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CHAPTER 3 LITERATURE REVIEW
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INVENTORY MANAGEMENT
In any business or organization, all functions are interlinked and connected to each other and are often overlapping. Some key aspects like supply chain management, logistics and inventory form the backbone of the business delivery function. Therefore these functions are extremely important to marketing managers as well as finance controllers. Inventory management is a very important function that determines the health of the supply chain as well as the impacts the financial health of the balance sheet. Every organization constantly strives to maintain optimum inventory to be able to meet its requirements and avoid over or under inventory that can impact the financial figures. Inventory is always dynamic. Inventory management requires constant and careful evaluation of external and internal factors and control through planning and review. Most of the organizations have a separate department or job function called inventory planners who continuously monitor, control and review inventory and interface with production, procurement and finance departments.
Defining Inventory management Inventory management is a collection of interdisciplinary processes that include a full circle from supply chain management to demand forecasting, through inventory control and including reverse logistics.
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Inventory management starts and ends with supply chain management because many of the opportunities to improve efficiencies start with shortening order to receipt time without incurring additional cost. That said, the other stages of the inventory management cycle are no less important in attaining overall efficiency. Inventory is an idle stock of physical goods that contain economic value, and are held in various forms by an organization in its custody awaiting packing, processing, transformation, use or sale in a future point of time. Any organization which is into production, trading, sale and service of a product will necessarily hold stock of various physical resources to aid in future consumption and sale. While inventory is a necessary evil of any such business, it may be noted that the organizations hold inventories for various reasons, which include speculative purposes, functional purposes, physical necessities etc.
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From the above definition the following points stand out with reference to inventory:
All organizations engaged in production or sale of products hold inventory in one form or other.
Inventory can be in complete state or incomplete state.
Inventory is held to facilitate future consumption, sale or further processing/value addition.
All inventoried resources have economic value and can be considered as assets of the organization.
Different Types of Inventory
Inventory of materials occurs at various stages and departments of an organization. A manufacturing organization holds inventory of raw materials and consumables required for production. It also holds inventory of semi-finished goods at various stages in the plant with various departments. Finished goods inventory is held at plant, FG Stores, distribution centers etc. Further both raw materials and finished goods those that are in transit at various locations also form a part of inventory depending upon who owns the inventory at the particular juncture. Finished goods inventory is held by the organization at various stocking points or with dealers and stockiest until it reaches the market and end customers. Besides Raw materials and finished goods, organizations also hold inventories of spare parts to service the products. Defective products, defective parts and scrap also forms a part of inventory as long as these items are inventoried in the books of the company and have economic value.
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Types of Inventory by Function
INPUT
PROCESS
OUTPUT
Raw Materials
Work In Process
Finished Goods
Consumables required for
Semi Finished Production
Finished Goods at
processing. Eg : Fuel,
in various stages, lying with Distribution Centers through
Stationary, Bolts & Nuts
various departments like
etc. required in
Production, WIP Stores,
manufacturing
QC, Final Assembly, Paint
out Supply Chain
Shop, Packing, Outbound Store etc.
Maintenance
Production Waste and
Items/Consumables
Scrap
Packing Materials
Rejections and Defectives
Finished Goods in transit
Finished Goods with Stockiest and Dealers
Local purchased Items
Spare Parts Stocks & Bought
required for production
Out items
Defectives, Rejects and Sales Returns
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Repaired Stock and Parts
Sales Promotion & Sample Stocks
Purposes of Inventory Management 1. Smooth-out variations in operation performances 2. Avoid stock out or shortage 3. Safeguard against price changes and inflation 4. Take advantage of quantity discounts
Inventory Management Techniques
Inventory management techniques can save your business thousands, even millions of dollars. There are several inventory related metrics that, when properly evaluated, help you determine the level of success of your inventory control. All inventory management techniques fall into one of two stock control methods: minimum stock levels and stock review. Minimum Stock Levels Minimum stock levels are a process by which management sets a minimum stock level or re-order point (ROP). When the number on-hand reaches or drops below the ROP, an
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order is generated. This can be done through a manual process or generated automatically by inventory management software. Stock Review Stock review is a regular analysis of stock versus projected future needs. This can be done through a manual review of stock levels or as part of the demand analysis forecasting by ERP/MRP automated ordering. In businesses where manual inventory management techniques are still in use, the primary inventory control methods include*: •
visual control
•
tickler control
•
click sheet control
While the terms originally applied to small scale inventory management, large businesses use automated versions of these tried and true inventory management techniques. Properly used, they help organizations track their usage and ensure timely reorder of stock, avoiding costly outages. Visual Control Visual
control
originally
referred
to
inventory
small
enough
that
the
purchasing/inventory manager can physically see the critical supplies. When supplies are visibly lean, he or she orders. Tickler Control Tickler control is slightly more involved, with the manager or a designee counting a portion of the inventory daily, ensuring a 100% inventory every so many days and ordering anything that is unacceptably low.
