how much to order? And when to order? But challenges of today require inventory managers to find answer to the question ‘where’ to stock the material as this greatly influences customer satisfaction level. High level of inventory indicates higher customer satisfaction level, but cost of high inventory is obviously high. Hence the modern challenge is high customer satisfaction at minimum inventory
Reactive Approaches
Fixed Order Quantity Approach: ‘Q’ model
The above approach also called Q model signifies that the order quantity can be fixed at a level depending on demand, value and inventory related costs. A stock level called Re Order Level [ROL] is fixed, which triggers ordering. Re Order Level is the lead-time consumption or product of lead-time and demand rate during lead-time. When we follow this approach order quantity is fixed by calculating EOQ and ROL is fixed by calculating lead-time consumption. Inventory cycles can be conceptualized by looking at the figure given below and drawn in the class.
Constant monitoring is the main disadvantage of this model
Salient Features of the above approach
Widely used technique
Requires constant monitoring of stock levels
Suitable for high value and critical items
Limited by the assumptions made – cost of in transit inventory, volume transportation rates, use of private carriage, etc
Economic Order quantity
The order quantity depends upon the cost of the inventory items, the rate and nature of demand (whether constant or fluctuating), the replenishment time, and the inventory carrying costs and ordering costs for the inventory items.
The EOQ can be calculated with the help of a mathematical formula. Following assumptions are implied in the calculation:
Constant or uniform demand- although the EOQ model assumes constant demand, demand may vary from day to day. If demand is not known in advance- the model must be modified through the inclusion of safe stock.
Constant unit price- the EOQ model assumes that the purchase price per unit of material will remain unaltered irrespective of the order offered by the suppliers to include variable costs resulting from quantity discounts, the total costs in the EOQ model could be redefined.
Constant carrying costs- unit carrying costs may very substantially as the size of the inventory rises, perhaps decreasing because of economies of scale or storage efficiency or increasing as storage space runs out and new warehouses have to be rented.
Constant ordering cost- this assumption is generally valid. However any violation in this respect can be accommodated by modifying the EOQ model in a manner similar to the one used for variable unit price.
Instantaneous delivery- if delivery is not instantaneous, which is generally the case; the original EOQ model must be modified through the inclusion of a safe stock.
Independent orders- if multiple orders result in cost saving by reducing paper work and the transportation cost, the original EOQ model must be further modified. While this modification is somewhat complicated, special EOQ models have been developed to deal with it.
These assumptions have been pointed out to illustrate the limitations of the basic EOQ model and the ways in which it can be easily modified to compensate for them.
Fixed Order Interval Approach: ‘P’ model
The time between two successive orders [order interval], T is fixed and the maximum stock that can be stored, S is also fixed as pre-requisites for this approach. The inventory level is not monitored as in ‘Q’ model continuously but checked in intervals of T fixed as a policy decision. On the fixed day as per ‘T’ the stock is checked and the difference between current stock level and maximum sock ‘S’ is calculated. This difference is the order quantity, which will be ordered immediately. The order quantity arrives after the lead-time. Next inventory check will be only after the interval ‘T’.
Salient Features of the above approach
Widely used technique
Does not require constant monitoring of stock levels
Suitable for lower value and non critical items
Min-Max Approach – a modification to EOQ model
When we follow EOQ model, an order is released when ROL is reached. Here the assumption is stock depletion is at a specific rate ‘D’ during replenishment cycle. In reality when stock depletes in larger increments we may suddenly find that we are suddenly way below ROL. Min-Max Approach suggests that the actual order quantity should be the sum of EOQ and the difference between ROL and actual stock on hand at the time ROL occurs.
Just In Time
The time-based approach to inventory management came into focus when Toyota Motors Company came out with the concept of kanban in 1950. This lead to the dramatic reduction in WIP quantities tying the inventory closely to the demand from subsequent process or internal customer. Kanban is conceptually a two-bin system, a signal being raised to warrant replenishment.
JIT approach became a modern production system seeking to implant concept of stockless production. JIT embraced a variety of manufacturing concepts like reduced lot sizes, quick switch over [SMED], load leveling [response to tact time], group technology, statistical process control [control charts], preventive maintenance and quality circles.
