DETERMINATION OF STOCK HOLDING POLICY
Definition of inventory
Inventory: A stock of materials kept for future sale or use.
Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business. It is also used for a list of the contents of a household. In accounting inventory is considered an asset..
Generally, inventory types can be grouped into four classifications: raw material, work-in-process, finished goods, and MRO goods.
1. RAW MATERIALS
Raw materials are inventory items that are used in the manufacturer’s conversion process to produce components, subassemblies, or finished products. These inventory items may be commodities or extracted materials that the firm or its subsidiary has produced or extracted. They also may be objects or elements that the firm has purchased from outside the organization. Even if the item is partially assembled or is considered a finished good to the supplier, the purchaser may classify it as a raw material if his or her firm had no input into its production. Typically, raw materials are commodities such as ore, grain, minerals, petroleum, chemicals, paper, wood, paint, steel, and food items. However, items such as nuts and bolts, ball bearings, key stock, casters, seats, wheels, and even engines may be regarded as raw materials if they are purchased from outside the firm.
Generally, raw materials are used in the manufacture of components. These components are then incorporated into the final product or become part of a subassembly. Subassemblies are then used to manufacture or assemble the final product. A part that goes into making another part is known as a component, while the part it goes into is known as its parent. Any item that does not have a component is regarded as a raw material or purchased item.
Work-in-process (WIP) is made up of all the materials, parts (components), assemblies, and subassemblies that are being processed or are waiting to be processed within the system. This generally includes all material—from raw material that has been released for initial processing up to material that has been completely processed and is awaiting final inspection and acceptance before inclusion in finished goods. Any item that has a parent but is not a raw material is considered to be work-in-process.
3. FINISHED GOODS
A finished good is a completed part that is ready for a customer order. Therefore, finished goods inventory is the stock of completed products. These goods have been inspected and have passed final inspection requirements so that they can be transferred out of work-in-process and into finished goods inventory. From this point, finished goods can be sold directly to their final user, sold to retailers, sold to wholesalers, sent to distribution centers, or held in anticipation of a customer order.
Any item that does not have a parent can be classified as a finished good. By looking at the rolling cart product structure tree example one can determine that the finished good in this case is a cart.
4. MRO GOODS INVENTORY
Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and maintain the production process and its infrastructure. These goods are usually consumed as a result of the production process but are not directly a part of the finished product. Examples of MRO goods include oils, lubricants, coolants, janitorial supplies, uniforms, gloves, packing material, tools, nuts, bolts, screws, shim stock, and key stock. Even office supplies such as staples, pens and pencils, copier paper, and toner are considered part of MRO goods inventory.
5. OTHER TYPES INVENTORY
Inventories can be further classified according to the purpose they serve. These types include transit inventory, buffer inventory, anticipation inventory, decoupling inventory, cycle inventory, and MRO goods inventory. Some of these also are know by other names, such as speculative inventory, safety inventory, and seasonal inventory. We already have briefly discussed some of the implications of a few of these inventory types, but will now discuss each in more detail.
(i) TRANSIT INVENTORY
Transit inventories result from the need to transport items or material from one location to another, and from the fact that there is some transportation time involved in getting from one location to another. Sometimes this is referred to as pipeline inventory. Merchandise shipped by truck or rail can sometimes take days or even weeks to go from a regional warehouse to a retail facility. Some large firms, such as automobile manufacturers, employ freight consolidators to pool their transit inventories coming from various locations into one shipping source in order to take advantage of economies of scale. Of course, this can greatly increase the transit time for these inventories, hence an increase in the size of the inventory in transit.
(ii) BUFFER INVENTORY
As previously stated, inventory is sometimes used to protect against the uncertainties of supply and demand, as well as unpredictable events such as poor delivery reliability or poor quality of a supplier’s products. These inventory cushions are often referred to as safety stock. Safety stock or buffer inventory is any amount held on hand that is over and above that currently needed to meet demand. Generally, the higher the level of buffer inventory, the better the firm’s customer service. This occurs because the firm suffers fewer “stock-outs” (when a customer’s order cannot be immediately filled from existing inventory) and has less need to backorder the item, make the customer wait until the next order cycle, or even worse, cause the customer to leave empty-handed to find another supplier. Obviously, the better the customer service the greater the likelihood of customer satisfaction.
(iii) ANTICIPATION INVENTORY
Oftentimes, firms will purchase and hold inventory that is in excess of their current need in anticipation of a possible future event. Such events may include a price increase, a seasonal increase in demand, or even an impending labor strike. This tactic is commonly used by retailers, who routinely build up inventory months before the demand for their products will be unusually high (i.e., at Val; Christmas, or the back-to-school season). For manufacturers, anticipation inventory allows them to build up inventory when demand is low (also keeping workers busy during slack times) so that when demand picks up the increased inventory will be slowly depleted and the firm does not have to react by increasing production time.
(iv) DECOUPLING INVENTORY
Very rarely, if ever, will one see a production facility where every machine in the process produces at exactly the same rate. In fact, one machine may process parts several times faster than the machines in front of or behind it. Yet, if one walks through the plant it may seem that all machines are running smoothly at the same time. It also could be possible that while passing through the plant, one notices several machines are under repair or are undergoing some form of preventive maintenance. Even so, this does not seem to interrupt the flow of work-in-process through the system. The reason for this is the existence of an inventory of parts between machines, a decoupling inventory that serves as a shock absorber, cushioning the system against production irregularities. As such it “decouples” or disengages the plant’s dependence upon the sequential requirements of the system (i.e., one machine feeds parts to the next machine).
The more inventory a firm carries as a decoupling inventory between the various stages in its manufacturing system (or even distribution system), the less coordination is needed to keep the system running smoothly. Naturally, logic would dictate that an infinite amount of decoupling inventory would not keep the system running in peak form. A balance can be reached that will allow the plant to run relatively smoothly without maintaining an absurd level of inventory. The cost of efficiency must be weighed against the cost of carrying excess inventory so that there is an optimum balance between inventory level and coordination within the system.