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Click Sheet Control Click Sheet Control is a manual tracking of sales or usage. By recording usage, it provides reorder data. Some of the most advanced Point of Sale systems are an electronically managed and monitored click sheet control system. For larger enterprises, an information system executes visual, tickler, or click sheet control but on a much more massive scale. The term "visibility" still applies to being able to check virtually for an item in a locator file. In all enterprises, these inventory management techniques include processes such as systemic rotating cycle count and automatic inventory orders when the system count reaches a certain level. In modern retail environments, Point of Sale systems offer the same result as click sheet control, but scalable across such enterprises as Wal-Mart and other international retailers.
Principles of Inventory Management There five key principles of inventory management: 1. demand forecasting, 2. warehouse flow, 3. inventory turns/stock rotation, 4. cycle counting and 5. process auditing. Focusing on these five fundamentals can yield significant bottom-line savings. 1. Demand Forecasting Depending on the industry, inventory ranks in the top five business costs. Accurate demand forecasting has the highest potential savings for any of the principles of inventory management. Both over supply and under supply of inventory can have
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critical business costs. Whether it is end-item stocking or raw component sourcing, the more accurate the forecast can be. Establishing appropriate max-min management at the unique inventory line level, based on lead times and safety stock level help ensure that you have what you needs when you need it. This also avoids costly overstocks. Idle inventory increases incremental costs due to handling and lost storage space for fast-movers. 2. Warehouse Flow The old concept of warehouses being dirty and unorganized is out dated and costly. Lean manufacturing concepts, including 5S have found a place in warehousing. Sorting, setting order, systemic cleaning, standardizing, and sustaining the discipline ensure that no dollars are lost to poor processes. The principles of inventory management are not any different from other industrial processes. Disorganization costs money. Each process, from housekeeping to inventory transactions needs a formal, standardized process to ensure consistently outstanding results. 3. Inventory Turns/Stock Rotation In certain industries, such as pharmaceuticals, foodstuffs and even in chemical warehousing, managing inventory down to lot numbers can be critical to minimizing business costs. Inventory turns is one of the key metrics used in evaluating how effective your execution is of the principles of inventory management.Defining the success level for stock rotation is critical to analyzing your demand forecasting and warehouse flow. 4. Cycle Counting One of the key methods of maintaining accurate inventory is cycle counting. This helps measures the success of your existing processes and maintain accountability of
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potential error sources. There are financial implications to cycle counting. Some industries
require periodic 100% counts. These are done through perpetual inventory count maintenance or though full-building counts. 5. Process Auditing Proactive error source identification starts with process audits. One of the cornerstone principles of inventory management is to audit early and often. Process audits should occur at each transactional step, from receiving to shipping and all inventory transactions in between. By careful attention to each of these critical core principles, your business can increase efficiency and reduce costs.
Inventory Management Models Understanding which of the core inventory management models applies to divisions of business it a critical first step in using the right techniques to manage your inventory. Inventory management models fall into two fundamental categories: independent and dependent inventory demand models. Independent Demand Independent demand inventory systems are at their very essence market driven. Whether the inventory is raw materials or a finished product, it is the end product of that particular organization. Pulls from inventory occur as an external customer purchases the units, either directly or as restock to a forward retail position.Items with an independent demand tend to be managed through one of two processes: periodic review or perpetual inventory management. Periodic Review: This process involves regular review of usage and reorder to a carrying point.
