Description
concepts like classification of inventory, control level of inventory, ABC analysis, economic order quantity, warehouse planning.
INVENTORY PLANNING
1
ELEMENTS OF INVENORY PLANNING - 1
• • • • Classification of inventory. Codification Specification of items Control Level:
– Minimum level – Maximum level – Reorder level – Safety stock
2
ELEMENTS OF INVENORY PLANNING - 2
• • • • ABC Analysis Economic Order Quantity (EOQ). Standardization. Warehouse planning:
– Receipt – Issues – Inspection – Storage,
3
INVENTORY AND ITS CLASSIFICATION
• Inventory: All the items used in an organization is termed as inventory. • Classification of inventory: Items an organization are classified into groups of materials. Items in the group are very close to each other from technical considerations. Inventories can be broadly divided into three categories, i.e. Regular inventory items for production activities. In-process inventories. Finished goods inventories • The classification of the inventory in different categories should be such that helps various activities such as stock control, purchasing, receiving of materials, storing, 4 accounting and codification.
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN STOCK CONTROL
• Identical materials are classified in different classes with stock control cards. • Review of stock items such as all raw materials, spares, consumables etc is easily done separately for each class. • Requisitions are prepared separately for different class of items to take effective procurement action. • Effective budgetary control by classifying items under various heads and sub-heads.
5
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN PURCHASING
• Separate enquiries can be issued for different classes of items. • Limited number of correct sources assists in efficient purchasing. Offers are received from correct sources. • Vendor’s catalogues of one class of inventory items can be kept together for pooling up of the information in most effective manner.
6
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN PURCHASING
• Price lists of each class of inventory items are kept separately. • Pooling of similar items in a class enables obtaining very attractive prices. • Pooling of orders for similar nature of items in a large purchase order helps in reducing number of purchase orders and thus reduces purchasing effort and cost.
7
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN STORING MATERIALS
• Classification helps to keep similar items together in the store. • Receipt and issue are posted correctly in the bin cards with the help of class and code number indicated on the goods receipt note. • Duplication of similar nature of items is reduced with proper classification.
8
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN ACCOUNTING
• Budget heads are allocated based on classification of inventory items. Receipts and issues are easily linked with the correct budget heads. • Entries for goods receipt notes and requisitions are done on the correct cards. • Budgetary control is easy with the classification of items in separate classes as each class is focused separately.
9
REGULAR INVENTORY ITEMS IN A PRODUCTION UNIT
• Capital equipment i.e. production machinery and other machines which are either used in manufacturing activities or are supportive to the production functions • Tools • Furniture • General Stores – Spare parts – Consumables – Inflammable Stores • Chemicals • Raw Materials • Scrap Materials • Packing Materials
10
IN-PROCESS INVENTORY
• Materials or semi-finished goods lying on the shop floor or in stores for temporary storage before being used in a production process are known as in-process inventories. • For example:
– Raw meal in a process plant like cement plant is an in-process material, which has been produced by processing of mix of raw materials. – Similarly clinker is an in-process inventory for producing cement.
11
FACTORS INFLUENCING THE LEVEL OF IN-PROCESS INVENTORY
• Realistic requirements of each item or semiprocessed items for the production process should be worked out to avoid any shortage or excess. • Acquisition cost, inventory carrying cost, quantity discounts and follow up costs should be considered while deciding on the level of in process inventory. • Investment needed and availability of funds for the size of inventory needed.
12
FACTORS INFLUENCING THE LEVEL OF IN-PROCESS INVENTORY
• In some of the plants, space restrictions do not permit storing of in-process inventory beyond certain limit. • Double or multiple handling of materials should be avoided since the handling cost becomes part of the product cost. • Other considerations such as pollution control aspects, upkeep of factory premises, affect on sales etc. should also be considered.
13
CODIFICATION
Codification is used to describe an item in short, thus avoiding long statement every time the need to describe the item arises.