QR, CR, AR, response-based techniques
Quick response
Information regarding retail sales is communicated by the retailer to the manufacturer via Electronic data Interface (EDI). The Manufacturer then decides upon the most effective and efficient replenishment response. The manufacturer then communicates the replenishment shipment schedule to the retailer to facilitate receipt. Thus, quick response is achieved by speedier technology-enabled information exchange.
Continuous replenishment strategy
Also known as vendor managed inventory. This approach eliminates the need for placing an order. Retail sales information is directly passed to the supplier, who takes the responsibility of replenishing the right variety of inventory at right time with advance shipping notification to the retailer
Automatic or profile Replenishment or AR
AR enables the supplier to anticipate the customers’ requirement in advance to make replenishment. The responsibility for inventory management is placed squarely on the supplier. There should be information flow between customer & supplier that makes inventory visibility possible. While this takes away the inventory management from the customer and gives it to the supplier, supplier gets the benefit of inventory visibility and more effective management to reduce total costs.
Planning approaches
Fair Share Allocation
Inventory planners decide to allocate an amount of inventory to a ware house based on the past consumption pattern of that particular facility from the available inventory volume at the source.
In the above example, in the plant warehouse the inventory is 600 units. If we decide to keep aside 100 units and allocate the balance, the allocation is done keeping the daily use performance pattern of the distribution centers. The methodology as given below.
Let A be the amount of inventory available for allocation.
Let I be the inventory in distribution center.
Let D be the daily demand,
Then a common day’s supply, DS, for distribution center inventories is,
A + ∑I
DS = --------------
∑D
500 + ∑50+100+75
DS = --------------------------
∑10+50+15
9.67days.
Now amount of inventory allocated to distribution center 1 is
[9.67 – 50/10]/10 = 4.67X10 = 46.7 units, say 47 units.
Similarly we can find allocations for distribution centers 2 & 3. We get 383 & 70 units. Fair share allocation method doesn’t take into account performance cycle times, EOQ & safety stock considerations.
Requirements Planning Approach
Requirements planning approach include materials or manufacturing requirement PlanNng or MRP, and DISTRIBUTION REQUIREMENTS PLANING or DRP. MRP controls inventory management from purchasing to Completion of manufacturing with delivery of finished goods to Plant Warehouse. DRP then takes over the inventory for distribution to the customers. MRP starts with MASTER PRODUCTION PLANNING (MPS) which details what, how much and when to manufacture based on forecasts and/or customer orders. On the basis of this end-product schedule, MRP prepares a schedule of raw Materials, Components and Sub-assemblies requirements to meet the MPS. DRP, on the other hand, starts with Customer Requirements for the end-product at diverse Geographical locations.
MRP DRP
Guiding factor Guided by production schedules
Guided by customer demand
Control of the firm Under control of the firm
Not under control of the firm
Demand situation Operates in dependant demand situation Operates in independent demand situation
Area of operation and coordination Coordinates scheduling and integration of materials into finished goods Coordinates demand between outlets and supply sources
Stage
of
functioning Controls inventory until manufacturing and assembly is complete. Controls and coordinates inventory after manufacturing and assembly of finished goods
The figure below shows the areas of functioning of MRP and DRP. MRP plans the procurement of raw materials as per their requirements, right from the first stage till the final assembly.
After the goods have been manufactured, DRP plans the distribution of finished goods from the plant warehouse to the wholesalers and retailers till it reaches the customer.
The integrated model seeks to combine these two areas. Taking into consideration the requirements of both MRP and DRP, it provides integrated planning.
Adaptive Logic Approach
Certain situations may warrant the use of a reactive inventory approach; while others may find the planning approach to be appropriate. In actual practice one night find a system wherein different conditions exist at difference locations and times requiring the use of both the reactive and panning approaches under different conditions. For example, during the product lifecycle, it is necessary to push the products through the distribution channels during the introductory and growth phases, while allowing customers to pull the inventories through the increased distribution channels during the saturation/maturity phases.
