Topic 2 Inventory control

Part C: Working capital management Topic 2: Inventory management

Topic 2: Inventory control

• I. Objectives of inventory management
  • 1. Balancing inventory
  • 2. Cost
    • 1.1 Costs of low inventory levels
      • i. Stockouts
        • （1） Lost contribution
        • （2） Emergency orders
      • ii. High re-order/ Setup costs
      • iii. Lost quantity discounts
    • 1.2 Costs of high inventory levels
      • i. Warehousing、Store labor、Insurance
      • ii. Cash tied-up (opportunity cost)
      • iii. Risk of theft/damage/obsolescence
  • 3. The objective of good inventory management
    • Minimize the total cost of inventory
    • Eliminate the risk of stock-outs
    • Balancing holding & ordering cost
  • 4. Types of inventory costs
    • 4.1 Purchase costs
    • 4.2 Ordering costs
    • 4,3 Holding costs
    • 4.4 Total annual cost
      • i. Total annual cost with buffer inventory
      • ii. Total annual cost without buffer inventory
    • 4.5 Stockout costs
      • （1） Loss of goodwill
      • （2） Lost contribution
      • （3） Extra cost for urgent purchase
    • Four critical inventory control levels
      • i. Reorder level
      • ii. Minimum level (Buffer/safety inventory)
      • iii. Maximum level
      • iv. Average level
      • Reorder quantity
  • 5. Economic order quantity (EOQ)
    • Assumptions (disads)
      • i. Certain or zero lead time
      • ii. Demand is constant & known
      • iii. Purchase price, Co, Ch is constant
      • iv. Ignore hidden cost of holding inventory
        • Example
          • （1） obsolescence
      • v. Ignore benefit of holding inventory
        • Example
          • （1） customer choice
• II. Inventory management systems
  • 1. Bin systems
    • i. Two bin system
    • ii. One bin system
    • Advantages of bin systems
      • Inventory can be kept at a lower level because of the ability to order whenever inventory falls to a low level, rather than having to wait for the next re-order date.
  • 2. Periodic review systems
    • i. Inventory levels are reviewed at fixed intervals
      • Example
        • every 4 weeks
    • ii. Inventory needed = demand before next review + demand during lead time + buffer inventory
    • Advantages of periodic review systems
      • （1） Order office load is more evenly spread and easier to plan
      • （2） For this reason the system is popular with suppliers
• III. Just in time (reduce waste)
  • 1. Objectives of JIT (Pull-based system)
    • 1.1 Elimination of waste
      • seeks to have zero inventories
    • 1.2 Continuous improvement
  • 2. Features of JIT
    • i. Suppliers
      • （1） Close relationships
      • （2） Reduced No. of suppliers
      • （3） Not single sourcing
      • （4） Locating suppliers nearby
    • ii. Smaller but frequent deliveries
    • iii. Short setup times & lead times
    • iv. Flexible and versatile staff
  • 3. Advantages of JIT
    • i. Less cash tied up in inventory
    • ii. Less storage space needed
    • iii. Better quality
    • iv. More flexible production
    • v. Fewer bottlenecks
    • vi. More reliable suppliers
  • 4. Disadvantages of JIT
    • i. More quality cost
    • ii. Harder to switch suppliers
    • iii. Relies on predictable demand, flexible suppliers & labor
    • iv. No fallback position
    • v. Initial large set up costs
    • vi. Difficult for business with a wide geographical spread