14
UTILITY OF CODE - 1
• Every one understands same meaning in identifying an item with the help of code. • Same item may be available under different names. Code eliminates the possibility of duplication in names • Items with different features but for same purpose can be differentiated easily. For example, a ball pen with ordinary refill will have different code than a ball pen with jotter refill.
15
UTILITY OF CODE - 2
• Code helps avoid long description in Purchase Requisitions. • Entries in bin cards, stock control cards, account records are made easy with code. Moreover code helps in uniform way of entry. • Entries in receipt and issue documents are posted easily with accuracy in the appropriate records. • Codes are necessary for mechanization of records through computerization of activities.
16
MINIMUM STOCK LEVEL
• It is the level below which the inventory level is not allowed to fall.
• If the level of inventory is below this level, there are chances that plant operations are adversely affected.
17
MINIMUM STOCK LEVEL
• As soon as the stock level reaches the minimum level for any reason: – The matter is to be reported to the higher management immediately – Extra efforts are made or additional resources are deployed to ensure that the material is received at the earliest.
• What is done?
The item could be received by faster mode of transport say by air or by courier service in place of sea or rail or is purchased from any other source even at a higher cost. • Minimum level is an indication of the danger and provides alert for stock out situation.
18
MAXIMUM STOCK LEVEL - 1
• It is the inventory level, beyond which the stock level is not allowed to exceed. • The maximum level is used as a control point to avoid any extra stocks. • Order quantity for material is controlled in such a way that when the material is received the inventory level is below the maximum level.
19
MAXIMUM STOCK LEVEL - 2
• However, at times the maximum level is crossed: – To avail benefits of attractive discounts, – Saving on the transportation/freight charges,
• Due to strategic buying decision. The maximum level if crossed with prior evaluation of overall benefits is a correct approach.
20
MAXIMUM STOCK LEVEL - 3
• If it crossed due to lack of control, the matter should be viewed seriously. • Failure to control the maximum level may result in non-moving or slow moving items and in some cases obsolete items. • Inventory turnover would be adversely affected if maximum level is not controlled. • Maximum level is fixed by taking into consideration the lead time for the item.
21
SAFETY STOCK -1
• Safety stock is the level of inventory which is to be maintained always to take care of unforeseen factors such as: – Delay in ordering, – Delay in supply by supplier, – Delay in transportation – Hindrances' in execution of orders by the supplier, which may be beyond his control like war, flood or strike. • A very high degree of safety would need high level of inventory, • A low degree of safety would require low inventory stock. • Safety stock follows the path of ‘S’curve.
22
S CURVE – PATH OF SAFETY STOCK
Level of Inventory
Degree of safety
23
SAFETY STOCK -2
• Higher level of inventory is to be maintained for high level of safety and blocking of financial resources. • The safety level is decided depending on: – The criticality of the stoppage of operations, – Reliability of source of supply, – Location of supplier – Number of sources of supply. • The desired safety level of inventory level then determine the ‘Safety Stock’. • Normally, most of the organizations maintain safety stock equal to minimum stock level.
24
REORDER POINT -1
• Reorder point is important tool for controlling inventory and to ensure that there is no stock out.
• Reorder point is dependant on lead time.
• It is set in such a manner that if order is placed at reorder point, the material is received by the time the inventory level reaches minimum stock level.
25
REORDER POINT - 2
• Reorder point shifts with the change in rate of consumption and is set based on average yearly consumption. • The lead time if changes, the reorder point should be adjusted. • In practice, the reorder point is established quite correctly based on: – Past experience, – Rate of consumption – Lead time. – Reorder point is normally calculated by computer automatically.
26
INVENTORY CONTROL MODEL
Maximum -level
Inventory Level Working quantity Minimum -level
Reorder point
Safetystock
Lead time Time
Receipt of materials
27
ASSUMPTIONS IN INVENTORY CONTROL MODEL - 1
• The consumption of inventory is at a uniform rate through out the cycle, • The order is placed when the inventory level reaches the reorder point.
