TERM PAPER PESIT MBA 2011-2013

3RD SEMISTER

OPERATIONS MANAGEMENT TOPIC: INVENTORY MANAGEMENT

SUB CODE: 10MBA33 NAME: SPOORTHI.K USN: 1PB11MBA33

CONTENTS
1. 2. 3. 4. 5. 6. ABSTRACT WITH KEY WORDS INTRODUCTION THERORATICAL BACKGROUND DISCUSSION CONCLUSION REFERENCE

ABSTRACT WITH KEYWORDS

Todays business environment is a competitive market with every organization aligning its resources towards achieving a niche position in the marketplace, and in the minds of its customers. With the entry of more and more companies in the market offering similar products, the market share of existing organizations has reduced. Every new entrant comes with new ideas, techniques and technologies. The market then witnesses competition in every function of the organization. Growth and survival depends on microscopic analysis of Operational Process and Marketing Effectiveness. Many Organizations are now directing their efforts towards retaining existing customers to increase profits. To achieve this objective, companies are chalking out strategies to reduce any instances of Customer dissatisfaction. Inventory Analysis has, therefore, attained limelight considering the investments involved in maintaining and managing Inventories. It has been observed that an increase in the profits is possible through reduction of losses due to Stock Mismanagement. The highlighting of Stock Management has opened numerous avenues of profits realization with negligible investment. This paper focuses on these techniques, intended to help organizations achieve Increased Profits and an Enhanced Customer Service Experience.

Keywords:
Inventory Management, Economic Order Quantity, ABC Analysis, Tools & Techniques

INTRODUCTION
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. Inventory management is primarily about specifying the shape and percentage of stocked goods. It is required at different locations within a facility or within many locations of a supply network to precede the regular and planned course of production and stock of materials. The scope of inventory management concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods, and demand forecasting. Balancing these competing requirements leads to optimal inventory levels, which is an on-going process as the business needs shift and react to the wider environment. Inventory management involves a retailer seeking to acquire and maintain a proper merchandise assortment while ordering, shipping, handling, and related costs are kept in check. It also involves systems and processes that identify inventory requirements, set targets, provide replenishment techniques, report actual and projected inventory status and handle all functions related to the tracking and management of material. This would include the monitoring of material moved into and out of stockroom locations and the reconciling of the inventory balances. It also may include ABC analysis, lot tracking, cycle counting support, etc. Management of the inventories, with the primary objective of determining/controlling stock levels within the physical distribution system, functions to balance the need for product availability against the need for minimizing stock holding and handling costs.

Definition Inventory management is primarily about specifying the size and placement of stocked goods. Inventory management is required at different locations within a facility or within multiple locations of a supply network to protect the regular and planned course of production against the random disturbance of running out of materials or goods. The scope of inventory management also concerns the fine lines between replenishment lead time, carrying costs of inventory, asset management, inventory forecasting, inventory valuation, inventory visibility, future inventory price forecasting, physical inventory, available physical space for inventory, quality management, replenishment, returns and defective goods and demand forecasting. 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. Need for Inventory Management Inventory is a necessary evil that every organization would have to maintain for various purposes. Optimum inventory management is the goal of every inventory planner. Over inventory or under inventory both cause financial impact and health of the business as well as effect business opportunities. Inventory holding is resorted to by organizations as hedge against various external and internal factors, as precaution, as opportunity, as a need and for speculative purposes. Reasons why organizations maintain Raw Material Inventory 1. 2. 3. 4. 5. 6. Meet variation in Production Demand Cater to Cyclical and Seasonal Demand Economies of Scale in Procurement Take advantage of Price Increase and Quantity Discounts Reduce Transit Cost and Transit Times Long Lead and High demand items need to be held in Inventory

THEORATICAL BACKGROUND
In accounting language, inventory may mean the stock of finished goods only. In manufacturing concern, it may include raw materials, work-in-process and stores etc. Inventory includes the following things. Raw Material:

Raw material form a major input into the organization. They are required to carry out production activities uninterruptedly. The quantity of raw materials required will be determined by the rate of consumption and the time required for replenishing the supplies. The factories like the availability of raw materials and government regulations etc, to affect the stock of raw materials. Work in Progress:

The work in progress is that stage of stocks which are in between raw materials and finished good. The quantum of work in progress depends up on the time taken in the manufacturing process. Together the time taken in manufacturing, the more will be the amount of work in progress. Consumables:

These are the materials which are needed to smoother the process of production. These materials do not directly enter production but they act as catalysts. Consumables may be classified according to their consumption and critically. Generally, consumable stores do not create any supply problem and firm a small part of production cost. There can be instances where these materials may account for much value than the raw materials. The fuel oil may form a substantial part of cost. Finished goods:

These are the goods which are ready for he consumers. The stock of finished goods provides a buffer between production and market. The purpose of maintaining inventory is to ensure proper supply of goods to customers. Spares:

The stocking policies of spares differ from industry to industry. Some industries like transport will require more spares than the other concerns. The costly spare parts like engines, maintenance spares etc are not discarded after use, rather they are kept in ready position for further use. All decisions about spare are base o the financial cost of inventory on such spares and the costs that may arise due to their non-availability.