(v) CYCLE INVENTORY
Those who are familiar with the concept of economic order quantity (EOQ) know that the EOQ is an attempt to balance inventory holding or carrying costs with the costs incurred from ordering or setting up machinery. When large quantities are ordered or produced, inventory holding costs are increased, but ordering/setup costs decrease. Conversely, when lot sizes decrease, inventory holding/carrying costs decrease, but the cost of ordering/setup increases since more orders/setups are required to meet demand. When the two costs are equal (holding/carrying costs and ordering/setup costs) the total cost (the sum of the two costs) is minimized. Cycle inventories, sometimes called lot-size inventories, result from this process. Usually, excess material is ordered and, consequently, held in inventory in an effort to reach this minimization point. Hence, cycle inventory results from ordering in batches or lot sizes rather than ordering material strictly as needed.
WHY KEEP INVENTORY?
Why would a firm hold more inventory than is currently necessary to ensure the firm’s operation? The following is a list of reasons for maintaining what would appear to be “excess” inventory.
1. MEET DEMAND.
In order for a organization to stay in business, it must have the products that the customer wants on hand when the customer wants them. If not, the retailer will have to back-order the product. If the customer can get the good from some other source, he or she may choose to do so rather than electing to allow the original retailer to meet demand later (through back-order). Hence, in many instances, if a good is not in inventory, a sale is lost forever.
2. KEEPING OPERATIONS RUNNING.
A manufacturer must have certain purchased items (raw materials, components, or subassemblies) in order to manufacture its product. Running out of only one item can prevent a manufacturer from completing the production of its finished goods.
Inventory between successive dependent operations also serves to decouple the dependency of the operations. A machine or work center is often dependent upon the previous operation to provide it with parts to work on. If work ceases at a work center, then all subsequent centers will shut down for lack of work. If a supply of work-in-process inventory is kept between each work center, then each machine can maintain its operations for a limited time, hopefully until operations resume the original center.
3. LEAD TIME.
Lead time is the time that elapses between the placing of an order (either a purchase order or a production order issued to the shop or the factory floor) and actually receiving the goods ordered.
If a supplier (an external firm or an internal department or plant) cannot supply the required goods on demand, then the client firm must keep an inventory of the needed goods. The longer the lead time, the larger the quantity of goods the firm must carry in inventory.
Inventory can also be used as a hedge against price increases and inflation. Salesmen routinely call purchasing agents shortly before a price increase goes into effect. This gives the buyer a chance to purchase material, in excess of current need, at a price that is lower than it would be if the buyer waited until after the price increase occurs.
5. QUANTITY DISCOUNT.
Often firms are given a price discount when purchasing large quantities of a good. This also frequently results in inventory in excess of what is currently needed to meet demand. However, if the discount is sufficient to offset the extra holding cost incurred as a result of the excess inventory, the decision to buy the large quantity is justified.
6. SMOOTHING REQUIREMENTS.
Sometimes inventory is used to smooth demand requirements in a market where demand is somewhat erratic. In fact, this is often called anticipation inventory. In essence, the use of inventory has allowed the firm to move demand requirements to earlier periods, thus smoothing the demand.
Inventories play a major role in the economy and businesses. From the firm’s view point, inventories represent an investment in capital; capital is required to store materials at any stage of completion. Thus the proper balance must be struck to maintain proper inventory level with the minimum financial impact to the organization.
Inventory management, or inventory control, is an attempt to balance inventory needs and requirements with the need to minimize costs resulting from obtaining and holding inventory. Inventory may be kept “in-house,” meaning on the premises or nearby for immediate use; or it may be held in a distant warehouse or distribution center for future use. With the exception of firms utilizing just-in-time methods, more often than not, the term “inventory” implies a stored quantity of goods that exceeds what is needed for the firm to function at the current time (e.g., within the next few hours).
BALANCING INVENTORY AND COSTS
As stated earlier, inventory management is an attempt to maintain an adequate supply of goods while minimizing inventory costs. We saw a variety of reasons companies hold inventory and these reasons dictate what is deemed to be an adequate supply of inventory. Now, how do we balance this supply with its costs? First let’s look at what kind of costs we are talking about.
There are three types of costs that together constitute total inventory costs: holding costs, set-up costs, and purchasing costs.
1. Holding Cost.
Holding costs, also called carrying costs, are the costs that result from maintaining the inventory. Inventory in excess of current demand frequently means that its holder must provide a place for its storage when not in use. This could range from a small storage area near the production line to a huge warehouse or distribution center. A storage facility requires personnel to move the inventory when needed and to keep track of what is stored and where it is stored. If the inventory is heavy or bulky, forklifts may be necessary to move it around.
Storage facilities also require heating, cooling, lighting, and water. The firm must pay taxes on the inventory, and opportunity costs occur from the lost use of the funds that were spent on the inventory. Also, obsolescence, pilferage (theft), and shrinkage are problems. All of these things add cost to holding or carrying inventory.
If the firm can determine the cost of holding one unit of inventory for one year (H) it can determine its annual holding cost by multiplying the cost of holding one unit by the average inventory held for a one-year period. Average inventory can be computed by dividing the amount of goods that are ordered every time an order is placed (Q) by two. Thus, average inventory is expressed as Q/2. Annual holding cost, then, can be expressed as H(Q/2).
2. Set-up Cost.
Set-up costs are the costs incurred from getting a machine ready to produce the desired good. In a manufacturing setting this would require the use of a skilled technician (a cost) who disassembles the tooling that is currently in use on the machine. The disassembled tooling is then taken to a tool room or tool shop for maintenance or possible repair (another cost). The technician then takes the currently needed tooling from the tool room (where it has been maintained; another cost) and brings it to the machine in question.