• The ordered quantity is received by the time inventory level reaches to the minimum level
28
ASSUMPTIONS IN INVENTORY CONTROL MODEL - 2
• The lead time does not change between reorder point and the point when inventory reaches the minimum level when fresh quantity is received. • However, in real life situations there are variations in each condition due to both internal and external factors and inventory controller has to review the situation regularly.
29
ABC ANALYSIS: PERCENTAGE OF INVENTORY ITEMS VS ANNUAL INVENTORY CONSUMPTION %
30
APPROPRIATE ATTENTION FOR DIFFERENT CATEGORY ITEMS
• The impact of the cost of ‘C’ category items in the inventory even if the stock levels is more than the requirements is not much. • If category ‘A’ items are more than the requirements, the same would have great impact on the inventory investment. • Great care is taken to keep low the inventory of ‘A’ category items low. Items of category ‘B’ need moderate attention and category ‘C’ items need minimum attention. • In real life situation, it may not be a clear division of items in three categories of ‘A’, ‘B’ and ‘C’ and may require to divide the inventory in four or five categories i.e. ‘A’, ‘B’, ‘C’ and ‘D’ or ‘A’, ‘B’, ‘C’, ‘D’ and ‘E’. • Management decision on such categorization for better control is based on the annual usage of the items.
31
CONTROL THROUGH ABC ANALYSIS - 1
• ABC analysis provides good guidelines for appropriate purchasing policy for different categories of items and suggests the extent of attention required from different levels of management for various items. • Top management must devote a major part of its time in procurement of ‘A’ category items, both from the point of view of cost control as well as in controlling the quantity to be procured. • Frequent purchases of ‘A’ category items in appropriate lots will on one hand ensure availability of items and on the other hand no excessive stocks are built up for these items.
32
TABLE 1: DETERMINATION OF RANKS BY ANNUAL USAGE IN US$
Item # 1 2 3 Average usage (units) 17 50 15 Unit cost (US$) 2.5 17 15 Annual usage (US$) Rank
4
5 6 7 8 9 10
25
5 50 153 20 16 17
17
17 119 5 2.125 2.656 2.5
33
TABLE 1: DETERMINATION OF RANKS BY ANNUAL USAGE IN US$
Item # 1 2 3 Average usage (units) 17 50 15 Unit cost (US$) 2.5 17 15 Annual usage (US$) 42.5 850 225 Rank
4
5 6 7 8 9 10
25
5 50 153 20 16 17
17
17 119 5 2.125 2.656 2.5
425
85 5950 765 42.5 42.5 42.5
34
TABLE 1: DETERMINATION OF RANKS BY ANNUAL USAGE IN US$
Item # 1 2 3 Average usage (units) 17 50 15 Unit cost (US$) 2.5 17 15 Annual usage (US$) 42.5 850 225 Rank 8 2 5
4
5 6 7 8 9 10
25
5 50 153 20 16 17
17
17 119 5 2.125 2.656 2.5
425
85 5950 765 42.5 42.5 42.5
4
6 1 3 7 9 10
35
TABLE 2:CATEGORIZING THE ITEMS IN ABC RANKING
Item # 6 2 7 Annual Cumulative annual usage (US$) usage (US$) 5950 850 765 5950 6800 7565 Annual usage % Category assigned
4
3 5 8 1 10 9 Total
425
225 85 42.5 42.5 42.5 42.5 8500
7990
8245 8330 8372.5 8415 8457.5 8500
36
TABLE 2:CATEGORIZING THE ITEMS IN ABC RANKING
Item # 6 2 7 Annual Cumulative annual usage (US$) usage (US$) 5950 850 765 5950 6800 7565 Annual usage % 70 80 89 Category assigned
4
3 5 8 1 10 9 Total
425
225 85 42.5 42.5 42.5 42.5 8500
7990
8245 8330 8372.5 8415 8457.5 8500
94
97 98 98.5 99 99.5 100
37
TABLE 2:CATEGORIZING THE ITEMS IN ABC RANKING