Techniques Of Inventory Management
ABC ANALYSIS
ABC analysis underlines a very important principle “Vital few: trivial many”. Statistics reveal that just a handful of items account for bulk of the annual expenditure on materials. These few items, called ‘A’ items, therefore, hold the key to business. The other items, known as ‘B’ and ‘C’ items, are numerous in number but their contribution is less significant. ABC analysis thus tends to segregate all items into three categories: A, B, and C on the basis of their annual usage. The categorization so made enables one to pay the right amount of attention as merited by the items.
A-items: it is usually found the hardly 5-10% of the total items account for 70-75% of the total money spent on the materials. These items require detailed and rigid control and need to be stocked in smaller quantities. These items should be procured frequently, the quantity per occasion being small.
B-items: these items are generally 10-15% of the total items and represent 10-15% of the total expenditure on the materials. These are intermediate items. The control on these items need not be as detailed and as rigid as applied to C items.
C-items: these items are generally 70-80% of the total items and represent 5-10% of the total expenditure on the materials. The procurement policy of these items is exactly the reverse of A items. C items should be procured infrequently and in sufficient quantities. This enables the buyers to avail price discounts and reduce work load of the concerned departments.
Policies of Control for A, B and c Categories.
Any sound stock control system should ensure that the each item gets the right amount of attention at the right time. ABC analysis makes this possible with considerably less efforts due to its selective approach there are number of ways in which ABC classification can be made use of:
Degree of Control
Some one at the senior level should be made responsible for regular reviewing of these items. Up-to-date and accurate records should be maintain for these items. “B” items should be brought under normal control made possible by goods record keeping and periodic attention. Little control is required for “C” items.
Ordering Procedure
A items should be subject to frequent review to reduce unwarranted stockouts and possibilities of overstocking. A reasonable good analysis for order points is required for “B” items but the stocks may be reviewed less frequently. No such computations are necessary for “C” items. These should be bought in bulk.
Staggering of delivery schedules
Staggering of delivery schedules is one of the best strategies to reduce the inventory investment and ensure un-interrupted inflow of materials. Staggered deliveries tend to reduce cost of order writing but increase the cost of inspection and receiving. Annual contract with scheduled deliveries are desirable for “A” and “B” class of items. “C” class of items, however, should be purchased in bulk on single-order-basis.
Stock records
Details records of goods ordered, received, issued and goods on hand should be maintained for “A” category of items. No such detailed records are necessary for “C” items. Any routine method that ensures goods and accurate records is enough for “B” category of items.
Priority treatment
VIP treatment may be accorded to A items in all activities such a processing of purchases orders, receiving, inspection movement on the shop floor, etc., with an object to reduce lead time and average inventory. No such treatment is necessary for “B” items. No priority is assigned to “C” items.
Safety Stock
All items of consumption are equally important from production point of view. Safety stock should be less for “A” items. The possibility of stockouts can considerably be cut down by closer forecasting, frequent reviewing and more progressing. “C” items, on the contrary, should have sufficient safety stock to eliminate progressing and to reduce the probability of stockouts. A moderate policy is required for “B” items, safety stock being neither too high nor too low.
Value Analysis
To secure maximum benefits, it is essential to select those items for value analysis which offer the highest scope for cost reduction. The usage classification is a useful step in this direction. Only “A” and “B” items are selected for detailed value analysis and the former is given priority over the latter. “C” items should not be value analysed.
HML ANALYSIS:
H-M-L analysis is similar to ABC analysis except for the difference that instead of “usage value”, “price” criterion is used. The items under this analysis are classified into three groups that are called “high”, “medium” and “low”. To classify, the items are listed in the descending order of their unit price. The management for deciding three categories then fixes the cut-off-lines. For example, the management may decide that all items of unit price above Rs. 1000/-will of ‘H’ category, those with unit price between Rs. 100/- to Rs.1000/- will be of ‘M’ category and those having unit price below Rs. 100/- will be of ‘L’ category.
