1. Topic 2: Inventory Management
ACC405
Topic 2: Inventory Management
Topic 2 Lecture Notes
12/3/2017

2. Topic 2 Lecture Notes
12/3/2017
Lecture Objective
After the completion of this lecture, student should be able to:
Translate the importance of inventory management
Apply the Just-in-Time and Just-in-Case inventory management systems
Calculate the reorder point of inventory
Calculate the amount of obsolete inventories
Apply the techniques to control inventory obsolescence

3. What is inventory Management
Topic 2 Lecture Notes
12/3/2017
What is inventory Management
Inventory management is the process of efficiently overseeing the constant flow of units into and out of an existing inventory. This process usually involves controlling the transfer in of units in order to prevent the inventory from becoming too high, or decreasing to levels that could put the operation of the company into jeopardy

4. Importance of Inventory Management
Topic 2 Lecture Notes
12/3/2017
Importance of Inventory Management
Inventory management is very important in order to control the in flow and out flow of the company productions, goods and assets. It will help also to determine the profit and loss
It has to minimize the investment in inventory to enhance firm's profitability.

5. Topic 2 Lecture Notes
12/3/2017
Cont…
The purchasing department relies on accurate inventory data to schedule purchases and ensure that materials arrive on time. Incorrect inventory information can result in product overbuys

6. Topic 2 Lecture Notes
12/3/2017
Cont…
Investment in inventory should neither be excessive nor inadequate. It should just be optimum. Maintaining optimum level of inventory is the main aim of inventory management. Excessive investment in inventory results into more cost of fund being tied up so that it reduces the profitability, inventories may be misused, lost, damaged and hold costs in terms of large space and others. At the same time, insufficient investment in inventory creates stock-out problems, interruption in production and selling operation. Therefore, the firm may loose the customers as they shift to the competitors. Financial manager, as he involves in inventory management, should always try to put neither excessive nor inadequate investment in inventory.

7. Topic 2 Lecture Notes
12/3/2017
Cont…
Inventory management helps in maintaining a trade off between carrying costs and ordering costs which results into minimizing the total cost of inventory.
Inventory management facilitates maintaining adequate inventory for smooth production and sales operations.

8. Topic 2 Lecture Notes
12/3/2017
Cont…
Inventory management avoids the stock-out problem that a firm otherwise would face in the lack of proper inventory management.
Inventory management suggests the proper inventory control system to be applied by a firm to avoid losses, damages and misuses.

9. What is Just in Time Inventory Management System
Topic 2 Lecture Notes
12/3/2017
What is Just in Time Inventory Management System
An inventory strategy companies employ to increase efficiency and decrease waste by receiving goods only as they are needed in the production process, thereby reducing inventory costs. This method requires that producers are able to accurately forecast demand.

10. Topic 2 Lecture Notes
12/3/2017
Just-in-Time (JIT) Purchasing is the purchase of materials or goods so they are delivered just as needed for production or sales
JIT is popular because carrying costs are actually much greater than estimated because warehousing, handing, shrinkage and investment costs have not been correctly estimated

11. Topic 2 Lecture Notes
12/3/2017
JIT Purchasing
JIT reduces the cost of placing a purchase order because:
Long-term purchasing agreements define price and quality terms. Individual purchase orders covered by those agreements require no additional negotiation regarding price or quality
Companies are using electronic links to place purchase orders at a small fraction of traditional methods (phone or mail)
Companies are using purchase-order cards

12. Topic 2 Lecture Notes
12/3/2017
Example
A good example would be a car manufacturer that operates with very low inventory levels, relying on their supply chain to deliver the parts they need to build cars. The parts needed to manufacture the cars do not arrive before nor after they are needed, rather they arrive just as they are needed.

13. Cont… Advantages Disadvantages lower inventory costs
Topic 2 Lecture Notes
12/3/2017
Cont…
Advantages
lower inventory costs
easy to identify problems and potential problems
Disadvantages
requires accurate timing and cooperation
breakdowns stop everything

14. What is Just in Case Inventory Management System
Topic 2 Lecture Notes
12/3/2017
What is Just in Case Inventory Management System
An inventory strategy in which companies keep large inventories on hand. This type of inventory management strategy aims to minimize the probability that a product will sell out of stock. A company practicing this strategy essentially incurs higher inventory holding costs in return for a reduction in the number of sales lost due to sold out inventory.

15. Topic 2 Lecture Notes
12/3/2017
Cont…
The JIC inventory strategy is much different than the newer 'just in time' (JIT) strategy where companies try to minimize inventory costs by producing the goods after the orders have come in.