Item # 6 2 7 Annual Cumulative annual usage (US$) usage (US$) 5950 850 765 5950 6800 7565 Annual usage % 70 80 89 Category assigned A B B
4
3 5 8 1 10 9 Total
425
225 85 42.5 42.5 42.5 42.5 8500
7990
8245 8330 8372.5 8415 8457.5 8500
94
97 98 98.5 99 99.5 100
C
C C C C C C
38
TABLE 3: ABC CATEGORY SUMMARY
category Item# % of items in inventory $ in the % $ in the category category
A
B C Total
6
2, 7 1, 3, 4,5,8,9,10 10
10
20 70 100
5950
1615 935 8500
70
19 11 100
39
RATIONALIZATION OF THE NUMBER OF ORDERS AND REDUCTION IN INVENTORY
• Let us consider three items accounting for a yearly consumption of Rs80,000; Rs6,000 and Rs2,000 respectively, each being ordered 4 times in a year. • If A, B, C analysis has been done, then it implies that ‘A’ items should be ordered more, say eight orders, three for ‘B’ and one for ‘C’ item.
40
ECONOMIC ORDER QUANTITY (EOQ)
41
ACQUISITION COST
Inventory acquisition cost is the cost of procuring inventory items and includes costs of:
– Building for the purchase department or its rental and maintenance cost. – Facilities, such as computer terminals, PCs, Type writers, Photo-copier etc. – Telephones, faxes, telex, email. – Manpower employed. – Travel of purchasing engineers/executives to the market. – Testing and third party inspection, if any. – Paper work.
42
INVENTORY CARRYING COST
Various elements of inventory carrying cost are: • Overhead charges for the storage space. • Cost of handling facilities. • Interest on the inventory investment. • Cost of manpower in stores division. • Cost of obsolete parts in the inventory. • Cost of insurance for the materials stored. • Depreciation cost on inventory investment.
43
DETERMINING ECONOMIC ORDER QUANTITY (EOQ) - 1
Following symbols are used in the EOQ formula: • q: Order quantity. • Q: Economic Order Quantity (EOQ) i.e. order quantity, where total cost of inventory is minimum. • U: Daily rate of usage. • n: number of working days in forecasted period. • Ac: ordering cost per order, in dollars per order. • Ic: Inventory carrying cost in dollars per order. • Pc: Unit cost of items dollars/unit of measurement.
44
FORMULA FOR ECONOMIC ORDER QUANTITY (Q)
Acquisition Cost (Ac) = Number of orders placed during the period x Cost to order
Quantity used during the period x = Order quantity nU x Ac = q Inventory Carrying Cost (ICC) = Average inventory (q/2) x Unit Cost (Pc) x Carrying charges (Ic) q x Pc x Ic = 2 At total minimum cost it is observed that: Acquisition cost (Ac) = Inventory Carrying Cost (ICC) nU x Ac q x Pc x Ic 2nUAc or q = = q 2 PcIc = Economic Order Quantity (Q) Cost to order
?
45
EXAMPLE
Calculate the Economic Order Quantity (EOQ), Acquisition Cost and Inventory Carrying Cost at EOQ and the minimum total cost for a product on the basis of following data: • Annual demand for the product = 50000 units • Ordering cost per order (Ac) = $12 • Inventory Carrying Cost/order (Ic) = 20% of the unit cost of the product Unit cost of the product = $5/unit
46
SOLUTION
• Annual demand (nU) = 50000 units • Ordering cost/order (Ac) = $12 • Inventory Carrying Cost/order (Ic) = 20% of the unit cost of the product = 0.2 x 5 = $1 • Economic Order Quantity (EOQ) =
?
=? 240,000 = 489.897 units say 490 units
47
2 x 50,000 x 12 5x1
doc_787626514.pptx
concepts like classification of inventory, control level of inventory, ABC analysis, economic order quantity, warehouse planning.