There the technician has to assemble the tooling on the machine in the manner required for the good to be produced (this is known as a “set-up”). Then the technician has to calibrate the machine and probably will run a number of parts, that will have to be scrapped (a cost), in order to get the machine correctly calibrated and running. All the while the machine has been idle and not producing any parts (opportunity cost). As one can see, there is considerable cost involved in set-up.
3. Ordering costs
If the firm purchases the part or raw material, then an order cost, rather than a set-up cost, is incurred. Ordering costs include the purchasing agent’s salary and travel/entertainment budget, administrative and secretarial support, office space, copiers and office supplies, forms and documents, long-distance telephone bills, and computer systems and support. Also, some firms include the cost of shipping the purchased goods in the order cost.
If the firm can determine the cost of one set-up (S) or one order, it can determine its annual setup/order cost by multiplying the cost of one set-up by the number of set-ups made or orders placed annually. Suppose a firm has an annual demand (D) of 1,000 units. If the firm orders 100 units (Q) every time it places and order, the firm will obviously place 10 orders per year (D/Q). Hence, annual set-up/order cost can be expressed as S(D/Q).
4. Purchasing costs
Purchasing cost is simply the cost of the purchased item itself. If the firm purchases a part that goes into its finished product, the firm can determine its annual purchasing cost by multiplying the cost of one purchased unit (P) by the number of finished products demanded in a year (D). Hence, purchasing cost is expressed as PD.
Now total inventory cost can be expressed as:
Total = Holding cost + Set-up/Order cost + Purchasing cost
Total = H(Q/2) + S(D/Q) + PD
If holding costs and set-up costs were plotted as lines on a graph, the point at which they intersect (that is, the point at which they are equal) would indicate the lowest total inventory cost. Therefore, if we want to minimize total inventory cost, every time we place an order, we should order the quantity (Q) that corresponds to the point where the two values are equal. If we set the two costs equal and solve for Q we get:
H(Q/2) = S(D/Q)
Q = 2 DS/H
There are a number of assumptions that must be made with the use of the EOQ. These include:
- Only one product is involved.
- Deterministic demand (demand is known with certainty).
- Constant demand (demand is stable through-out the year).
- No quantity discounts.
- Constant costs (no price increases or inflation).
While these assumptions would seem to make EOQ irrelevant for use in a realistic situation, it is relevant for items that have independent demand. This means that the demand for the item is not derived from the demand for something else (usually a parent item for which the unit in question is a component). For example, the demand for steering wheels would be derived from the demand for automobiles (dependent demand) but the demand for purses is not derived from anything else; purses have independent demand.
SUPPLIER MARKET CONDITIONS/EVALUATIONS
Is a term used in business and refers to the process of evaluating and approving potential suppliers by factual and measurable assessment. The purpose of supplier evaluation is to ensure a portfolio of best in class suppliers is available for use. Supplier evaluation is also a process applied to current suppliers in order to measure and monitor their performance for the purposes of reducing costs, mitigating risk and driving continuous improvement.
Supplier evaluation is a continual process within purchasing department and forms part of the pre-qualification step within the purchasing process, although in many organizations it includes the participation and input of other departments and stakeholders.. It often takes the form of either a questionnaire or interview, sometimes even a site visit, and includes appraisals of various aspects of the supplier’s business including capacity, financials, quality assurance, organizational structure and processes and performance. Based on the information obtained via the evaluation, a supplier is scored and either approved or not approved as one from whom to procure materials or services. In many organizations, there is an approved supplier list (ASL) to which a qualified supplier is then added. If rejected the supplier is generally not made available to the assessing company’s procurement team. Once approved, a supplier may be reevaluated on a periodic, often annual, basis. The ongoing process is defined as supplier performance management.
This focuses on obtaining and interpreting the following supplier information:
- Core business;
- Capability and reputation;
- Working procedures related to the service
- Capacity; and
- Track record.
This information enables the contracting organization to determine the overall capability and capacity of the prospective service provider It is crucial to the achievement of best value for money that only competent suppliers are selected.
Obtaining Market Information
A request for proposal (referred to as RFP) is an invitation for suppliers, often through a bidding process, to submit a proposal on a specific commodity or service. A bidding process is one of the best methods for leveraging a company’s negotiating ability and purchasing power with suppliers. The RFP process brings structure to the procurement decision and allows the risks and benefits to be identified clearly upfront. The RFP purchase process is lengthier than others, so it is used only where its many advantages outweigh any disadvantages and delays caused. The added benefit of input from a broad spectrum of functional experts ensures that the solution chosen will suit the company’s requirements.
The RFP may dictate to varying degrees the exact structure and format of the supplier’s response. The creativity and innovation that suppliers choose to build into their proposals may be used to judge supplier proposals against each other, at the risk of failing to capture consistent information between bidders and thus hampering the decision making process. Effective RFPs typically reflect the strategy and short/long-term business objectives, providing detailed insight upon which suppliers will be able to offer a matching perspective.
- Obtain correct information to enable sound business decisions.
- Decide correctly on strategic procurement.
- Leverage the company’s purchasing power to obtain a favorable deal.
- Informs suppliers that your company is looking to procure and encourages them to make their best effort.
- Requires the company to specify what it proposes to purchase. If the requirements analysis has been prepared properly, it can be incorporated quite easily into the Request document.
- Alerts suppliers that the selection process is competitive.
- Allows for wide distribution and response.
- Ensures that suppliers respond factually to the identified requirements.
By following a structured evaluation and selection procedure an organization can demonstrate impartiality – a crucial factor in public sector procurement.
Benefits and Drawbacks
There are various benefits associated with an effective supplier evaluation process such as mitigation against poor supplier performance or performance failures. The benefits typically include sourcing from suppliers that provide high standards of product and service levels whilst offering sufficient capacity and business stability. Supplier evaluation can help customers and suppliers identify and remove hidden cost drivers in the supply chain. The process of evaluating performance can motivate suppliers to improve their performance.