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Perpetual Inventory: This process revolves around reorders when an item reaches a pre-set minimum stocking level, or reorder point.
While demand can be somewhat indirectly influenced via pricing, merchandising, marketing and a whole spectrum of marketing initiative, in the end the market determines the inventory turns. The challenges in predicting independent demand is that there may not be a history, or the history may not match due to the life cycle stage of the product. Dependent Demand Dependent demand inventory systems are classically associated with Enterprise Resource Planning systems. The known demand is generally based on production numbers and the inventory represents the raw materials required to meet those requirements. This overall demand model allows the use of such inventory management models as Economic Ordering Quantity, Safety Stock Analysis, Fill Rates, and Cycle Service Levels. In this demand model, supply chain concerns become more and more critical to inventory control decisions. Lead times, quantity price breaks, and the costs of expediting orders all play a role. Knowing the type of demand you need to accommodate is the first step in developing your own customized inventory management models. Different segments of your inventory may actually service a different demand type.Learning how to recognize the operating demand conditions is the first step to growing into a more efficient organization. The next step is implementing the processes that support the inventory management models.
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Fundamentals of Executing Effective Inventory Management
Effective inventory management is critical to all operations. It can have a different definition from business to business, but certain core practices ensure success whether a company is supplying a retail store or manufacturing shipping peanuts. No operation can function properly without knowing what is in stock and where to find it. Achieving efficient inventory processes starts with a culture of understanding and accountability. i) Inventory Accuracy Starts at Receiving The most critical stage of effective inventory management is the receiving dock. Errors made in receiving flow through the building, creating other problems along the way. As with any aspect of inventory control, strong managers look keenly at the three pillars of fulfillment control: people, system, and process. Your receivers must be properly trained. They must understand the standards for accuracy and record management. ii) Leverage Technology Data automation provides engineering constraints on errors. Us of RF scanning and RF ID technology goes a long way to reducing the errors from manual record keeping. Companies can gain a lot of efficiency and accuracy in receiving by incorporating ASN data into your receiving system. ASN is Advance Ship Notices. This is where vendors send data electronically regarding the contents of the incoming shipment.
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This reduces the chances of receiving to the wrong purchase order or the wrong items. Finally, you must have established processes for receiving, cycle counting, auditing and problem solving when exceptions arise. Effective inventory management must be measurable.
iii) Establish Expectations With labor and inventory both a huge component of overall cost, businesses must decide up front what level of accuracy is necessary for success. In some environments, there may not be a return on investment past 90% inventory accuracy. In others, anything less that 100% may cause a critical process failure. Once those expectations are in place, you must follow the old adage of inspect what you expect. As with many business processes, effective inventory management starts with effective front-line leadership. Accurate receiving, appropriate technology, and proper standards enforced through cycle counts and auditing are the key support structures to effective inventory management. With these in place, your business will have the visibility necessary to increase efficiency and profitability. Without proper attention, your business is at risk for a broad range of potential process failures, from angry customers to stopped production lines.
Inventory Management: Five Critical Steps Inventory management shares many traits with standard inventory management, but requires an extra layer of cost consideration. Whether a maintenance and repair organization (MRO) is internal to a larger business, or providing maintenance services to an external customer, efficient spare parts inventory management plays a critical role in reducing costs and maximizing customer service.
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For this example, we will look at an internal MRO to a production facility. These five steps collect the information you need for executing effective spare parts inventory management.