INVENTORY PLANNING
1
ELEMENTS OF INVENORY PLANNING - 1
• • • • Classification of inventory. Codification Specification of items Control Level:
– Minimum level – Maximum level – Reorder level – Safety stock
2
ELEMENTS OF INVENORY PLANNING - 2
• • • • ABC Analysis Economic Order Quantity (EOQ). Standardization. Warehouse planning:
– Receipt – Issues – Inspection – Storage,
3
INVENTORY AND ITS CLASSIFICATION
• Inventory: All the items used in an organization is termed as inventory. • Classification of inventory: Items an organization are classified into groups of materials. Items in the group are very close to each other from technical considerations. Inventories can be broadly divided into three categories, i.e. Regular inventory items for production activities. In-process inventories. Finished goods inventories • The classification of the inventory in different categories should be such that helps various activities such as stock control, purchasing, receiving of materials, storing, 4 accounting and codification.
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN STOCK CONTROL
• Identical materials are classified in different classes with stock control cards. • Review of stock items such as all raw materials, spares, consumables etc is easily done separately for each class. • Requisitions are prepared separately for different class of items to take effective procurement action. • Effective budgetary control by classifying items under various heads and sub-heads.
5
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN PURCHASING
• Separate enquiries can be issued for different classes of items. • Limited number of correct sources assists in efficient purchasing. Offers are received from correct sources. • Vendor’s catalogues of one class of inventory items can be kept together for pooling up of the information in most effective manner.
6
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN PURCHASING
• Price lists of each class of inventory items are kept separately. • Pooling of similar items in a class enables obtaining very attractive prices. • Pooling of orders for similar nature of items in a large purchase order helps in reducing number of purchase orders and thus reduces purchasing effort and cost.
7
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN STORING MATERIALS
• Classification helps to keep similar items together in the store. • Receipt and issue are posted correctly in the bin cards with the help of class and code number indicated on the goods receipt note. • Duplication of similar nature of items is reduced with proper classification.
8
ADVANTAGES OF CLASSIFICATION OF INVENTORY IN ACCOUNTING
• Budget heads are allocated based on classification of inventory items. Receipts and issues are easily linked with the correct budget heads. • Entries for goods receipt notes and requisitions are done on the correct cards. • Budgetary control is easy with the classification of items in separate classes as each class is focused separately.
9
REGULAR INVENTORY ITEMS IN A PRODUCTION UNIT
• Capital equipment i.e. production machinery and other machines which are either used in manufacturing activities or are supportive to the production functions • Tools • Furniture • General Stores – Spare parts – Consumables – Inflammable Stores • Chemicals • Raw Materials • Scrap Materials • Packing Materials
10
IN-PROCESS INVENTORY
• Materials or semi-finished goods lying on the shop floor or in stores for temporary storage before being used in a production process are known as in-process inventories. • For example:
– Raw meal in a process plant like cement plant is an in-process material, which has been produced by processing of mix of raw materials. – Similarly clinker is an in-process inventory for producing cement.
11
FACTORS INFLUENCING THE LEVEL OF IN-PROCESS INVENTORY
• Realistic requirements of each item or semiprocessed items for the production process should be worked out to avoid any shortage or excess. • Acquisition cost, inventory carrying cost, quantity discounts and follow up costs should be considered while deciding on the level of in process inventory. • Investment needed and availability of funds for the size of inventory needed.
12
FACTORS INFLUENCING THE LEVEL OF IN-PROCESS INVENTORY
• In some of the plants, space restrictions do not permit storing of in-process inventory beyond certain limit. • Double or multiple handling of materials should be avoided since the handling cost becomes part of the product cost. • Other considerations such as pollution control aspects, upkeep of factory premises, affect on sales etc. should also be considered.
13
CODIFICATION
Codification is used to describe an item in short, thus avoiding long statement every time the need to describe the item arises.