Associated challenges with supplier evaluation include resource and cost commitments in establishing and maintaining a robust and effective system, challenges with specifying and gathering meaningful and relevant information, data integrity, scorecards that do not get at the root causes of supplier problems, and subjective or inconsistent scoring which may result in inaccurate assessment Another challenge is making sure that evaluation of current suppliers goes beyond measurement to actual performance improvement by providing feedback to suppliers on their performance and working on continuous improvement opportunities. Thus, management commitment to and support of a supplier evaluation process is essential
RFPs often include specifications of the item, project or service for which a proposal is requested. The more detailed the specifications, the better the chances that the proposal provided will be accurate. Generally RFPs are sent to an approved supplier or vendor list.
The bidders return a proposal by a set date and time. Late proposals may or may not be considered, depending on the terms of the initial RFP. The proposals are used to evaluate the suitability as a supplier, vendor, or institutional partner. Discussions may be held on the proposals (often to clarify technical capabilities or to note errors in a proposal). In some instances, all or only selected bidders may be invited to participate in subsequent bids, or may be asked to submit their best technical and financial proposal, commonly referred to as a Best and Final Offer (BAFO).
Request for Quotation (RFQ) is used when discussions with bidders are not required (mainly when the specifications of a product or service are already known) and when price is the main or only factor in selecting the successful bidder. An RFQ may also be used as a step prior to going to a full-blown RFP to determine general price ranges. In this scenario, products, services or suppliers may be selected from the RFQ results to bring in to further research in order to write a more fully fleshed out RFP.
RFP is sometimes used for a request for pricing.
Request for Information (RFI) is a proposal requested from a potential seller or a service provider to determine what products and services are potentially available in the marketplace to meet a buyer’s needs and to know the capability of a seller in terms of offerings and strengths of the seller. RFIs are commonly used on major procurements, where a requirement could potentially be met through several alternate means. An RFI, however, is not an invitation to bid, is not binding on either the buyer or sellers, and may or may not lead to an RFP or (RFQ).
Request for Qualifications (RFQ) is a document often distributed before initiation of the RFP process. It is used to gather vendor information from multiple companies to generate a pool of prospects. This eases the RFP review process by preemptively short-listing candidates which meet the desired qualifications.
CATEGORIES OF RISK AND THEIR EVALUATION
Creating an Effective Risk Management Strategy
Does your company have a risk management strategy? What will happen if one of your key suppliers has a service disruption due to a labor issue such as a strike? How will it affect your operations? More importantly, how will it affect service to your customers?
Progressive organizations are implementing a risk management strategy to enable them to react to potential issues in a streamlined fashion. By having a plan, organizations are able to minimize a large ripple effect other operations within their organization.
1. Supplier capacity
If you have a sole supplier for a major product line, your operation may be at risk if there is a supply issue. Determine what percentages of your products (dollar or unit volume) are sourced from your top suppliers.
2. Internal processes (i.e. Manufacturing, Assembly)
Review everything from equipment maintenance to quality control procedures. Ensure there are back-up plans in the event of equipment failure. Identify a back-up supplier if you source a specialty item from a supplier that may have a quality issue in the future (i.e. company sold, new management, etc.).
3. Warehouse capacity
Monitor seasonal trends to identify the peak volumes in your operation. Forecast volumes at least 1-2 months in advance to determine if your operations will be able to meet demand. Have a plan to use a preferred supplier for outside storage space if required – don’t wait until it’s needed.
3. Transportation availability & rates
Ensure that your organization has relationships with other carriers in the event of a disruption with your current one. Review other modes of transportation (i.e. Air) if the primary mode fails to meet your customer’s needs.
4. Assign Risk Owners
Ensure accountability, once each potential risk has been identified, a risk owner should be assigned to each area. It will be their responsibility to report on the risk strategy on a periodic basis. If no-one owns it, it will not get done.
REQYUIREMENT OF THE BUSINESS AND THE NEED FOR STOCK
Stock management is defined as the control of stock to ensure that it is adequate for immediate needs without using up excessive financial resources. Stock costs are an important aspect of a firm’s overall costs. This means that firms ensure that efficient stock management is used. Hence any proficient method of stock management used to reduce the cost of holding stock increases profitability and that is a major objective of any firm.
Firms understand that they have to incur an expense to hold stock but this will ensure that the business can remain functioning. So the central aim of stock management is to effectively minimize the cost to stockholding while allowing the business to operate smoothly by retaining sufficient stock.
A firm must ensure efficient stock management to ensure that enough supplies of raw materials for the production process. The business must be supplied with enough raw materials to meet output requirements. If the firm cannot meet demand of the consumers because it does not have enough stock to do so, it will start to lose sales. This is especially true in the growth stage of the product’s lifecycle where there is an anticipated increase in demand for the product. This is also true of seasonal which have variations in demand. Too much stock can’t be kept when demand is low otherwise depending on the nature of the stock it may go bad, become obsolete or lose its quality.
If a business does not ensure efficient stock management then a lot of wastage can arise as a result. A stock out happens when a firm experiences total depletion or runs out of stock. Stock outs lead to lost profits and loss of customer goodwill and loyalty therefore future sales. If the customers cannot get their goods at one firm they will leave and purchase it somewhere else that has it in stock. Continuously unfavorable stock outs by that firm will cause them to lose future sales. These are reasons is why it is of major importance for a firm to have efficient stock management.
Stock management teams must use some method of stock management in order to ensure that they do not experience an unwanted stock out. The stock management team must decide whether to make large occasional orders to hold in stock or small frequent orders.
METHOD OF AVOIDING CARRYING STOCK
Two major methods utilized are the ‘Buffer Stock’ technique and the ‘Just in Time’ system.
MRP AND MRP II.
