Industrial Engineering - INVENTORY

INVENTORY

INTRODUCTION

THE AMOUNT OF MATERIAL, A COMPANY HAS IN STOCK AT A SPECIFIC TIME IS KNOWN AS INVENTORY OR IN TERMS OF MONEY IT CAN BE DEFINED AS THE TOTAL CAPITAL INVESTMENT OVER ALL THE MATERIALS STOCKED IN THE COMPANY AT ANY SPECIFIC TIME. INVENTORY MAY BE IN THE FORM OF,

• RAW MATERIAL INVENTORY
• IN PROCESS INVENTORY
• FINISHED GOODS INVENTORY
• SPARE PARTS INVENTORY
• OFFICE STATIONARY ETC.

AS A LOT OF MONEY IS ENGAGED IN THE INVENTORIES ALONG WITH THEIR HIGH CARRYING COSTS, COMPANIES CANNOT AFFORD TO HAVE ANY MONEY TIED IN EXCESS INVENTORIES. ANY EXCESSIVE INVESTMENT IN INVENTORIES MAY PROVE TO BE A SERIOUS DRAG ON THE SUCCESSFUL WORKING OF AN ORGANIZATION. THUS THERE IS A NEED TO MANAGE OUR INVENTORIES MORE EFFECTIVELY TO FREE THE EXCESSIVE AMOUNT OF CAPITAL ENGAGED IN THE MATERIALS.

WHY INVENTORIES?

INVENTORIES ARE NEEDED BECAUSE DEMAND AND SUPPLY CAN NOT BE MATCHED FOR PHYSICAL AND ECONOMICAL REASONS. THERE ARE SEVERAL OTHER REASONS FOR CARRYING INVENTORIES IN ANY ORGANIZATION.

• TO SAFE GUARD AGAINST THE UNCERTAINTIES IN PRICE FLUCTUATIONS, SUPPLY CONDITIONS, DEMAND CONDITIONS, LEAD TIMES, TRANSPORT CONTINGENCIES ETC.
• TO REDUCE MACHINE IDLE TIMES BY PROVIDING ENOUGH IN-PROCESS INVENTORIES AT APPROPRIATE LOCATIONS.
• TO TAKE ADVANTAGES OF QUANTITY DISCOUNTS, ECONOMY OF SCALE IN TRANSPORTATION ETC.
• TO DECOUPLE OPERATIONS I.E. TO MAKE ONE OPERATION'S SUPPLY INDEPENDENT OF ANOTHER'S SUPPLY. THIS HELPS IN MINIMIZING THE IMPACT OF BREAK DOWNS, SHORTAGES ETC. ON THE PERFORMANCE OF THE DOWN STREAM OPERATIONS. MOREOVER OPERATIONS CAN BE SCHEDULED INDEPENDENT OF EACH OTHER IF OPERATIONS ARE DECOUPLED.
•  TO REDUCE THE MATERIAL HANDLING COST OF SEMI-FINISHED PRODUCTS BY MOVING THEM IN LARGE QUANTITIES BETWEEN OPERATIONS.
• TO REDUCE CLERICAL COST ASSOCIATED WITH ORDER PREPARATION, ORDER PROCUREMENT ETC.

INVENTORY COSTS

IN ORDER TO CONTROL INVENTORIES APPROPRIATELY, ONE HAS TO CONSIDER ALL COST ELEMENTS THAT ARE ASSOCIATED WITH THE INVENTORIES. THERE ARE FOUR SUCH COST ELEMENTS, WHICH DO AFFECT COST OF INVENTORY.

• UNIT COST: IT IS USUALLY THE PURCHASE PRICE OF THE ITEM UNDER CONSIDERATION. IF UNIT COST IS RELATED WITH THE PURCHASE QUANTITY, IT IS CALLED AS DISCOUNT PRICE.
• PROCUREMENT COSTS: THIS INCLUDES THE COST OF ORDER PREPARATION, TENDER PLACEMENT, COST OF POSTAGES, TELEPHONE COSTS, RECEIVING COSTS, SET UP COST ETC.
• CARRYING COSTS: THIS REPRESENTS THE COST OF MAINTAINING INVENTORIES IN THE PLANT. IT INCLUDES THE COST OF INSURANCE, SECURITY, WAREHOUSE RENT, TAXES, INTEREST ON CAPITAL ENGAGED, SPOILAGE, BREAKAGE ETC.
• STOCKOUT COSTS: THIS REPRESENTS THE COST OF LOSS OF DEMAND DUE TO SHORTAGE IN SUPPLIES. THIS INCLUDES COST OF LOSS OF PROFIT, LOSS OF CUSTOMER, LOSS OF GOODWILL, PENALTY ETC.

IF ONE YEAR PLANNING HORIZON IS USED, THE TOTAL ANNUAL COST OF INVENTORY CAN BE EXPRESSED AS:

TOTAL ANNUAL INVENTORY COST = COST OF ITEMS + ANNUAL PROCUREMENT COST + ANNUAL CARRYING COST  +  STOCKOUT COST

VARIABLES IN INVENTORY MODELS

D = TOTAL ANNUAL DEMAND (IN UNITS)

Q = QUANTITY ORDERED (IN UNITS)

Q* = OPTIMAL ORDER QUANTITY (IN UNITS)

R = REORDER POINT (IN UNITS)

R* = OPTIMAL REORDER POINT (IN UNITS)

L = LEAD TIME

S = PROCUREMENT COST (PER ORDER)

C = COST OF THE INDIVIDUAL ITEM (COST PER UNIT)

I = CARRYING COST PER UNIT CARRIED (AS A PERCENTAGE OF UNIT COST C)