14
UTILITY OF CODE - 1
• Every one understands same meaning in identifying an item with the help of code. • Same item may be available under different names. Code eliminates the possibility of duplication in names • Items with different features but for same purpose can be differentiated easily. For example, a ball pen with ordinary refill will have different code than a ball pen with jotter refill.
15
UTILITY OF CODE - 2
• Code helps avoid long description in Purchase Requisitions. • Entries in bin cards, stock control cards, account records are made easy with code. Moreover code helps in uniform way of entry. • Entries in receipt and issue documents are posted easily with accuracy in the appropriate records. • Codes are necessary for mechanization of records through computerization of activities.
16
MINIMUM STOCK LEVEL
• It is the level below which the inventory level is not allowed to fall.
• If the level of inventory is below this level, there are chances that plant operations are adversely affected.
17
MINIMUM STOCK LEVEL
• As soon as the stock level reaches the minimum level for any reason: – The matter is to be reported to the higher management immediately – Extra efforts are made or additional resources are deployed to ensure that the material is received at the earliest.
• What is done?
The item could be received by faster mode of transport say by air or by courier service in place of sea or rail or is purchased from any other source even at a higher cost. • Minimum level is an indication of the danger and provides alert for stock out situation.
18
MAXIMUM STOCK LEVEL - 1
• It is the inventory level, beyond which the stock level is not allowed to exceed. • The maximum level is used as a control point to avoid any extra stocks. • Order quantity for material is controlled in such a way that when the material is received the inventory level is below the maximum level.
19
MAXIMUM STOCK LEVEL - 2
• However, at times the maximum level is crossed: – To avail benefits of attractive discounts, – Saving on the transportation/freight charges,
• Due to strategic buying decision. The maximum level if crossed with prior evaluation of overall benefits is a correct approach.
20
MAXIMUM STOCK LEVEL - 3
• If it crossed due to lack of control, the matter should be viewed seriously. • Failure to control the maximum level may result in non-moving or slow moving items and in some cases obsolete items. • Inventory turnover would be adversely affected if maximum level is not controlled. • Maximum level is fixed by taking into consideration the lead time for the item.
21
SAFETY STOCK -1
• Safety stock is the level of inventory which is to be maintained always to take care of unforeseen factors such as: – Delay in ordering, – Delay in supply by supplier, – Delay in transportation – Hindrances' in execution of orders by the supplier, which may be beyond his control like war, flood or strike. • A very high degree of safety would need high level of inventory, • A low degree of safety would require low inventory stock. • Safety stock follows the path of ‘S’curve.
22
S CURVE – PATH OF SAFETY STOCK
Level of Inventory
Degree of safety
23
SAFETY STOCK -2
• Higher level of inventory is to be maintained for high level of safety and blocking of financial resources. • The safety level is decided depending on: – The criticality of the stoppage of operations, – Reliability of source of supply, – Location of supplier – Number of sources of supply. • The desired safety level of inventory level then determine the ‘Safety Stock’. • Normally, most of the organizations maintain safety stock equal to minimum stock level.
24
REORDER POINT -1
• Reorder point is important tool for controlling inventory and to ensure that there is no stock out.
• Reorder point is dependant on lead time.
• It is set in such a manner that if order is placed at reorder point, the material is received by the time the inventory level reaches minimum stock level.
25
REORDER POINT - 2
• Reorder point shifts with the change in rate of consumption and is set based on average yearly consumption. • The lead time if changes, the reorder point should be adjusted. • In practice, the reorder point is established quite correctly based on: – Past experience, – Rate of consumption – Lead time. – Reorder point is normally calculated by computer automatically.
26
INVENTORY CONTROL MODEL
Maximum -level
Inventory Level Working quantity Minimum -level
Reorder point
Safetystock
Lead time Time
Receipt of materials
27
ASSUMPTIONS IN INVENTORY CONTROL MODEL - 1
• The consumption of inventory is at a uniform rate through out the cycle, • The order is placed when the inventory level reaches the reorder point.