MRP and MRP II are computer-based resource management systems designed for items that have dependent demand. MRP and MRP II look at order quantities period by period and, as such, allow discrete ordering (ordering only what is currently needed). In this way inventory levels can be kept at a very low level; a necessity for a complex item with dependent demand.
- Low level inventory benefit
- Ability to keep tracts of inventory requirements
- Ability to evaluate capacity requirements generated by a given master schedule
- A means of allocating production times
The Just in Time System is a manufacturing practice developed by the Japanese in order to minimize holdings of stock. Suppliers deliver materials needed for production at the exact moment they are required. Goods are produced only as they are needed for the next phase of production. Stock is frequently delivered therefore there is a zero inventory situation. The firm only produces something when there is actual customer demand for it (First sell it, then make it). The Just in Time system only work when there is high employee flexibility and commitment and a well coordinated production system to ensure quality and continuous improvements to minimize bottlenecks.
- The Just in Time system has a much less risk of their stock becoming obsolete or going bad (losing its quality).
- The firm keeps a small inventory hence using less space required, lower maintenance costs and capital requirements.
- As a result of the ‘First sell it, then make it’ method of operation the right quantities are produced at the right time.
- There is increased workforce participation as a result of their employment flexibility and commitment.
- The continuous emphasis on improvement and problem solving results in higher quality, good customer service and reduced costs.
The Buffer stock technique
BST is referred to as a conventional method of stock management. The firm has a fixed amount of stock held in inventory. They specify a certain stock level that if stock reaches that point, a reorder must be made to bring it back to normal level. There is a time lapse between the actual order of stocks and its delivery. During this time supplies are still decreasing. A buffer stock is held as reserve stock in the event that the reorder takes longer than expected. Buffer stock ensures that the firm always has reserve stock, enough to fend off a stock out experience.
The Buffer Stock method is beneficial:
- given that they can benefit from purchasing economies of scale.
- Profits that derive from the rise of the price of stock they purchased at a previously lower price.
- They also have the security of an emergency source of supplies.
Firms must place emphasis on their stock management system. This is a vital part of business operations because it affects crucial parts of the business such as profitability and customer relations. The business’ environment will determine what method of stock management they employ and how effective it turns out to be.
The ABC approach classifies inventory items according to some measure of important usually annual naira usage, and then allocates control efforts accordingly. In this method, inventories are grouped into three categories as follows:
|Class A||Very important|
|Class B||Moderately important|
|Class C||Least important|
Items in Class A generally account for 15-20% of the number items in stock but about 60-70% of the Naira usage. At the extreme end are Class C items which account for about 60% of items but only about 105 of Naira usage in inventory.
What this means is that items in class A should be given close attentions by management through constant review of stock in-hand and their withdrawal to avoid stock-out. Items in Class C should receive only loose control, while Class B control lies between the two.
Kanban is a Japanese word meaning “signal” or “visible record”. In a pull system workflow is dictated by “next-step demand”. A system can communicate such demand by using a kanban card. When a worker needs material or works from the preceding station, he/she uses a kanban card. The kanban card is an authorization to move or work on parts. In kanban system no part can be worked or move without one of the card.
It worked like this. Each container is affixed with a card. When a process or work station needs to replenish its supply of parts, a worker goes to the area where these parts are stored and withdraws one container of parts. Each container holds a predetermined quantity. The worker removes the kanban card from the container and posts it in a designated spot where it will be clearly visible. The worker moves the container to the work station. The posted kanban card is then picked up by a stock person who replenished the stock with another containerm and so on down the line.
The number of kanban card need for a given production level can be calculated using this formular:
N = DT (1+X)/C
Where: N = Total number of containers (1 card per container)
D= Planned usage rate of a center
T= Average waiting time
X= Policy variable set by management
C= Capacity of a standard container (should not be less than 10%
Note that D & T must use the same units (e.g. minutes or days)
- Kanban system is very simple to implement
- Kanban usually have very small lot size.
- It handles changes very easily.
- Kanban has short lead time, and high quality output, and simplifies teamwork.
- Kanban is two-bin types of inventory management. Suppliers are replenished as soon as inventories reach predetermined level.
CONWIP stands for Constant Work-In-Process, and designates a control strategy that limits the total number of parts allowed into the system at the same time. Once the parts are released, they are processed as quickly as possible until they wind up in the last buffer as finished goods. One way to view this is that the system is enveloped in a single kanban cell: Once the consumer removes a part from the finished goods inventory, the first machine in the chain is authorized to load another part.
- First of all, like kanban, the CONWIP system only responds to actual demands that have occurred, so it is still a “pull” type system.
- New parts will not be released if the finished goods buffer is full.
- The inventory in finished goods is now available to serve the customer, and there is no internal inventory to collect dust.
CONTROL OF STOCK RANGE
Its aim is to control the quantity and quality of stocks to enable production and sales to continue whilst minimizing costs.
What is coding and classification?
Broadly speaking, coding and classification are about using a number or set of alphanumeric characters to:
• Identify a specific thing; or
• Group similar things together.
For example, a bar code number on a can of drink identifies what the drink is, who manufactures the drink and the unit and pack size of the drink. This particular code is known as an identification code as it has no relation to other codes and wouldn’t be used to group products together for analysis. It is important to distinguish between coding and classification as they support totally different business roles. Adopting the wrong approach can present significant challenges by distorting the information available to the point that it cannot support the business requirement for which it was intended.
Coding for identification
Identification codes are used for recording and tracking items and are used for inventory management, point of sale transactions or historical record keeping. An identification code can also identify other information such as:
• Address/Location identifiers
• Language identifiers
• Unit of measures or issue
• Currency identifiers
• Country identifiers
• Price/cost identifiers
Coding and classification of information brings uniformity across business divisions, business functions and even across business units within an organization. It allows purchasing activity to be viewed from macro or micro level. It demonstrates the value of spend with a particular supplier, or at a higher level the value of spend within a corporate structure. This spending power may be greater than you think. Unless an organization has analyzed sources and levels of supply, it is hard to quantify overall spend with a group of related companies.