High-level financial inventory has these two basic formulas, which relate to the accounting period: Cost of Beginning Inventory at the start of the period + inventory purchases within the period + cost of production within the period = cost of goods available Cost of goods available cost of ending inventory at the end of the period = cost of goods sold The benefit of these formulas is that the first absorbs all overheads of production and raw material costs into a value of inventory for reporting. The second formula then creates the new start point for the next period and gives a figure to be subtracted from the sales price to determine some form of sales-margin figure. Manufacturing management is more interested in inventory turnover ratio or average days to sell inventory since it tells them something about relative inventory levels. Inventory turnover ratio (also known as inventory turns) = cost of goods sold / Average Inventory = Cost of Goods Sold / ((Beginning Inventory + Ending Inventory) / 2) and its inverse Average Days to Sell Inventory = Number of Days a Year / Inventory Turnover Ratio = 365 days a year / Inventory Turnover Ratio While these accounting measures of inventory are very useful because of their simplicity, they are also fraught with the danger of their own assumptions. There are, in fact, so many things that can vary hidden under this appearance of simplicity that a variety of 'adjusting' assumptions may be used. These include: Specific Identification Weighted Average Cost Moving-Average Cost FIFO and LIFO. Inventory Turn is a financial accounting tool for evaluating inventory and it is not necessarily a management tool. Inventory management should be forward looking. The methodology applied is based on historical cost of goods sold. The ratio may not be able to reflect the usability of future production demand, as well as customer demand.

Business models, including Just in Time (JIT) Inventory, Vendor Managed Inventory (VMI) and Customer Managed Inventory (CMI), attempt to minimize on-hand inventory and increase inventory turns. VMI and CMI have gained considerable attention due to the success of thirdparty vendors who offer added expertise and knowledge that organizations may not possess. Inventory procurement, storage and management is associated with huge costs associated with each these functions.

Inventory costs are basically categorized into three headings: 1. 2. 3. 4. 5. Ordering Cost Carrying Cost Shortage or stock out Cost & Cost of Replenishment Replenishment Costs System Control Costs

Determining other Costs 1. 2. 3. 4. 5. Ordering/Setup Cost Carrying Cost Storage Costs Stock out Costs Transportation Costs

Inventory categories 1. 2. 3. 4. 5. Raw Material Work-In-Progress Finished Goods Distribution Inventory Maintenance Repair & Operating Supplies

Inventory Model: The Economic Order Quantity (EOQ) Model Undoubtedly, the best-known and most fundamental inventory decision model is the Economic Order Quantity Model. Its origin dated back to the early 1900s. The purpose of using the EOQ model in this research is to find out the particular quantity, which minimize total inventory costs that are the total ordering and carrying costs. ABC Classification Inventory in any organization can run in thousands of part numbers or classifications and millions of part numbers in quantity. Therefore inventory is required to be classified with some logic to be able to manage the same. In most of the organizations inventory is categorized according to ABC Classification Method, which is based on Pareto principle. Other Models are: Q-System, P- System and Wager-Within (WW) System

DISCUSSION
1. The short answer is that higher inventories do not provide an advantage in any of the nine competitive priority categories. The important point is that firms must have the right amount of inventory to meet their competitive priorities. The only relevant costs considered in this chapter are ordering costs, holding costs, and stock out costs. In the economic order quantity (EOQ) model, costs of placing replenishment orders tradeoff against the costs of holding inventory. Under the assumptions of the EOQ, average inventory is one-half of the order quantity. The number of orders placed per year varies inversely with order quantity. When we consider stock out costs, an additional inventory (safety stock), is held to trade-off costs of poor customer service or costs for expediting shipments from unreliable suppliers. In the lean systems chapter, we see order quantities (lot sizes) that are much smaller than the ideal suggested by the EOQ model. As a result, lean systems average inventory is also much lower. Are there some other relevant costs of holding inventory that we have not considered in the EOQ model? If there are, a firm that ignores these costs will make the wrong inventory decisions. These wrong decisions will make the firm less competitive. 2. Reducing cycle inventories has an effect on practically every functional area. Although responses will vary, and sometimes be quite insightful, the following list contains some standard answers: MarketingReducing cycle inventories implies that there is less inventory on hand, which could increase stock outs if the inventories are not managed properly. FinanceSmaller-cycle inventories implies that there is less capital tied up in inventory, thereby reducing the pressure for short-term operating capital and allowing for alternative investment options. Operations reducing cycle inventories imply that order quantities are to be reduced. Order times and costs must be reduced to facilitate that move. Smaller order quantities enable a shift toward a lean system and enhance a uniform flow of materials through the production process. 3. Organizations will never get to the point where inventories are unneeded. Inventories provide many functions and should be managed, not eliminated. It is impossible to eliminate uncertainties in the provision of products or services. In addition, unless materials can be transported instantaneously, there will always be pipeline inventories. Cycle inventories will exist unless we universally get to the point where production of single units is feasible. TOOLS AND TECHNIQUES OF INVENTORY MANAGEMENT A proper inventory control not only helps in solving the actual problem of liquidity but also increase profits and causes substantial reduction in the working capital of the concern. Determination of stock levels:

