Chapter 5: Inventory Management

Introduction

Inventory, which is the amount of the material kept for meeting future demands or requirements in production, can be found in different forms almost in all organizations.

Every organization needs inventory management to plan, organize and control procedures so that items will meet requirements and keep production at the desired level at all times.

The methods used in inventory control systems are as follows;

• Simple counting
• Visual inspection
• Two-bin methods
• Electronic data processing systems

While we have some traditional methods like “continuous” and “periodic” review systems, there are various production systems such as “material requirements planning” and “just in time today.

Inventory Management

Inventory management is the process of ordering, storing, and using a company’s inventory in order to make quantity and timing of the inventory certain.

Inventory can be raw materials, parts, components, work in process or finished goods. Inventory concept includes the management of raw materials, components, finished products, warehousing and processing.

By the help of inventory, companies can be ready for sudden and seasonal changes in demand, provide protection against problems, provide stability in employment tolerate the failures and postures in the system, take advantage of the price advantages, protect the enterprise against price and delivery uncertainties.

When there is inventory shortage, loss of customer, risk of stopping production and loss of image may occur.

Inventory Control Systems

Inventory control systems control the quantity and timing of inventory transactions to make sure that the material requirements are met at the “desired time” , at the “desired quantity” , at the “desired location” and at the “desired quality” . Lot sizes, the quantity of an item ordered for delivery on a specific date or manufactured in a single production run, are very important production planning and control.

While the main purpose of inventory control is to increase the long-term profitability of the company’s investments, there are some short term goals like meeting the expectations of the customers and ensuring company’s maintaining inventory in economic quantities.

“Continuous” and “periodic” review systems are traditional inventory control systems. “Material requirements planning” and “just in time” systems are the popular ones today.

In the continuous review system, a fixed amount of order (calculated by considering the annual average demand amount, order expenses, and unit price) is placed when the inventory level falls to a predetermined level. Safety stock (the amount of inventory held against the uncertainties in demand), usage speed and the duration of the lead time (the time between the initiation and completion of a production process) usage speed and the duration of the lead time are also essential for the order point. There are some ways for the control mentioned before like by the eyes, by two bin methods (a simple and effective method commonly used in enterprises), by hand-held records or by the help of a computer.

You can either control the inventory level at the beginning or end of predetermined time intervals in periodic review system.

Visual control is mostly preferred by small businesses or markets. The experienced worker checks inventory levels individually.

Material Requirement Planning (MRP) mainly focuses on “when to order” and “how much to order” for dependent inventory items determining when and how much a material is needed.

In order to successfully implement the MRP system;

• Supply sources should be reliable and punctual
• Computer and other information technologies are needed
• All employees, must be fully trained in the updating of the system

Keeping inventory investments in a minimum level, being sensitive to changes, creating a forward-looking perspective based on inventory items, determining Order quantities according to the requirements and focusing on the timing and complete fulfillment of requirements are some of the advantages of the MRP system.

Just-in-time (JIT), can be defined as the production of the required products at the required quality level, at the required time and also defined as defined as zero inventory, non-stop production or kanban system (an information system that controls production) . The main objectives of JIT are;

• Minimizing intermediate inventory levels in production
• Minimizing changes in intermediate inventory levels
• Facilitating inventory control
• Reducing production demand fluctuations,
• Streamlining production flow
• providing effective control with a simple system
• Reducing waste rate

JIT is an important component of lean production system, which is a production philosophy that eliminates all the factors that cause waste. Toyota is the developer of this system and it states some wastes like overproduction, transport, inventory, motion, defects, over-processing, waiting, which cause the costs to increase.

Inventory Models

By the help of the inventory models companies can decide the time and amount of materials to be renewed with the minimal total cost. The components of this cost are

• Inventory holding cost (H) (sum of the cost of capital plus the variable costs of keeping items on hand)
• Shortage cost (costs that occur when there is no inventory or when the stock is out of stock)
• Order cost (A): (cost that depends on the production or purchase of the material ordered)

Economic Order Quantity (EOQ), which is one of the oldest classical production planning models, refers to that number ordered in a single purchase so that the accumulated costs of ordering and carrying costs are at the minimum level. There are some assumptions to be considered for the EOQ model like the demand rate for the product, the order quantity, the demand rate for the year, the product price, the lead time, the average inventory level, the cost of ordering, all the demand in the planning period and all orders.

The variables used in the EOQ model are

• D = Annual demand (unit/year)
• C = Purchasing price per unit (T/unit)
• A = Ordering cost per batch (T/batch)
• i = Annual interest rate (%)
• H = Annual cost of holding per unit (T/unit-year)
• Q = Order quantity (unit)

It is not possible to enter orders placed in production systems into inventory at the same time. Products are stocked at a certain delivery speed. In the Economic Production Quantity (EPQ) model a certain period of time is required to complete the Q unit order. For the materials produced in the enterprise cost of preparation and cost of holding are taken into account.

ABC Analysis

As controlling all inventory items at the same level of importance can be very difficult, when applying inventory control systems, it is considered to develop a classification system that will help management in order to determine order decisions of the materials to be kept.

The level of control of various inventory items may sometimes be classified according to their criticality or value.

ABC analysis helps to examine the inventories if there are many different inventory items. This analysis divides a large number of inventory items into three groups representing letters A, B and C to identify and control significant inventory items.

• Class A Inventory (very few inventory items in this class receive the largest share of the inventory investment in monetary terms)
• Class B Inventory (inventory items in this class cover 30% to 35% of the total inventory items and account for approximately 20% of the total inventory investment)
• Class C Inventory (the materials in this class constitute 50% -55% of the total inventory items)

In inventory some items require close monitoring and control, but some not. When separating items that require close control from items that do not require close monitoring and control, the ABC inventory classification system works well.