• The ordered quantity is received by the time inventory level reaches to the minimum level
28
ASSUMPTIONS IN INVENTORY CONTROL MODEL - 2
• The lead time does not change between reorder point and the point when inventory reaches the minimum level when fresh quantity is received. • However, in real life situations there are variations in each condition due to both internal and external factors and inventory controller has to review the situation regularly.
29
ABC ANALYSIS: PERCENTAGE OF INVENTORY ITEMS VS ANNUAL INVENTORY CONSUMPTION %
30
APPROPRIATE ATTENTION FOR DIFFERENT CATEGORY ITEMS
• The impact of the cost of ‘C’ category items in the inventory even if the stock levels is more than the requirements is not much. • If category ‘A’ items are more than the requirements, the same would have great impact on the inventory investment. • Great care is taken to keep low the inventory of ‘A’ category items low. Items of category ‘B’ need moderate attention and category ‘C’ items need minimum attention. • In real life situation, it may not be a clear division of items in three categories of ‘A’, ‘B’ and ‘C’ and may require to divide the inventory in four or five categories i.e. ‘A’, ‘B’, ‘C’ and ‘D’ or ‘A’, ‘B’, ‘C’, ‘D’ and ‘E’. • Management decision on such categorization for better control is based on the annual usage of the items.
31
CONTROL THROUGH ABC ANALYSIS - 1
• ABC analysis provides good guidelines for appropriate purchasing policy for different categories of items and suggests the extent of attention required from different levels of management for various items. • Top management must devote a major part of its time in procurement of ‘A’ category items, both from the point of view of cost control as well as in controlling the quantity to be procured. • Frequent purchases of ‘A’ category items in appropriate lots will on one hand ensure availability of items and on the other hand no excessive stocks are built up for these items.
32
TABLE 1: DETERMINATION OF RANKS BY ANNUAL USAGE IN US$
Item # 1 2 3 Average usage (units) 17 50 15 Unit cost (US$) 2.5 17 15 Annual usage (US$) Rank
4
5 6 7 8 9 10
25
5 50 153 20 16 17
17
17 119 5 2.125 2.656 2.5
33
TABLE 1: DETERMINATION OF RANKS BY ANNUAL USAGE IN US$
Item # 1 2 3 Average usage (units) 17 50 15 Unit cost (US$) 2.5 17 15 Annual usage (US$) 42.5 850 225 Rank
4
5 6 7 8 9 10
25
5 50 153 20 16 17
17
17 119 5 2.125 2.656 2.5
425
85 5950 765 42.5 42.5 42.5
34
TABLE 1: DETERMINATION OF RANKS BY ANNUAL USAGE IN US$
Item # 1 2 3 Average usage (units) 17 50 15 Unit cost (US$) 2.5 17 15 Annual usage (US$) 42.5 850 225 Rank 8 2 5
4
5 6 7 8 9 10
25
5 50 153 20 16 17
17
17 119 5 2.125 2.656 2.5
425
85 5950 765 42.5 42.5 42.5
4
6 1 3 7 9 10
35
TABLE 2:CATEGORIZING THE ITEMS IN ABC RANKING
Item # 6 2 7 Annual Cumulative annual usage (US$) usage (US$) 5950 850 765 5950 6800 7565 Annual usage % Category assigned
4
3 5 8 1 10 9 Total
425
225 85 42.5 42.5 42.5 42.5 8500
7990
8245 8330 8372.5 8415 8457.5 8500
36
TABLE 2:CATEGORIZING THE ITEMS IN ABC RANKING
Item # 6 2 7 Annual Cumulative annual usage (US$) usage (US$) 5950 850 765 5950 6800 7565 Annual usage % 70 80 89 Category assigned
4
3 5 8 1 10 9 Total
425
225 85 42.5 42.5 42.5 42.5 8500
7990
8245 8330 8372.5 8415 8457.5 8500
94
97 98 98.5 99 99.5 100
37
TABLE 2:CATEGORIZING THE ITEMS IN ABC RANKING
Item # 6 2 7 Annual Cumulative annual usage (US$) usage (US$) 5950 850 765 5950 6800 7565 Annual usage % 70 80 89 Category assigned A B B