Carrying of too much and too little of inventory is determined to the firm. If the inventory level is too little, the firm will face frequent stock outs involving heavy ordering cost and if the inventory level is too high it will be unnecessary tie up of capital. An efficient inventory management requires should maintain an optimum level of inventory where inventory costs are the minimum and at the same time there is no stock out which may result in loss or shortage of production. A) Minimum stock level: It represents the quantity below its stock of item should not be allowed to fall. Lead-time: A purchase firm requires some time to process the order time is alsorequired by the supplying firm to execute the order. The time taken in processing theorder and then executing it is known as lead time. Rate of consumption: It is the average consumption of materials in the factory. Therate of consumption will be decided on the basis of past experience and production plans. Nature of material: The nature of material also affects the minimum level if a material `is required for such material. Minimum stock level can be calculated with the help of following formula. Minimum stock level = Re ordering level -(Normal consumption x normal reorder period.) B) Re ordering level: When the quantity of materials reaches at a certain figures then fresh order is sent to get material again. The order is sent before the materials reach minimum stock level. Re ordering level is fixed between minimum level and maximum level. Re-ordering level = Maximum consumption x Maximum Re- order period. C) Maximum Level: It is the quantity of materials beyond which a firm should not exceed its stocks. If the quantity exceeds minimum level limit then it will be overstocking. Over stocking will mean blocking of more working capital, more space for storing the materials, more wastage of materials and more chances of losses from obsolescence. Maximum Stock Level = Reordering Level + Re-order Quantity (Minimum consumption x Minimum Re-order period). D) Danger Stock Level: It is fixed below minimum stock level. The danger stock level indicates emergence of stock position and urgency of obtaining, fresh supply at any cost. Danger stock level = Average Rate of consumption x emergency delivery time E) Average stock level: This stock level indicates the average stock held by the concern. Average stock level = Minimum stock level + x Re-order quantity.

CONCLUSION
Inventory management has become highly developed to meet the rising challenges in most corporate entities and this is in response to the fact that inventory is an asset of distinct feature. A basis for inventory planning and control was also provided in this study. Though looking through the inventory policy of the company, it can be said to be dynamic to some extent but the analysis and findings have revealed the need to remedy some situations in the company's management of inventory. First, emphasis should be normally placed on the economic order quantity model because it was seen to be in the best interest of manufacturing companies to maintain an optimal level of materials in store, the level that minimizes total cost of investment in inventory. To achieve this successfully, different costs, which are associated with inventory, should be segregated and accumulated in such a way that EOQ can be easily determined. Inventory reduction requires knowledge of the operating system. It is not simply a case of selecting an inventory model off the shelf and plugging in some numbers. In the first place, a model might not even be appropriate. The numbers might be full of errors or even based on erroneous data. Determining order quantities is often referred to as a trade-off problem; that is, trading off holding costs for setup costs. The simple fact is that firms have very large investments in inventory, and the cost to carry this inventory runs from 25 to 35 percent of the inventories worth annually. Therefore, a major goal of most firms today is to reduce inventory. A caution is in order, though. The formulas in this chapter try to minimize cost. Objective should be something like making moneyso be sure that reducing inventory cost does, in fact, support this. Usually, correctly reducing inventory Lowers cost, improves quality and performance, and enhances prior to. Secondly, in the analysis we also mentioned that there was a positive relationship between inventory and sales and between inventory and production cost. This does not imply that inventory automatically determines production costs or sales and vice-versa. However, it does show that inventory levels can be a useful indication of what level of sales to expect. It is thus recommended that the sales and marketing department of the company should pay closer attention to the growth pattern of inventory usage and incorporate it in sales forecasting technique. Lastly, materials management unit should also pay attention to sales growth over the years and thus take into consideration, the apparent relevance of sales and production cost in making decision with regards to inventory.

REFERENCE
Inventory Management Prof. P W C DE WIT: Inventory Management as a Determinant for Improvement of Customer Service, University of Pretoria Review of literature Inventory Management Delivering Profits through Stock Management- Aarti Deveshwar and Dhawal Modi. Multi Stage Inventory Management with Expediting: David G. Lawson; Evan L. Porteus, Stanford Graduate School of Business. Evaluating Inventory Management Performance: Ronald H. Ballou, Weatherhead School Of Management, USA Basics Of Inventory Management: J. David Viale Best Practices in Inventory Management: K. Ravichandran; Debjyoti Paul Three essays on Inventory Management: Jiang Zhang, Case Western Reserve University. Wikipedia.