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Management of inventories - Coggle Diagram
Management of inventories
Inventory management is a key aspect of WC management
It is crucial for businesses as it has a direct impact on profitability
The main objective of inventory management is to achieve maximum profits by maintaining adequate investor levels for smooth business operations while monitoring the levels to minimise the costs of inventory holding
Holding too much inventory can result in the company's cash being tied up in purchasing, storing, insuring and managing inventory
By holding too little inventory, the business faces liquidity issues and costs of stock outs, including re-order costs, setup costs and lost quantity discounts
The key task of inventory management involves determining
The optimum re order level
The optimum re order quantity
Re-order level
Companies need to identify the level of inventory that must be reached before an order is placed
The re-order level idnciates how much inventory to re-order and when to re-order
Demand will vary from period to period
When demand are lead time are known with certainty, ROL equals the demand in lead time
Lead time is the time taken to receive inventory after it is ordered
When demand and lead times are not known with certainty, inventory must include an optimum level of buffer inventory to minimise the costs of stock outs
Economic order quantity
Focuses on maintaining an optimum order quantity for inventory items
The aim of the EOQ model is to balance the relevant costs by minimising the total cost of holding and ordering inventory
The model makes the following assumptions relating to its relevant costs
Holding costs
The model assumes that it costs a certain amount to hold a unit of inventory for a year
The variable cost of holding the inventory is referred to as the holding cost
As the average level of inventory increases, so too will the annual holding cost
Holding cost per unit * average inventory
Ordering costs
Ordering costs are the fixed costs of placing the order incurred every time an order is placed
These include costs of transportation, inspections etc
As the order quantity increases, the total ordering cost reduces
Order cost per order * no. of orders per annum
EOQ = √2
c
d / h
Where:
d = annual demand
c = ordering cost per order
h = holding cost per unit for one year
Assumptions and drawbacks
Demand and lead time are constant, this model will be ineffective for the business whose demand fluctuates frequently
Purchase price, ordering and holding costs remain constant
No buffer inventory is held or needed
Seasonal fluctuations can be ignored
Inventory levels are continuously monitored
Determining inventory levels
Minimum level
The lowest balance that should be maintained at all times
Ensures that production will not be suspended due to lack of raw materials
While fixing the minimum level of inventory, one should keep in mind the time required for delivery and daily consumption
Re-order level
This is the level of inventory at which the company should make. new order for supply
It is between the minimum level and maximum level
The minimum level and rate of consumption have to be considered
Re order level = minimum level + (rate of consumption * re order period)
Maximum level
This is the maximum inventory level that the company can hold at any point in time
The inventory should not be more than the maximum level
If the level of inventory exceeds the maximum level, it increases the carrying costs and is treated as overstocking
Re-order level + Re-order quantity - (minimum rate of consumption * minimum re-order period)
Danger level
Fixed below minimum level
Inventory reaches this level when the normal issue of raw material is stopped and issued only in case of emergecny
Immediate action must be taken by the company when the inventory reaches danger level
rate of consumption * maximum re-order period in case of emergency
Just in Time systems
A series of manufacturing and supply chain techniques that aim to reduce inventory to an absolute minimum or eliminate it altogether by manufacturing at the exit time customers require in the exact quantities they need and at competitive prices
Reducing the level of inventory not only reduces the carrying costs, but by using this technique, manufacturers also get more control over their manufacturing processes - making it easier to respond quickly when the needs of customers change
JIT aims to eliminate waste, capital being tied up in inventory and activities that do not add value by ensuring a Smoot flow of work at every stage, this reduces storage and labor costs
Relationships with suppliers are an important aspect of the JIT system, if the supplier doe snot deliver the raw materials in time, it could become ver expensive for the business
A JIT manufacturer prefers a reliable, local supplier to meet the small but frequent orders at short notice, in return for a long term business relationship
JIT has very low inventory holding costs however inventory ordering costs are high
Drawbacks
Since the manufacturer does no maintain high levels of inventory, any price fluctuations in raw materials could make the JIT system costlier
This model may not be helpful in cases of excess and unexpected demand since it means few or no inventories of finished goods are held
Production is highly reliant on supliers if raw materials are not delivered on time it could become very expensive for the bsuiness
It may need an investment in technology that links the information systems of the category and is suppliers
ABC Inventory Control
An analytical approach for classifying items based on the consumption values
Materials are divided into 3 categories
A Category Items
High investment but only represent small amounts of inventory items
Only 15-20% of inventory but have a high consumption
Due to the high value associated and the greatest potential to reduce costs or losses, these are closely monitored and controlled to ensure they are not over or under stocked
B Category Items
Represent 30-35% of inventory items by item type and about 20% of cosnumption
Less important than A items but will be maintained with good records and regular attention
C Category Items
Remaining items of inventory with a relatively lo value of consumption
Only make up to 10% of the total value of consumption
Ordered on a half yearly or yearly basis
Not cost effective to deploy tight inventory controls as the value at risk of significant loss is low
Better control over high value inventory improves efficiency and improves overall profitability
Requires keeping track of all inventory items and will be successful only if there is proper standardisation of inventories
VED Analysis
Popular technique with companies at the start up stage who are working with limited resources and small budgets
The key objective is to identify the criticality of inventory items that the business cannot operates without
Inventory items are classed based on the degree of criticality
Vital
Without which the production activities would come to halt
These inventories should always be kept in hand
Essential
Essential spare parts but whose non availability may not adversely affect procution
Such spare parts may be available from multiple sources and the procurement lead time may not be long
Desirable
Desirable items are those items whose stock out or shortage causes only a minor distruption for a short duration in the production schedule
The cost incurred is very nominal