4
3 5 8 1 10 9 Total
425
225 85 42.5 42.5 42.5 42.5 8500
7990
8245 8330 8372.5 8415 8457.5 8500
94
97 98 98.5 99 99.5 100
C
C C C C C C
38
TABLE 3: ABC CATEGORY SUMMARY
category Item# % of items in inventory $ in the % $ in the category category
A
B C Total
6
2, 7 1, 3, 4,5,8,9,10 10
10
20 70 100
5950
1615 935 8500
70
19 11 100
39
RATIONALIZATION OF THE NUMBER OF ORDERS AND REDUCTION IN INVENTORY
• Let us consider three items accounting for a yearly consumption of Rs80,000; Rs6,000 and Rs2,000 respectively, each being ordered 4 times in a year. • If A, B, C analysis has been done, then it implies that ‘A’ items should be ordered more, say eight orders, three for ‘B’ and one for ‘C’ item.
40
ECONOMIC ORDER QUANTITY (EOQ)
41
ACQUISITION COST
Inventory acquisition cost is the cost of procuring inventory items and includes costs of:
– Building for the purchase department or its rental and maintenance cost. – Facilities, such as computer terminals, PCs, Type writers, Photo-copier etc. – Telephones, faxes, telex, email. – Manpower employed. – Travel of purchasing engineers/executives to the market. – Testing and third party inspection, if any. – Paper work.
42
INVENTORY CARRYING COST
Various elements of inventory carrying cost are: • Overhead charges for the storage space. • Cost of handling facilities. • Interest on the inventory investment. • Cost of manpower in stores division. • Cost of obsolete parts in the inventory. • Cost of insurance for the materials stored. • Depreciation cost on inventory investment.
43
DETERMINING ECONOMIC ORDER QUANTITY (EOQ) - 1
Following symbols are used in the EOQ formula: • q: Order quantity. • Q: Economic Order Quantity (EOQ) i.e. order quantity, where total cost of inventory is minimum. • U: Daily rate of usage. • n: number of working days in forecasted period. • Ac: ordering cost per order, in dollars per order. • Ic: Inventory carrying cost in dollars per order. • Pc: Unit cost of items dollars/unit of measurement.
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FORMULA FOR ECONOMIC ORDER QUANTITY (Q)
Acquisition Cost (Ac) = Number of orders placed during the period x Cost to order
Quantity used during the period x = Order quantity nU x Ac = q Inventory Carrying Cost (ICC) = Average inventory (q/2) x Unit Cost (Pc) x Carrying charges (Ic) q x Pc x Ic = 2 At total minimum cost it is observed that: Acquisition cost (Ac) = Inventory Carrying Cost (ICC) nU x Ac q x Pc x Ic 2nUAc or q = = q 2 PcIc = Economic Order Quantity (Q) Cost to order
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EXAMPLE
Calculate the Economic Order Quantity (EOQ), Acquisition Cost and Inventory Carrying Cost at EOQ and the minimum total cost for a product on the basis of following data: • Annual demand for the product = 50000 units • Ordering cost per order (Ac) = $12 • Inventory Carrying Cost/order (Ic) = 20% of the unit cost of the product Unit cost of the product = $5/unit
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SOLUTION
• Annual demand (nU) = 50000 units • Ordering cost/order (Ac) = $12 • Inventory Carrying Cost/order (Ic) = 20% of the unit cost of the product = 0.2 x 5 = $1 • Economic Order Quantity (EOQ) =
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=? 240,000 = 489.897 units say 490 units
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2 x 50,000 x 12 5x1
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