Inventory managment 80 20 rule and abc analysis

InventoryFundamentals

Inventory Fundamentals

Contents

• ABC Analysis • 80 ~ 20 Rule

• Cost for carrying inventories

– Increase operation cost– Decrease profit• Inventory management is responsible for– Planning inventory from raw material to customer– Controlling inventory from raw material to customer


Inventory Fundamentals Involves

1. Flow and kind of inventory needed2. Supply and demand pattern3. Functions that inventories perform4. Objective of inventory management5. Cost associated with inventory


Item inventory management

• Item level, not aggregate• Management establishes decision ruleabout inventory item• Rules– Which inventory items are most important– How individual items are to be controlled– How much to order at one time– When to place an order


Factors affecting inventory

management decision1. Types of inventory based on the flow ofmaterial2. Supply and demand pattern3. Function performed by inventory4. Objective of inventory management5. Inventory cost


a) Anticipation inventory:

• Build up in anticipation of future demand• Example: before specific season, Festivals etc.• To help Immediate Service Ratio• To reduce cost of change in prices


b) Fluctuation inventory (Safety stock):

• Inventory is held to cover random, unpredictable fluctuation in supply and demand or in lead time• If demand or lead time is greater than forecast, a stock out occurs• Safety stock is carried to protect stock out


Fluctuation inventory (Safety stock):

• Prevent disruption in manufacturing or deliveries to customer

Safety stock – buffer stock – reserve stock


Transportation inventory:

Transportation inventory – Pipeline inventory – movement inventory• Time needed to move goods from one location to another location



I = t x A/ 365; I = average amount; A=annual demand; t = transit time, days I Cost; I t; Reduce transit time to reduce inventory and hence cost



Example: Delivery of goods from a supplier is in transit for ten days. If the annual demand is 5200 units, what is the average annual inventory in transit?

I = 10 x 5200 / 365 = 142.5 units


Objective of inventory management:

A. Maximum customer serviceB. Low cost plant operationC. Minimum inventory investment Maximum customer service:• Ability to satisfy customer needs• Availability of items when needed and a measure of inventory management effectiveness


Maximum customer service:

Customers: who they are!• Walk-in Commuters• Retailer• Road Side Workshops


Objective of inventory management

Inventories cost money, they must be balanced with•Cost of placing order• Each order placed cost

•Transportation cost• Small quantity cost more per unit

•Therefore, carry inventory if it cost less than not to carry


Inventory costs:

1. Item cost2. Carrying cost3. Ordering cost4. Stock out cost


Inventory costs:•1. Item cost• Landed price

Purchase costCost to get it in at dealership

Transportation


2. Carrying cost

• Cost of carrying volume of inventory• Capital cost• Storage cost

• Space• Labor• equipment

• Risk cost• Obsolescence: model change, out dated• Damage: in handling• Pilferage: lost, misplace, stray, stolen


3. Ordering cost • Associated with placing an order with a factory or supplier • Independent of quantity order • Depends on number of orders placed in a year • Lost capacity cost* Incurred when an order is placed * Order preparation * Expediting * Follow-up * Receiving * Authorizing payment * Receiving and paying


Example

A company carry an average annual inventory of 2,000,000. If they estimate the cost of capital is 10%. Storage costs are 7% and risk costs are 6%. What does it cost per year to carry this inventory?•Total cost of carrying inventory = 10% + 7% + 6%•Total cost of carrying inventory = 23%•Total annual cost of carrying inventory = 23% x 2,000,000•Total annual cost of carrying inventory = 0.23 x 2,000,000•Total annual cost of carrying inventory = 460,000


The average cost of placing one order:

Staff Salaries = 40, 000Operating expenses = 5,000 Cost of setting up for an order = 120Order placed each year = 1000•Average cost = fixed cost/number of orders + variable cost•Average cost = (40, 000 + 5,000 )/1000 + 120•Average cost = 45 + 120 = 165


4. Stock out cost

• If demand during the lead time exceeds forecast we expect a stock out– Back order – Lost of sale– Lost customer


ABC Inventory Control:

• Controlling individual items – What is the importance of inventory item? – How are they to be controlled? – How much should be ordered at one time? – When should an order be placed?


ABC inventory classification system

Inventory item• Value• Quantity– Level of controlPareto principle – 80-20 rule1. A – 20% of items; 80% of value2. B – 30% of items; 15% of value3. C – 50% of items; 5% of value


Steps in making an ABC analysis:1. Establish item characteristics – value – scarcity2. Classify items into groups3. Apply a degree of control in proportion toimportance


Procedure for classifying by annual values: (5 steps)

•1. Determine annual usage•2. Multiply annual usage by its cost; total annual usage•3. List items according to their annual usage•4. Calculate the cumulative annual usage and cumulative percentage of the items•5. Examine the annual usage distribution and group the items into A, B and C groups based on annual percentage usage


ABC Analysis: Example

A company manufactures a line of ten items. Their usage and unit costs are shown in the following table along with the annual usage.a. Calculate the annual usage of each itemsb. List the items according to their annual usagec. Calculate the cumulative annual dollar usage and the cumulative percent of itemsd. Group items into A, B and C classification


Control based on ABC classification: (2 rules)

1. Have plenty of low $ value items – C items – 50% items – 5% cost – Keep safety stock – Order annually2. Use the money and control effort to reduce the inventory of high value items – A items – 20% items – 80% cost – Deserve the tightest control – Frequent review


Different Controls:

• A – items: High priority– Tightest control– Complete accurate record– Regular and frequent review– Frequent review of demand– Close follow up and expediting to reduce lead time


B – items: Medium priority– Normal control– Good record– Regular attention– Normal processing


C – items: Lowest priority

– Simplest possible control– Make sure there are plenty– Simple or no record– Two bin system– Periodic review– Order large quantity– Carry safety stock


Thanks for taking Interest

Inventory managment 80 20 rule and abc analysis

Automotive

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