Coding and classification methods
1. The UNSPSC™ was developed jointly by the UNDP (United Nations
Development Programme) and D&B (Dun & Bradstreet Corporation) in 1998. The
latter came to an amicable agreement with ECCMA in October 2002 regarding
the use of the rival Universal Standard Product and Services Classification
(UNSPSC) which has now been unified into a single structure.
EAN International (non profit making)
Eight digits, e.g. 44.12.19.03 equals
2. The EANUCC System has been in use since 1974, enabling over 900,000
organizations in 129 countries worldwide to improve their business efficiency
The general form of the EAN/UCC-
13 number, issued in the UK is 50
12345 67890 0.
Where 50 is country of issue,
12345 is the unique company identifier, 67890 is the part allocated by the company as
they see fit, to define the product,
and the last digit (0) in this case, is a check digit.
|NATO – managed in UK by UKNational Codification Bureau||Thirteen digits, e.g.5905-00-7345199 equals
RESISTOR, FIXED, FILM
|Well-established, manufacturer specific code. Defence orientated. New codes,however, need world wide agreement.|
|Common Procurement Vocabulary (CPV)||Eight digits plus check digit, e.g.15961100-3 equals
|Used for Public Sector EU reporting derived from the UN Common ProcurementClassification. Now adopted as an EU standard for Public Sector Procurement.
Crown Copyright, managed by Coding International Ltd
|National Supplies Vocabulary (NSV)|| Three alpha, four numeric, e.g.
Paint, Gloss, Acrylic, 400ML,
| Devised by the NHS in the 1970s. Rationalised in the 1990s and used as the
defacto standard by UK Government. Heading Classification with Item Codes and
Standardised Descriptions. Maintained within Track-IT Database and crossreferenced
to other main coding systems. Previously managed by the NSV
Centre, NHS which was privatised in 2000 and renamed Coding International Ltd.
|ProClassCrown Copyright, managed and
owned by Local Government
Regional Centres of Excellence
|No digits. Three level hierarchydesigned for classification
purposes only with emphasis on
mirroring the local government
|Devised in 2006 by the nine Regional Centres of Excellence. It is particularlydesigned to support both Expenditure Analysis and Contracts management and
alignment. It is mapped to NSV, UNSPSC and the Thomson structures.
Variety Reduction and Standardization
The deliberate elimination of the number of variants in a product range or line, in order to improve efficiency and secure scale economies, usually accomplished through Pareto analysis
Part variety reduction. Drastic reductions in existing part variety are possible through Product Line Rationalization, which eliminates or out-sources products and product variations that are problem prone, don’t “fit” into a BTO, have low sales Not only is rationalization an important prerequisite for spontaneous BTO, it can have the immediate benefits of raising profits and freeing valuable resources.
Part variety can also be reduced by designing new products around standard parts.
Part variety can be further reduced by consolidating many inherently inflexible parts into a few very versatile standard shapes
As raw material variety is reduced, it becomes more feasible to use automatic re-supply techniques, like kanban, min/max or bread-truck
Too many types of raw materials can thwart spontaneity and make the manufacturer have to choose between stocking all types or ordering them and waiting for delivery. The solution is to aggressively standardize incoming raw materials
Standardization can be defined as: The development and implementation of concepts, doctrines, procedures and designs to achieve and maintain the required levels of compatibility, interchangeability or commonality in the operational, procedural, material, technical and administrative fields to attain interoperability.
In material management, standardization refers to approaches for increasing commonality of part, process, product or procurement. Such change will enable making of manufacturing or procurement decisions, thus reducing variability found in having many non-standard components.
Application and approval of new stock items
The actual purchase of all materials is usually made by the purchasing department headed by a general purchasing agent. In some small and medium size companies, however, department heads or supervisors have authority to purchase materials as the need arises. In any case, systematic procedures should be in writing in order to fix responsibility and to provide full information regarding the ultimate use of materials ordered and received. The purchasing department should receive purchase requisitions for materials, supplies, and equipment; keep informed concerning sources of supply, prices, and shipping and delivery schedules; prepare and place purchase orders; and arranging for adequate and systematic reports between the purchasing, the receiving, and the accounting departments. An additional function of the purchasing department in many enterprises is to verify and approve for payments all invoices received in response to purchase orders placed by the department.
Control of slow moving, obsolete and redundant stock
Slow moving goods
Every manufacturer runs into the problem of having slow moving merchandise. Unused, dated, end-of-line, discontinued and un-useable merchandise is the bane of all businesses no matter what the products are. Rather than the problem being a negative, trying to solve it will open up many opportunities for having a more profitable business.
- Close-out sales — usually done after Christmas or in January.
- Selective temporary retirement. This relates to #1. Where it differs is that these goods are perennials, ones that would be reordered the next year anyway.
- Trade-back agreements. Some suppliers offer trade-back agreements. This gives the store the opportunity to exchange slow moving merchandise against an order of faster selling items.,
- Buying less. Oh my, what an easy thing to say, what a difficult thing to do. Many buyers believe or are told by their management that the savings gained by ordering and shipping larger orders are a justification for the large order.
- Moving goods around. It is not unusual to find that some goods haven’t sold because of where they are placed. Moving goods around has, on occasion, made a slow seller into a good, if not great, seller.
- Grouping — putting like things with like things. One aspect of having leftovers is that they are treated as left over. Pulling things into groups separated by space makes each group important.
- Signage — something that allows customers to know what the price is without having to turn it over to see the price. Many items remain unsold because the price was not where it could be seen .
- Market Trends — very often some goods become less desirable because the market has changed. Watching for market trends takes time and effort. Trade shows and trade journals offer good methods for seeing trends.
- Inventory control — and not automatic inventory control! When working with products the important thing is “rate of sale. Every item cycles differently.
