Inventory Chapter 1_student.pdf

Inventory Management Manisra Baramichai, Ph.D  Chapter 1 Introduction to Inventory Management Reasons for Holding Stocks  Objectives of Inventory Management Minimize inventory investment. Meet targeted level of customer service....

Inventory Management Manisra Baramichai, Ph.D  Chapter 1 Introduction to Inventory Management Reasons for Holding Stocks  Objectives of Inventory Management Minimize inventory investment. Meet targeted level of customer service. Maximize manufacturing efficiency. Smooth, uninterrupted flow  The Balance of Supply Chain View Decision Customer Service Operation Cost Inventory Cost Lowest purchasing price Increase raw material inventory to smooth out production Long Production run Standardized Product Delivery Full Truck Load Short Delivery Lead- time Availability items Type of Inventory  Inventory Through the Supply Chain Customer Manufacturer Distribution center Supplier Raw materials Finished Distribution Customer WIP center goods Supplier Components Distribution Supplier MRO center Distribution Customer inventories  Inventory by Functions Anticipation inventory (e.g., seasonal) Transportation inventory Hedge inventory Lot-size inventory (cycle stock) Safety stock  Cycle Stock Cycle stock is the normal stock used during operations.  Reduce Cycle Stock Lot Size 200 Lot Size 100 1 2 3 4 5 6 7 8 Week Average inventory = (Lot size)/2  Safety Stock Raw materials, WIP, or finished goods that are kept as minimum inventory level at any locations to protect against uncertainties (like insurance) Reasons demand higher than expected – Supply disrupted or breakdown, Supply Uncertainties – Quality problem – Demand unexpected increase – Forecast is not accurate  Inventory by Types of Demand Independent Demand for an item unrelated to the demand for other items but come directly from customer Demand need to be forecasted Dependent Demand that is directly related to other items or end products Calculated, not forecast Inventory Over Time Inventory Related Cost  Inventory Related Costs Item Carrying Ordering Stockout Capacity- related  Item Costs Unit price plus shipping, taxes Unit price plus shipping, taxes Purchased items Manufactured items Product Direct material Transportation Direct labor Customs duties Factory overhead Insurance  Carrying Costs Capital Storage Risk costs costs costs Obsolescence Space Damage Opportunity cost Personnel Pilferage Equipment Insurance Utility Deterioration Inventory Carrying Costs  Ordering and Set Up Costs Purchase Factory Cost of purchasing Production control cost administrative tasks Set up and Cost of Handling activities teardown cost Receiving Cost Lost capacity cost Ordering and Set Up Cost Relationship Total cost Carrying cost Cost Ordering cost , Set up cost Order quantity  Exercise 1 An importer operate a small warehouse that has the following annual cost; wages for purchasing are $80,000, purchasing expense are $70,000, and customs brokerages is $45 per order. In addition, for every purchasing order when it arrive at the warehouse , company need to inspect the quality of the incoming items. The inspector who performs this activity need to spend two hours on average to complete all inspection requirements. The wage of the inspector is $28 per hours and 10,000 orders are placed in a year.  Exercise 1 Based on past information, 2,000 pallets of item A are normally kept in this warehouse (anytime, you go to the warehouse, you will see 2,000 pallets of item A). Item A is purchased from supplier at a price of $245 per pallet. Company need to spend additional $5 to transport item A to their warehouse. In the warehouse, item A is stored on 4 tier pallet rack. The area required for one pallet is 1.25 square meter. The estimated cost of financing the inventory is 10% and the rental rate of warehouse is $10 per square meter per month. If What are the annual ordering costs and carrying costs? What is the average ordering cost?  Exercise 1 What is the average ordering cost? What are the annual ordering costs for item A Whet are the annual carrying costs for item A? What are the carrying cost / pallet for item A If company change to order item A more frequently , what will happen to the ordering cost and the carrying cost?  Stockout Costs Causes of stockouts Stockout costs Backorder costs Demand exceeds forecast and Lost sales available inventory Lost customers Production and supplier Expediting costs problems cause inventory shortages Additional manufacturing and purchasing costs  Capacity-Related Costs Overtime Hiring Training Shift premiums Inventory and Financial Results  Inventory and Financial Results Accounting systems classify activities of a company into two types of accounts. 1. Assets Assets = Liabilities + Owners’ Balance sheet accounts 2. Liabilities Equity 3. Owners’ equity 1. Revenues Income statement Income = accounts 2. Expenses Revenue - Expenses Inventory and Financial Results  Inventory and Financial Results inventory is asset on balance sheet, but having more assets require more liabilities or owner investment. 