K = STOCKOUT COST PER UNIT OUT OF STOCK

P = PRODUCTION RATE OR DELIVERY RATE

D_L = DEMAND PER UNIT TIME DURING LEAD TIME

D_L = TOTAL DEMAND DURING LEAD TIME

TC = TOTAL ANNUAL INVENTORY COSTS

TC* = MINIMUM TOTAL ANNUAL INVENTORY COSTS

NUMBER OF ORDERS PER YEAR = 

TOTAL PROCUREMENT COST PER YEAR = S.D / Q

TOTAL CARRYING COST PER YEAR = CARRYING COST PER UNIT * UNIT COST * AVERAGE INVENTORY PER CYCLE

COST OF ITEMS PER YEAR = ANNUAL DEMAND * UNIT COST

                                              = D.C

TOTAL ANNUAL INVENTORY COST (TC) =  

THE OBJECTIVE OF INVENTORY MANAGEMENT TEAM IS TO MINIMIZE THE TOTAL ANNUAL INVENTORY COST. A SIMPLIFIED GRAPHICAL PRESENTATION IN WHICH COST OF ITEMS, PROCUREMENT COST AND CARRYING COST ARE DEPICTED 

IT CAN BE SEEN THAT LARGE VALUES OF ORDER QUANTITY Q RESULT IN LARGE CARRYING COST. SIMILARLY, WHEN ORDER QUANTITY Q IS LARGE, FEWER ORDERS WILL BE PLACED AND PROCUREMENT COST WILL DECREASE ACCORDINGLY. THE TOTAL COST CURVE INDICATES THAT THE MINIMUM COST POINT LIES AT THE INTERSECTION OF CARRYING COST AND PROCUREMENT COST CURVES.

INVENTORY OPERATING DOCTRINE

WHEN MANAGING INVENTORIES, OPERATIONS MANAGER HAS TO MAKE TWO IMPORTANT DECISIONS:

• WHEN TO REORDER THE STOCK (I.E. TIME TO REORDER OR REORDER POINT)
• HOW MUCH STOCK TO REORDER (I.E. ORDER QUANTITY)

REORDER POINT IS USUALLY A PREDETERMINED INVENTORY LEVEL, WHICH SIGNALS THE OPERATIONS MANAGER TO START THE PROCUREMENT PROCESS FOR THE NEXT ORDER. ORDER QUANTITY IS THE ORDER SIZE.

INVENTORY MODELLING

THIS IS A QUANTITATIVE APPROACH FOR DERIVING THE MINIMUM COST MODEL FOR THE INVENTORY PROBLEM IN HAND.

ECONOMIC ORDER QUANTITY (EOQ) MODEL

THIS MODEL IS APPLIED WHEN OBJECTIVE IS TO MINIMIZE THE TOTAL ANNUAL COST OF INVENTORY IN THE ORGANIZATION. ECONOMIC ORDER QUANTITY IS THAT SIZE OF THE ORDER WHICH HELPS IN ATTAINING THE ABOVE SET OBJECTIVE. EOQ MODEL IS APPLICABLE UNDER THE FOLLOWING CONDITIONS.

• DEMAND PER YEAR IS DETERMINISTIC IN NATURE
• PLANNING PERIOD IS ONE YEAR
• LEAD TIME IS ZERO OR CONSTANT AND DETERMINISTIC IN NATURE
• REPLENISHMENT OF ITEMS IS INSTANTANEOUS
• DEMAND/CONSUMPTION RATE IS UNIFORM AND KNOWN IN ADVANCE
• NO STOCKOUT CONDITION EXIST IN THE ORGANIZATION

THE TOTAL ANNUAL COST OF THE INVENTORY (TC) IS GIVEN BY THE FOLLOWING EQUATION IN EOQ MODEL.

EXAMPLE 1

ABC MANUFACTURERS PRODUCES 1,25,000 OIL SEALS EACH YEAR TO SATISFY THE REQUIREMENT OF THEIR CLIENT. THEY ORDER THE METAL FOR THE BUSHING IN LOT OF 30,000 UNITS. IT COST THEM $40 TO PLACE THE ORDER. THE UNIT COST OF BUSHING IS $0.12 AND THE ESTIMATED CARRYING COST IS 25% UNIT COST. FIND OUT THE ECONOMIC ORDER QUANTITY? WHAT PERCENTAGE OF INCREASES OR DECREASE IN ORDER QUANTITY IS REQUIRED SO THAT THE ORDERED QUANTITY IS ECONOMIC ORDER QUANTITY ?

ECONOMIC PRODUCTION QUANTITY (EPQ) MODEL

IN EOQ MODEL SUPPLY WAS INSTANTANEOUS, WHICH MAY NOT BE THE CASE IN ALL INDUSTRIAL APPLICATIONS. IF SUPPLY OF ITEMS IS GRADUAL TO SATISFY A CONTINUOUS DEMAND, THEN SUPPLY LINE WILL BE DEPICTED BY A SLANTED LINE.

IN THIS SITUATION, WHEN THE ORDER IS PLACED, THE SUPPLIER BEGINS PRODUCING THE UNITS AND SUPPLIES THEM CONTINUOUSLY. WHILE NEW UNITS ARE ADDED TO INVENTORY, OTHER UNITS ARE BEING USED. THUS, IF DELIVERY RATE (P) > DEMAND RATE (D), THE NET RESULT WILL BE A NET INCREASE IN THE INVENTORY LEVEL. THE SLOPE OF REPLENISHMENT LINE WILL THUS BE (P-D). SIMILLARLY THE SLOPE OF DEMAND LINE WILL BE (-D). THE AVERAGE INVENTORY CARRIED PER YEAR IS

REFERENCES :-www. nptel.iitm.ac.in