- Alliances with other stores — better known as “buying groups”. Buying together may give the group some advantages not available to the individual stores. The real benefit for these alliances is that one store’s slow seller may be another store’s good seller
- Liquidators. Liquidators usually need larger quantities. It may be possible that if a group of stores with like items/lines wishes to put their inventories together, they may have a better chance to sell to a liquidator.
In every business or institution, machinery, equipment and materials can become obsolete, surplus or worn. The actual disposal of such equipment is the responsibility of the Purchasing Department.
There are several ways to dispose of equipment. If replacement equipment is to be purchased, every effort should be made to obtain a reasonable trade-in-allowance for the old equipment. In this case, Purchasing would negotiate with the vendors interested in supplying the replacement equipment.
Obsolete materials are defined as stocked materials that can no longer be used for their original purpose or any other purpose and therefore require disposal.
Materials which at present have no demand are regarded as dormant or redundant stocks. There is a possibility that in future they may be required. Consultation between purchasing department, productions, cost accountants and storekeeper is important in deciding what to do with redundant stock. The decision may be either to disposed of it in order to cut cost in term of losses and warehouse space or to continue to hold the in stock if there is a chance that there may be a demand in the future.
Role of other functions in determining stock range
Purchase department received requisition and buy material on behalf of the organization. They process the requisition and make necessary contacts with suppliers for contract negotiation, inspections of materials for specification and receipt of material falls within their purview.
The finance department takes the responsibility for processing bills and act promptly by settling the bills as directed by the purchase department. Finance must checks the purchasing department punitive purchase behavior in order to ensure prudent buying. They make payment as stipulated in the contract and to take advantages of prompt payment rebates.
The production department is responsible for production of goods within the firm. Production does not exist in a vacuum, it must interact with the purchasing department for the materials which are needed. Purchasing must ensure that they liaise with production in term of material specification requirements and quality.
The role of marketing in stock control can not overstate. Marketing management are responsible for finding out what the consumers want in terms of varieties, functionalities and quality. They transmit this information to production who informs purchasing as the materials required. Marketing must ensure that the final product is sold at a profit so that the firm will continue to be in business.
The purchasing department must communicate to HR department in matters connected with their professional expertise, performance evaluations, rewards etc. This is to ensure that the people who are responsible for spending about 80% of organizations money in terms of material purchases have the required knowledge and experience to carry out the task.
These other department makes inputs in one way or the order in deciding the level and quality of material held in stock.
CONTROL OF STOCK LEVEL
Forecasting techniques in relation to demand an lead time
A forecast is statement about the future. There are two uses for forecast.
1. Planning the system. Forecast helps managers plan the system. planning the system generally involved long-range plan about the type of product or service to offer, what facilities and equipment to use, where to locate the plant, etc.
2. Planning the use of the system: This involved short range and intermediate range planning, which focuses on such task as planning inventory and work force level, purchases and production planning, budgeting, and scheduling.
Business forecasting pertains to more than predicting demand. Forecast is also used to predict profits, revenues, cost and availability of materials etc.
Demand can be forecast using the following techniques:
What Are Time Series Models
- Quantitative forecasting models that use chronologically arranged data to develop forecasts.
- Assume that what happened in the past is a good starting point for predicting what will happen in the future.
- These models can be designed to account for:
- Seasonality effects
- Can quickly be applied to a large number of products
- Forecast accuracy measures can be used to identify forecasts that need adjustment (management by exception
Basic Idea behind Time Series Models
…Distinguish between random fluctuations & true changes in underlying demand patterns.
Simplicity is a virtue – Choose the simplest model that does the job
Moving Average Models
- Based on last x periods
- Smoothes out random fluctuations
- Different weights can be applied to past observations, if desired
Table of forecast
Lead time: A lead time is the period of time between the initiation of any process of production and the completion of that process. Thus the lead time for ordering a new car from a manufacturer may be anywhere from 2 weeks to 6 months. In industry, lead time reduction is an important part of lean manufacturing.
Lead time in Supply Chain Management
A more conventional definition of Lead Time in the Supply Chain Management realms is the time from the moment the supplier receives an order to the moment it is shipped. In the absence of finished goods or intermediate (Work In Progress) inventory–it is the time it takes to actually manufacture the order without any inventory other than raw materials or supply parts.
Lead time in Manufacturing
In the manufacturing environment, Lead Time has the same definition as that of Supply Chain Management, but it includes the time required to ship the product to the purchaser. The shipping time is included because the manufacturing company needs to know when the parts will be available for Material requirements planning. It is also possible for lead time to include the time it takes for a company to process and have the part ready for manufacturing once it has been received. The time it takes a company to unload a product from a truck, inspect it, and move it into storage is non-trivial. With tight manufacturing constraints or when a company is using Just In Time manufacturing it is important for supply chain to know how long their own internal processes take.
Company A needs a part that can be manufactured in two days once Company B has received an order. It takes three days for company A to receive the part once shipped, and one additional day before the part is ready to go into manufacturing.
- If Company A’s Supply Chain calls Company B they will be quoted a lead time of 2 days for the part.
- If Company A’s manufacturing division asks the Supply Chain division what the lead time is, they will be quoted 5 days since shipping will be included.
- If a line worker asks the Manufacturing Division boss what the lead time is before the part is ready to be used, it will be 6 days because setup time will be included.
Lead time begins with the first receipt of a customer order and ends with customer receipt of the product or service. Everything in between is the lead time.
The scope of the lead time can vary for the purposes of analysis.
For example, the extreme might be from the point of the ore being in the ground to the customer selecting a vehicle at the dealership.
Another lead time study could be on any process within that larger extreme.
This brings up an important point. The “customer” can be external or internal to an organization. The next person or process down the assembly line is the “customer” for the preceding process.
Talk about who the customer is for the study area.