HML analysis helps to -
Assess storage and security requirements
To keep control over consumption at the departmental head level
Determine the frequency of stock verification
To evolve buying policies to control purchase
To delegate authorities to different buyers to make petty cash purchase
VED ANALYSIS:
‘V’ stands for vital, ‘E’ for essential, ‘D’ for desirable. This classification is usually applied for spare parts to be stocked for maintenance of machines and equipments based on the criticality of the spare parts. The stocking policy is based on the criticality of the items. The vital spare parts are known as capital or insurance spares. The inventory policy is to keep at least one number of the vital spare irrespective of the long lead-time required for procurement. Essential spare parts are those whose non-availability may not adversely affect production. Such spare parts may be available from many sources within the country and the procurement lead time many not be long. Hence, a low inventory of essential spare parts is held. The desirable spare parts are those, which, if not available, can be manufactured by the maintenance department or may be procured from local suppliers and hence no stock is held usually.
S-D-E ANALYSIS:
S-D-E analysis is based on the problems of procurement namely:
Non-availability
Scarcity
Longer lead time
Geographical location of suppliers, and
Reliability of suppliers, etc.
S-D-E analysis classifies the items into three groups called “scarce”, “difficult” and “easy”. The information so developed is then used to decide purchasing strategies.
“Scare” classification comprise of items, which are in short supply, imported or canalized through government agencies. Such items are best to procure limited number of times a year in lieu of effort and expenditure involved in the procedure for import.
“Difficult” classification includes those items, which are available indigenously but are not easy to procure. Also items, which come from long distance and for which reliable sources do not exist, fall into this category. Even the items, which are difficult to manufacture and only one or two manufacturers are available belong to this group. Suppliers of such items require several weeks of advance notice.
“Easy” classification covers those items, which are readily available. Items produced to commercial standards, items where supply exceeds demand and others, which are locally available, fall into this group.
The purchase department employs S-D-E analysis:
To decide on the method of buying
To fix responsibility of buyers
GOLF ANALYSIS:
This stands for Government, Open Market, Local or Foreign source of supply. For many items, imports are canalized through Government agencies such as state trading corporation, minerals and metals trading corporation, Indian drugs and pharmaceutical etc.
For such items the buying firms cannot apply any inventory control techniques and hence to accept the quota allocated by the government. Open market category is those who form bulk of suppliers and procurement is rather easy. ‘L’ category includes those local suppliers from whom items can be purchased off-the-shelf on cash purchase basis. ‘F’ category indicates foreign suppliers since an elaborate import procedure is involved, it is better to buy imported items in bigger lots usually covering the annual requirements.
S-OS ANALYSIS
S-OS analysis is based on seasonality of the items and it classifies the items into two groups S (seasonal) and OS (off seasonal). The analysis identifies items which are:
Seasonal and are available only for a limited period. For example agriculture produce like raw mangoes, raw materials for cigarette and paper industries, etc. are available for a limited time and therefore such items procured to last the full year.
Seasonal but are available throughout the year. Their prices, however, are lower during the harvest time. The quantity of such items requires to be fixed after comparing the cost savings due to lower prices if purchased during season against higher cost of carrying inventories if purchased throughout the year.
Non-seasonal items whose quantity is decided on different considerations.
M-N-G ANALYSIS;
M-N-G analysis based on stock turn over rate and it classifies the items into M (moving items), N (non-moving items) and G (ghost items).
M (moving items) is those items, which are consumed from time to time. N (non-moving items) are those items, which are not consumed in the last one year. G (ghost items) is those items that had nil balance, both in the beginning and at the end of the last financial year and there were no transactions (receipt or issues) during the year.
Analysis mainly helps to identify non-existing items for which the store keeps bin-cards or waste computer memory or waste computer stationary while preparing stores ledger. Stores department even might have even ear-marked space for these non-existent items.
All pending/ open purchase orders (if any) of such items should be canceled.
F-S-N ANALYSIS;
F-S-N analysis is based on the consumption figures of the items. The items under this analysis are classified into three groups: F (fast moving), S (slow moving) and N (non-moving).
To conduct the analysis, the last date of receipt or the last date of issue whichever is later is taken into account and the period, usually in terms of number of months, that has elapsed since the last movement is recorded.