1. Reduction on cash very liquid asset 2. more liabilities 3. Investment from owner Purchasing raw material and producing something and store them as WIP or finished good cause some expenses (warehouse cost, inventory carrying cost) which reduce the company profit  Cash Flow Analysis To survive, a business must have the cash available to pay its bills (wages, materials, debt payment. Cash flow analysis is the inflow and outflow of cash in the business over a given period of time. Inventory status Effect on cash flow Raw material Cash outflow WIP Cash outflow Finished goods Cash outflow Accounts receivable paid Cash inflow  Example 2 Axe trading currently has sales of 20 million a year, with a stock level of 25 percent of sales. Annual holding cost for the stock is 20 percent of value. Cost of good sold is 13 million a year and other operating costs (excluding the holding cost) are 2 million a year. Other assets excluding inventory are value at 30 million. What is the current profit and return on assets? How does this charge if stock levels are reduced to 20 percent of sales?  Solution: Current Holding Cost = amount of stock X holding cost = (20 million X 25%) X 20% = 1 million a year Total Costs = COG+ operating expense + Holding Cost = 13 + 2 + 1 = 16 million Profit = sales – total costs = 20 million – 16 million = 4 million a year Total assets = other assets + stock = 30 million + (20 millionX0.25) = 35 million Return on assets = profit / total assets = 4 million/35 million = 11.4% 32  Solution: After Inventory Reduction Holding Cost = amount of stock X holding cost = (16 million X 25%) X 20% = 0.8 million a year Total Costs = COG+ operating expense + Holding Cost = 13 + 2 + 0.8 = 15.8 million Profit = sales – total costs = 20 million – 15.8 million = 4.2 million a year Total assets = other assets + stock = 30 million + (16 millionX0.25) = 34 million Return on assets = profit / total assets = 4.2 million/3.4 million = 12.35% 33  Value of Stocks Stocks appear as current assets in a company’s accounts. It is, therefore, important to have an accurate value for stocks. In principle, we can find the stock value of any item by simply multiplying the number of units Actual cost in stock by the unit cost. FIFO Because the stocks are normally bought over LIFO some period so the unit cost changes because of inflation, discounts, variations in Weighted quality, alternative suppliers, and variations in average trading conditions and terms  Example Ulrika Harkness records the following monthly purchases and sales of an item. Assuming she has no opening stock, what is the value of her stock at the end of the period? What is the profit and profit margin if each unit sold for $35? Total Purchase = 410 units Total Sales = 354 units Closing stock = 410-354 = 56 units How to value this stock  Total Cost Total Purchasing Cost = (110X22)+(60X26)+(70X30)+(50X28)+(80X24)+(40X32) = 10,680 Profit = Income - Cost of units sold = Income - (Cost of purchases - Cost of remaining stock)  Actual Cost We need detailed information on Number Remaining bought Stock the remaining stock November 110 7 The remaining stock consists of 7 units December 60 6 bought in November, 6 bought in January 70 8 December, 8 bought in January, 11 in February 50 11 March 80 17 February, 17 in March and 7 in April April 40 7 Value of Stock = Profit = 12,390 – (10,680–1,490) = 3,200 Profit = 12,390 – (9,190) = 3,200  FIFO 56 units remaining are the last 56 bought = Profit = 12,390 – (10,680–1,664) = 3,374 Profit = 12,390 – (9,016) = 3,374  LIFO 56 units remaining are the first 56 bought = Profit = 12,390 – (10,680–1,232) = 2,942 Profit = 12,390 – (9,448) = 2,942  Weighted Average Cost Weighted average cost Number bought Cost of item November 110 22 = December 60 26 Value of current stock January 70 30 = February 50 28 March 80 24 April 40 32 Profit = 12,390 – (10,680–1,459) = 3,169 Profit = 12,390 – (9,221) = 3,169  FIFO vs LIFO FIFO Method LIFO Method In most businesses, the actual There are few businesses where Materials flow flow of materials follows FIFO, the oldest items are kept in stock which makes this a logical choice. while newer items are sold first. If costs are increasing, the first If costs are increasing, the last items sold are the least items sold are the most expensive, so your cost of goods expensive, so your cost of goods Inflation sold decreases, you report more sold increases, you report fewer profits, and therefore pay a larger profits, and therefore pay a amount of income taxes in the smaller amount of income taxes in near term. the near term. Amount of Stock in Supply Chain If the supply chain is very long, or very broad, there will be a lot of material held in storage  Amount of Stock in Supply Chain AS (N2) = AS (N1) X N2 N1 N2 =number of planned future facilities N1 = number of existing facilities AS (Ni) = aggregate stock with N, facilities  Example 3 FT is planning to increase its services to Bangkok. It currently has 12 depots with aggregate stock valued at 12 million and plans to expand to 16 depots. With a carrying cost is 20 percent of value a year, what is the likely cost of this change?