Independent demand situations and the use of fixed order quantity and periodic review systems
In planning, and controlling inventories forecasting is based on whether demand for items in inventories is independent or dependent
Dependent items are usually subassemblies or components parts that will be used in the production of final or finished products. Demand (i.e. usage) of subassemblies and components parts is derived from the numbers of finished product to be produced. And example is demand for wheels for new cars. If each car is to have four wheels, then the total number of wheels require for a production run is simply a function of the number of cars that are to be produced in that run. For instance; if 500 cars are to be produce in a run, then the numbers of wheels required is 500 x 4 = 2000 wheels.
Independent demand items are the finished goods or other end items that are sold to someone. There is usually no way to determine precisely how many of these items will be demanded during any given time period because demand typically includes an element of randomness.
Forecasting plays an important role in stocking decision, whereas stock requirements for dependent demand items are determined by reference to the production plan.
EOQ, Perpetual inventory, and Two- bin system etc, all deals with dependent demand.
Inventories are used to satisfy demand requirements, so it is essential to have reliable estimates of the amount and timing of demand it is important to know how long it will take for orders to be delivered. Managers need to know the extent to which demand and lead time might vary; the greater the potential variability, the greater the need for additional stock to reduce the risk of shortage between deliveries. Thus there is crucial link between forecasting and inventory management.
MRP and MRP11
Material Requirements planning is a computer-based information system designed to handle ordering and scheduling dependent demand inventories. (E.g. raw materials, components parts, and subassemblies). A production plan for a specified number of finished products is translated into requirements for component parts and raw materials working backward from the due date, using lead times and other information to determined when and how much to order. Thus MRP is designed to answer the questions: what is needed? How much is needed? And when it is needed?
To implement MRP you need:
- The master schedule: master schedule also refers to as mater production schedule, states which end items are to be produced, when they are needed, and what quantities.
- Bill-of-Materials file: BOM contains a listing of all the assemblies, subassemblies, parts, and raw materials that are needed to produce one unit of a finished product. Thus each finished product has its own bill of materials.
- Inventory Record file: This is used to store information on the status of each item by time period. This includes gross requirements, scheduled receipts, and expected amount on hand. It also includes other details for each items, such as supplier, lead-time, and lot-size, changes due to stock receipts and cancelled order, withdrawals and similar events are also recorded in this file.
- Hardware and Software: Computers and appropriate software program to handle computations and maintained records.
Advantages of MRP
- Low level of in-process inventories
- The ability to keep tract of material requirements
- The ability to evaluate capacity requirements generated by a given mater scheduled.
- A means of allocating production time.
Disadvantages of MRP
- Need to maintained accurate record in master record and BOM. Inaccuracy can lead to unpleasant surprises, ranging from missing parts, ordering two many of some items or too few of others and failure to stay on schedule.
- It is very tedious and costly to implement.
Manufacturing Resource Planning. It represents an effort to expand the scope of production resources planning, and to involve other functional areas of the firm in the planning process especially marketing and finance. In too many instances, production, marketing, and finance operate without complete knowledge or regards for what other areas of the firm are doing. For the firm need to focus on a common set of goals. This is the major purpose of MRP2, to integrate all functions.
The rationale for having these functional areas work together is the increased likelihood of developing a plan that works and with which everyone can live by. Again, because each of the functional areas is involved in formulating the plan, they will have reasonably knowledge of the plan and more reason to work towards achieving it.
This is MRP2 comes into play, generally material requirements and schedules. Next, management must make more detailed capacity requirements planning to determine whether these more specific capacity requirements can be met.
Note that, MPR2 is not a replacement of MRP nor is it an improved version of MRP.
Distribution Requirement Planning is a system for inventory management and distribution planning. It is especially useful in multi-echelon warehouse system. (factory and regional warehouse) It extends the concepts of material requirements planning to multi-echelon warehouse inventory, starting with demand at the end of the channel and working that back through the warehouse system to obtain time phased replenishment, schedules for moving inventories through the warehouse network. DRP is used to plan and coordinate transportation, warehousing location, workers, equipment, and financial flows.
THE PULL OR PUSH SYSTEM
The term push and pull are used to describe two different systems for moving work through a production process. in traditional production environments, a push system is used; when work finished at a work-station, the output is pushed to the next station, or, in the case of the final operation, it is pushed on to final inventory.
In a Pull system, control of moving the work rests with the following operation, each work-station pull the output from the preceding station as it is needed; output of the final operation is pulled by customers demand or the master schedule. Thus in a Pull system, work moves on in response to demand from the next stage in the process, whereas in a Push system, work moves on as it is completed, without regard to the next station’s readiness for the work. As a result, work may pile up at work stations that fell behind schedule because of equipment failure or the detection of a problem with quality.
Coping with uncertainty in achieving require service levels
To make successful and skillful decisions, a plan is essential and the key to an effective plan is a good forecast. The forecast begins with the understanding of the business cycle in the economy and the series of economic events which repeat themselves regularly and in the same basic sequence. Specific forecast consider unique characteristics of firm’s economic sector, its products or services, and the items and services purchased, taken with the context of the overall economy. Historical data are essential for forecasting, as is the assumptions that what has happened in the past will continues to prevail in the future.
In order to cope with businesses uncertainties, you need to:
- Understand the economic business cycle and a sequence of events in all business cycle;
- Gather historical data in terms of price changes for the items over several economic cycles, or at least five years period;
- Assess the present economy, market and conditions for the items in order to develop a scenario for the future.
Suppliers contribution to controlling stock
- Suppliers’ suggestions can lead to important cost saving in terms of material specification and design which do not reduce product quality but reduce production cost significantly. Thus making the buyer to buy at a lower price.
- The supplier can also present the buyer the experience of other customers who have identical production and procurement problems and how they solve them
- Continuously meeting the buyers needs and expectations at the upon price.
- Conformance to mutually agree upon requirements.
- Suppliers can recommend changes in the buyer’s production process that will make it blend more perfectly in its own for mutual benefits of the two.