16. Topic 2 Lecture Notes
12/3/2017
Cont…
The older 'just in case' strategy is used by companies that have trouble forecasting demand. With this strategy, the companies have enough production material on hand to meet unexpected spikes in demand. Higher storage costs are the main disadvantage of this strategy.

17. Topic 2 Lecture Notes
12/3/2017
Re order Point
Inventory level of an item which signals the need for placement of a replenishment order, taking into account the consumption of the item during order lead time and the quantity required for the safety stock. Also called reorder level, reorder quantity, or replenishment order quantity.

18. Topic 2 Lecture Notes
12/3/2017
Cont…
A reorder point is the inventory unit quantity on hand that triggers the purchase of a predetermined amount of replenishment inventory. If the purchasing process and supplier fulfillment work as planned, the reorder point should result in the replenishment inventory arriving just as the last of the on-hand inventory is used up.

19. Topic 2 Lecture Notes
12/3/2017
Cont…
Reorder Level = Lead Time in Days × Daily Average Usage + Safety Stock Examples
For example, ABC International uses an average of 25 units of its green widget every day, and the number of days it takes for the supplier to replenish inventory is four days. Therefore, ABC should set the reorder point for the green widget at 100 units. When the inventory balance declines to 100 units, ABC places an order, and the new units should arrive four days later, just as the last of the on-hand widgets are being used up.

20. Topic 2 Lecture Notes
12/3/2017
Cont…
However, this formula for the reorder point is only based on average usage; in reality, demand may spike above or decline below the average level, so there may still be some inventory on hand when the replenishment order arrives, or there may have been a stock out condition for several days.

21. Topic 2 Lecture Notes
12/3/2017
Cont…
Reorder Level = Lead Time in Days × Daily Average Usage Lead time is the time it takes the supplier or the manufacturing process to provide the ordered units.
Daily average usage is the number of units used each day.
If a business is holding a safety stock to act as buffer if daily usage accelerates the reorder level would increase by the level of safety stock.

22. Topic 2 Lecture Notes
12/3/2017
Cont…
Example 1: ABC Ltd. is a retailer of footwear. It sells 500 units of one of a famous brand daily. Its supplier takes a week to deliver the order.
The inventory manager should place an order before the inventories drop below 3,500 units (500 units of daily usage multiplied with 7 days of lead time) in order to avoid a stock-out.

23. Topic 2 Lecture Notes
12/3/2017
Cont…
Example 2: ABC Ltd. has decided to hold a safety stock equivalent to average usage of 5 days. Calculate the reorder level.
Safety stock which ABC Ltd. has decided to hold equals 2,500 units (500 units of daily usage multiplied by 5 days).
In this scenario reorder level would be 6,000 units (2,500 of safety stock plus 3,500 units based on 7 days of lead time).

24. Topic 2 Lecture Notes
12/3/2017
Obsolete Inventory
Term that refers to inventory that is at the end of its product life cycle and has not seen any sales or usage for a set period of time usually determined by the industry. This type of inventory has to be written down and can cause large losses for a company. Also referred to as "dead inventory" or "excess inventory".

25. Topic 2 Lecture Notes
12/3/2017
Cont…
Large amounts of obsolete inventory are a warning sign for investors: they can be symptomatic of poor products, poor management forecasts of demand, and poor inventory management. Looking at the amount of obsolete inventory a company creates will give investors an idea of how well the product is selling and of how effective the company's inventory process is.

26. How to reduce obsolete Inventories
Topic 2 Lecture Notes
12/3/2017
How to reduce obsolete Inventories
Obsolete stocks are an old problem: any purchasing organisation is bound to base its activity on forecasts and forecasts are just that: not reality. Errors, miscalculations, lost sales and abrupt changes in the product life cycle are bound to take their toll. Many companies end up with warehouses cluttered with non- moving goods (which generates huge costs in terms of inventory space, useless logistic movements and administration) or scrapping millions-worth of stock every year.

27. Topic 2 Lecture Notes
12/3/2017
Inventory Reduction
Inventory is the largest single asset that most companies have. Unfortunately, it consumes space, gets damaged, and sometimes becomes obsolete. Inventory itself does not create value for customers. Yet for most companies, inventory is a necessary component of the business cycle and must be carefully managed.

