Costs of holding inventory
Measuring inventory value is useful for balance/sheet tax records, measuring profits (as items from
inventory used in production need to be recorded as costs) and measuring holding costs.
Inventory holding costs can be classified into direct and indirect
(those costs that are directly related to inventory holding, and not).
There are direct and indirect costs of acquisition.
·
Direct costs: the purchase and delivery costs paid by the buyer
·
Indirect costs: costs of processing the
purchase e.g. making a specification, goods unloading costs etc
Indirect costs
are rarely measured because the benefit of knowing these costs isn’t worth the time.
There are also direct and indirect costs of
production. Direct costs relate to the materials and labour used directly for
production, whereas indirect
costs relate to indirect materials and labour used only for support.
What are the main costs of holding inventory?
1.
Loss in value
2.
Financial costs
3.
Warehousing and materials handling costs
Loss in value: this can happen
for a variety of reasons including damage, spillage, theft, obsolescence /
redundancy.
·
Items could deteriorate if they’re held in inadequate conditions
·
Some damages could be protected through insurance e.g. if caused by
fire
·
Obsolescence / redundancy can occur when items are held in storage
for long periods of time
Financial costs: stock insurance
+ cost of capital invested in inventory
·
Stock insurance: the cost of insuring stock is an inventory holding cost
·
Cost of capital invested in inventory: the opportunity cost. Instead of holding inventory, the
capital could have been invested.
o
Cost of holding inventory = average value of inventory x
Opportunity cost of capital (%)
Warehousing and storage and materials handling
costs: the general
costs of operating a store /
warehouse.
·
Security and costs of security: warehouse
security will also be a cost to the organisation, particularly if the goods
held are valuable and therefore require greater security.
Stockouts and how they affect the organisation
Quantitative estimates of the cost of a stockout will likely be limited to
the lost profits from lost sales. However, there are additional costs such as
the added cost of a ‘rush order’ (i.e. getting an order for rapid delivery from a supplier) and loss of
customer goodwill etc.
When stockouts occur, service levels reduce.
E.g. if there are no stockouts, then service level will be 100%. But realistically,
it will be somewhat less.
·
If you hold too much inventory in order to achieve a 100% service level, then costs will be too high
·
Therefore, one needs to find a balance between holding costs and
stockout costs
·
Stockouts will depend on: the level of stock remaining when an order for re-supply is made, the supply lead
time, and rate of demand for stock during the lead time
·
Safety stock should be held to reduce likelihood of stockouts
Vendor managed and vendor owned inventory
Vendor managed inventory (VMI): inventory
levels are managed by the supplier, but inventory is physically held by the buyer. So supplier
decides when to restock.
Vender owned inventory (VOI): a type of VMI
arrangement where the supplier owns the inventory, even through it’s held by the buyer. So the buyer
pays for stock as they use it.
·
The advantage of VOI is that the buyer doesn’t need to put
capital in stock
·
But standard VMI would minimise stockout risk
·
VOI is used for MROs
First in, first out (FIFO): idea that units
of stock that are used first should come into the store the earliest. I.e. stock is used in the order that it’s received.
A scenario: a buyer may choose an organisation
with a higher purchase price, if their lead time is shorter. This is
because it minimises stockholding costs. Therefore, purchase price +
stockholding costs need to be factored in.
Techniques of
inventory control
Forecasting is important for inventory control, to track how many items should be ordered
and held. There are two types of forecasting techniques:
·
Subjective / qualitative forecasting (estimates from
sales, market research, experts’ opinion, delphi method)
o
Delphi method: expert opinions are shared anonymously among the
group, allowing them to all reconsider. This happens until a consensus is reached. This removes
risk of individual bias.
·
Objective / quantitative forecasting (time series analysis e.g. moving averages etc)
o
This is basically making forecasts based on
results from the past
o
Examples are simple moving averages, weighted moving averages
Bullwhip effect (Forrester
effect): a small change in final consumer demand leads to a larger change in
the upstream supply chain. This highlights need for sharing forecast sales with other suppliers.
Reorders
Reorder level: the stock level at which a replenishment order is raised.
There are two
types of stock replenishment systems: period review systems and fixed order point systems.
Periodic review systems: monitoring
stock levels and deciding on purchases at each review slot.
·
There’s a desired stock level set. At each review, a
replenishment order may be placed to get the level back to the desired stock
level.
·
Therefore, the quantity of each order isn’t set: the regularity is
·
The review frequency would be based on the particular item: how frequently the item is
used, value of item etc
·
Useful to apply an ABC analysis: A items reviewed more frequently, C items less so
·
Review could happen through a physical stocktake, or using live computer systems (perpetual inventory)
Fixed order point systems: stock is
replenished when inventory falls to a reorder level (ROL). This could be automated. Therefore, order quantities are
fixed, regularity isn’t.
·
The ROL should cater to the maximum amount used
per day and the maximum lead time (for safety)
·
This system might use economic order quantities: minimising combined total of acquisition + holding
costs (AC + HC = TC:
Total Cost)
The above two systems are useful for
independent demand stock items (finished
goods and indirect supplies). But for direct supplies, demand is dependent on production
quantities. MRPII is more useful for this.
Hierarchy of components: each item’s demand
is dependent on the item above it. E.g. demand for car
engine is dependent on the demand for cars.
MRP
MRP is based on a master production schedule (MPS) using forecast sales quantities. This derives a bill of materials, showing order quantities.
·
Use the inventory status to deduct the amount of stock from the gross requirement, to arrive at
the net requirement (i.e. how much stock do we need to buy, bearing in mind
what we already have in stock?)
MRPII: derived from
MRP systems but also consider other production resources such as labour, machinery and money.
·
It is a modular system, with modules
including MPS, BOM, MRP, capacity requirement etc
ERP: Integrates all
functions in an organisation e.g. supply chain, sales, finance, HR. It is a modular
system, with various modules such as those outlined above.
JIT: for Just in
Time to work, there will need to be zero defects. Suppliers must also be willing to work to guaranteed lead times. It requires
deep supplier partnerships.
·
Investing in JIT may not be worth it for all categories. ABC analysis might be useful in ranking most salient goods
for JIT
Inventory optimisation: Lean
Lean is about
minimising waste while maximising value. There are seven types of waste:
·
Over-production
·
Holding inventory
·
Movement
·
Defects
·
Over-processing
·
Delays
·
Transportation
Kanban: a pull system. Output from an earlier stage in a production cycle should
only be produced if there is a signal from the next stage that output is required. There would be a signalling system e.g. electronic message.
Kaizen: continuous
improvement. Making small improvements over time.
Useful KPIs for inventory performance:
·
Lead times
·
Stockouts in a given period
·
Rate of stockturn
o
Stock turnover (times per year) = cost of stock used / average
inventory level
o
Stock turnover (days) = (average inventory
level / cost of stock used) x 365 days
·
Stock cover
o
Stock cover (days) = (current inventory level / expected average
daily usage) x 365 days
o
If stock cover increases, could indicate that the item is over-stocked
No comments:
Post a Comment