Such an analysis helps to identify:
Active items which require to be reviewed regularly
Surplus items whose stocks are higher than their rate of consumption; and
Non-moving items which are not being consumed
X-Y-Z ANALYSIS;
X-Y-Z analysis is based on value of the stocks on hand (i.e. inventory investment). Items whose inventory value are high are called as X items while those inventory value are low are called Z items. And Y items are those which have moderate inventory stocks.
Usually X-Y-Z analysis is used in conjunction with either ABC analysis or HML analysis.
XYZ analysis helps to identify a few items, which account for large amount of money in stock and take steps for their liquidation/retention.
XYZ when combined with FSN analysis helps to classify non-moving items into XN, YN, and ZN group and thereby identify a handful of non-moving items, which account for bulk of non-moving stock. These can be studied individually in details to take decision on their disposal or retention.
PECULIRITIES IN INDIA
All the well-known inventory control techniques have a basic assumption: “free availability of materials” as and when required in any quantity. This is however not true of Indian conditions. We operate in a seller’s market for most of the materials. There is a perpetual scarcity of key raw materials and the prices fluctuate widely. However, the techniques should not be discarded but used judiciously as a broad guideline, keeping in mind their limitations.
The Indian industry tends to stress a lot on production and machine utilization-this focus of attention in the context of scarcity of materials leads to hoarding of stocks. The inflation that prevails in the country prompts hoarding
In view of the shortage of foreign exchange, strict import procedures are enforced. The time taken for import clearance is high and the inventory of imported materials is therefore usually very high.
In its initial stage of industrial development, the country relied solely on foreign collaboration. Machinery and spare parts ware readily imported. The lack of technological knowledge made the country rely on the collaborators for the estimation of the requirements of spare parts. This stock of spares is abnormally high. It is extremely evident that these spares are useless and should be written off; however, for financial reasons they continue to exist on inventory records.
Inventory control systems are built on the foundation laid by materials management techniques such as ABC-VED analysis, standardization and codification. Setting up an inventory control system without the pre-use of these techniques is like building a castle in the air. The importance of ABC-VED analysis is brought out in the light of the inability to measures precise costs on the basis of which inventory levels could be set Standardization and codification help in variety reduction and make inventory control purposeful.
Inventories, built to act as a cushion between supply and demand, serve the following needs: it is sufficient to take care of the requirements of demand till the next supply arrives, it is sufficient to take care of probable delays in supply as well as probable variations in demand.
The problems that to be tackled are: the determination of the level of inventory for placing a replenishment order, the quantity to be ordered, the amount of delay in supplies and the amount of variations in demand which the inventory should be able to withstand. The problems can be resolved by the cost implications. Costs, which are relevant for consideration, are discussed in the following paragraphs.
Relevant Costs
Basically there are four costs relevant for consideration in developing an inventory model. These are: (1) the cost of placing a replenishment order, (2) the cost of carrying inventory, (3) the cost of under stocking, and (4) the cost of overstocking. The cost of ordering and the inventory carrying cost are viewed as the supply side costs and help in the determination of the quantity to be ordered for each replenishment. The understocking and overstocking costs are viewed as the demand side costs and help in the determination the amount of variations in demand and the delay in supplies, which the inventory should withstand.
Cost of ordering
Every time an order is placed for stock replenishment, certain are involved, and, for most practical purposes, it can be assumed that the cost per order is constant. The ordering cost—C o may very, dependent upon the type of items: raw materials like steel against production components like casting. However, it is assumed that an estimate Co can be obtained for a given range of items. This cost of ordering, Co includes:
Paper work costs, typing and dispatching an order.
Follow-up costs – the follow-up required to ensure timely suppliers- includes the travel cost for purchase follow-up, telephone, telex and postal bills.
Costs involved in receiving the order, inspection, checking and handing to the stores.
Any set up cost of machines if charged by the supplier, either directly indicated in quotations or assessed through quotations for various quantities.
The salaries and wages to the purchase department. This is relevant for consideration if the purchase function is carried out at same level with the existing staff. If the level of purchasing activity decreases significantly, obviously a proportional amount of personnel will be transferred to other departments.