Step #1: Understanding existing (or projected) consumption Because repairs happen due to system failures, rather than as part of a production plan, many logistics professionals overlook consumption predictions. Depending on the age of the MRO, spare parts consumption can be based on either actual historic consumption, or projected based on equipment manufacturer preventative maintenance recommendations and fleet records of other system owners. Step #2: Calculating system failure costs In-stock levels and the size of your on-site inventory should be directly linked to costs of system failure or “down time”. Every machine in a production facility plays a role. Some have redundancy, like the multiple fork lifts in a warehouse, while others act as a single point of failure for the whole building, such as an automated full-building outbound sorter. Step #3: Estimate soft cost impact of out-of-stocks It is a picture familiar to many industry professionals: parts hoarded in toolboxes, a spare motor under a desk in the maintenance supervisor’s office, or the "secret stash" closet with thousands of dollars worth of parts. Reducing inventory dollars on the books as part of spare parts inventory management can lead to an off-books rise in inventory costs. You are guaranteed these behaviors will start when your out-of-stock rate in your frequently requested spare parts inventory reaches 4-5%.
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Step #4: Work with vendors for cost-reduction and in-stock improvement In many instances, leveraging vendor relationships will allow you to reduce your overall inventory dollars and keep better in-stocks.
Rather than using your own time and resources to monitor spare parts usage, establish reorder points, and project parts required for preventative maintenance, the manufacturer can often provide you a starting point for your stocking levels. In the best cases, you can find vendors willing to provide spare parts inventory management on a consignment bases: you pay only for parts consumed. Step #5: Calculate costs (hard and soft) of expedited orders It is sometimes impossible to maintain a spare parts inventory for every contingency. The key is to establish an expedited spare parts ordering process and understand the costs involved. This allows subordinate managers and maintenance person to make good decisions on what to expedite and what to order on standard orders. These five steps are just the beginning to achieving optimum spare parts inventory management. From these basics, you can measure, evaluate and further stream line your spare parts inventory control processes. Cost reduction, increased system availability, and improved moral because workers have the tools they need to do their jobs are just some of the benefits you can experience.
How to Calculate an Inventory Turn Calculating an inventory turn accurately starts with precise and consistent valuation on both sales and inventory on-hand. Assumptions regarding value must be universally applied and sustained throughout the valuation period.
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One of the advantages of the more robust inventory management tools is that the IT systems allow for an item number level tracking of Cost of Goods Sold (COGS). In some instances, cost of goods is maintained at a purchase order level, allowing for real valuation for goods ordered at different price points.
An inventory turn can be calculated for any period pertinent to your business. The most commonly used time periods are a month or a year, but sometimes a single inventory turn may be defined in a number of days for fast-moving inventory. Another set of costs associated with cost of goods are waste and shrinkage. Depending on the industry, these two factors can significantly impact these calculations. In manufacturing environments, flawed final products or scrap produced represent a material loss to the overall value of product sold. The tricky part is that scrap and shrinkage from theft or sales incentives are sometimes difficult to track. It is critical to have processes in place to record values and then include them in the inventory turns calculation. Instead of the standard: COGS= beginning inventory cost + purchase cost - end inventory cost A proper COGS reads as: COGS = beginning inventory cost + purchase cost + scrap/shrink cost – end inventory cost. By include that proper COGS valuation in the formula for calculating your inventory turn rate, there is more operational analysis credibility to the result of: Inventory turn rate = COGS / Cost of average inventory level Once accurately determined for the whole inventory, it is critical to identify where the areas of opportunity are in your inventory population. Inventory turn rate can be artificially elevated or deflated by certain inventory items. A high cost, high margin item may conceal the presence of many slow-moving items. Master of Business Administration
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While the big picture is what investors look at for determining the efficiency of an organizations inventory management, it is the job of the inventory managers themselves to do a deeper analysis. They can achieve this by looking at particular populations of inventory.
Top 100 and Bottom 100 items can both carry significant impact of the frequency of an inventory turn. Digging into the details of inventory turns can be the critical analysis necessary to take your inventory management to the next level of efficiency. Top 100 and Bottom 100 items can be viewed from a number of different measures. These can be calculated in terms of number of units sold, number of orders containing those units, or total dollars sold. By actively managing the Top and Bottom 100 items, this can impact you rate the most significantly with the least amount of analysis. While full inventory turns are an investor number and an operational management indicator, similar metrics at an item level, properly managed is where true efficiencies start.
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