If the level of purchasing increases, the extra load will be tackled by paying overtime to existing staff or by recruiting new personnel. This additional cost can be viewed as the marginal cost of orders. The ordering cost in a typical Indian firm is around Rs. 100 per order, but experience shows that this cost varies considerably depending upon the efficiency of the purchasing department
Some firms operate on the basis of “receipt cost” particularly when dealing with staggered delivers. The mathematical models can be suitably modified to get the “economic receipt quantity” instead of “economic order quantity’.
Cost of Inventory Carrying
This cost Cc is measured as a percentage of the unit cost of the item. This measure, therefore, gives a basis for estimating what it actually costs a firm to carry stock. This cost includes: 1) interest on capital, (2) insurance and tax charges, (3) storage costs-any labour, excluding handing of receipts of new orders-the costs of provision of storage area and facilities like bins, racks, etc… (4) allowance for deterioration or spoilage, (5) Salaries of stores staff, and (6) obsolescence. The inventory carrying cost varies and in a typical Indian industry is about 30 percent. A major portion of this is accounted for by he interest on capital, which depends on the fiscal policies of the government. A few firms differentiate the costs as fixed and variable. In the analysis of and use of mathematical formula, only the variable costs of ordering should be considered as the fixed costs will be constant irrespective of the number of orders placed or the inventory carried
Understocking Cost
This cost, Ku is the cost incurred when an item is out of stock. It includes the cost of lost production during the period of stock out and extra cost per unit, which might have to be paid for an emergency purchase.
Overstocking Cost
This cost K o is the inventory carrying (which is calculated per year) for a specific period of time. The time varies in different contexts- it could be the lead time of procurement or the entire life-time of a machine. In the case of one-time purchases, overstocking cost would be: purchase price-scrap price.
Based on the above costs several scientific models have been developed and these are discussed separately for consumables and for spares in the following chapters. The need for using these models in India has been stressed by various committees. For example, the report of the committee* on public undertakings mentions: “For proper inventory control, it is essential to adopt the scientific practices and techniques that have been developed in this regard”.
Spare parts management
Spare parts management is an important section of any system and a part that needs much planning and organization. The right parts much be ready when need to prevent the process to stop and the project to be slowed down to much. On the other hand, too many spare parts will mean a both unpractical and expensive situation.
Spare Parts Management Indicators
There is a saying: “What you can’t measure, you can’t improve”. The saying
are not necessarily always true, but it is interesting, because I think a
derivative of the saying is true: “What you measure, is usually what you
get”.
Reducing Inventory Value
It is common for plants to have a lot of focus on reducing inventory value.
Inventory value is one of those numbers that acts like salt in a wound for
corporate accountants. No, it doesn’t matter if it’s high or low, it always
hurt to look at the number. Most of the time we don’t know if the number is
too high or too low, we just know we want the number to be lower.
Cost of Keeping Spare Parts and Materials.
The cost for keeping inventory is usually an estimated number, often called
“inventory interest” (or similar), that varies from 10-40% depending on
company accounting rules. The cost included storeroom, storeroom personnel,
depreciation, etc. If you have a spare parts and materials inventory value
of 10 Million, it costs the company 1-4 Millions (10-40%) a year to keep
that spare parts and materials inventory.
The Problem
Since it is common that inventory value is the only number the plant really
cares about, it tends to get reduced. But, anyone can reduce inventory value
very easily, IF it’s the only thing that matters. I can tell you to scrap
all spare parts right now bringing your spare parts and materials inventory
to zero. But the consequences will be devastating to production since we
don’t have any spare parts.
Measure a “Counterweight”
Spare parts inventory value is important, but to effectively reduce spare
parts inventory value, the “counterweight” has to be measured as well. The
counterweight to inventory value can be “stock-outs” for example (times we
get the spare part needed divided by total request for spare parts). When
stock outs go over around 4-5%, you will start seeing signs of people not
trusting the storeroom. These signs are spare parts in supervisor’s office,
satellite stores, spare parts in crafts peoples toolboxes etc.