28. Topic 2 Lecture Notes
12/3/2017
Cont…
Many businesses underestimate the carrying cost of inventory. They calculate carrying cost based on the borrowing cost of money alone. Other factors can outweigh this cost.
Major costs of high inventory include increased rent expense and handling costs, greater product damage, more frequent product obsolescence, and longer delay in noticing quality errors. For most products, the annual carrying cost of inventory is an astounding 20 percent to 40 percent of the materials cost.

29. STEP 1: Inventory Planning
Topic 2 Lecture Notes
12/3/2017
STEP 1: Inventory Planning
Inventory control requires inventory planning.
Inventory refers to more than the goods on
hand in the retail operation, service business, or
manufacturing facility. It also represents goods
that must be in transit for arrival after the goods
in the store or plant are sold or used. An ideal
inventory control system would arrange for the arrival of new goods at the same moment the last
Item has been sold or used.

30. Topic 2 Lecture Notes
12/3/2017
The economic order quantity, or base orders, depends upon the amount of cash (or credit) available to invest in inventories, the number of units that qualify for a quantity discount from the manufacturer, and the amount of time goods spend in shipment

31. STEP 2: Establish order cycles
Topic 2 Lecture Notes
12/3/2017
STEP 2: Establish order cycles
If demand can be predicted for the product or
if demand can be measured on a regular
basis, regular ordering quantities can be setup that take into consideration the most economic
relationships among the costs of preparing an
order, the aggregate shipping costs, and the
economic order cost. When demand is regular, it is possible to program regular ordering levels so
that stock-outs will be avoided and costs will be
Minimized.

32. Topic 2 Lecture Notes
12/3/2017
If it is known that every so many weeks or months a certain quantity of goods will be sold at a steady pace, then replacements should be scheduled to arrive with equal regularity. Time
should be spent developing a system tailored to the needs of each business. It is useful to focus on items whose costs justify such control recognizing that in some cases control efforts may cost more the items worth.

33. Topic 2 Lecture Notes
12/3/2017
At the same time, it is also necessary to include low return items that are critical to the overall sales effort. If the business experiences seasonal cycles, it is important to recognize the demands that will be placed on suppliers as well as other sellers.

34. STEP 3: Balance Inventory Levels
Topic 2 Lecture Notes
12/3/2017
STEP 3: Balance Inventory Levels
Efficient or inefficient management of merchandise inventory by a firm is a major factor between healthy profits and operating at a loss. There are both market-related and budget- related issues that must be dealt with in terms of coming up with an ideal inventory balance:
Is the inventory correct for the market being served?
Does the inventory have the proper turnover?

35. Topic 2 Lecture Notes
12/3/2017
What is the ideal inventory for a typical retailer or wholesaler in this business?

36. Topic 2 Lecture Notes
12/3/2017
STEP 4: Review Stocks
Items sitting on the shelf as obsolete inventory are simply dead capital. Keeping inventory up to date and devoid of obsolete merchandise is another critical aspect of good inventory control. This is particularly important with style merchandise, but it is important with any merchandise that is turning at a lower rate than the average stock turns for that particular business.

37. Topic 2 Lecture Notes
12/3/2017
One of the important principles newer sellers frequently find difficult is the need to markdown merchandise that is not moving well.

38. STEP 5: Follow-up and Control
Topic 2 Lecture Notes
12/3/2017
STEP 5: Follow-up and Control
Periodic reviews of the inventory to detect
slow-moving or obsolete stock and to identify fast sellers are essential for proper inventory management. Taking regular and periodic
inventories must be more than just totaling the costs. Any clerk can do the work of recording an
inventory.

39. Topic 2 Lecture Notes
12/3/2017
However, it is the responsibility of key management to study the figures and review the items themselves in order to make correct
decisions about the disposal, replacement, or discontinuance of different segments of the inventory base

40. Obsolete Inventory Percentage
Topic 2 Lecture Notes
12/3/2017
Obsolete Inventory Percentage
When a company has a significant investment in inventory, one of the more essential accompanying metrics is the obsolete inventory percentage. This measurement is needed to derive that portion of the inventory that is no longer usable. The percentage should be tracked on a trend line and compared to the results of similar businesses, to see if a company is experiencing an unusually large proportion of inventory problems

41. Topic 2 Lecture Notes
12/3/2017
Formula
To derive the obsolete inventory percentage, summarize the book value of all inventory items which have been designated as not being needed, and divide it by the book value of the entire inventory. The formula is:
Book value of inventory items with no recent usage Total inventory book value

42. Topic 2 Lecture Notes
12/3/2017
Example
The warehouse manager of Mole Industries wants to investigate the extent of obsolete inventory in his warehouse, so that he can remove items and consolidate the remaining inventory. He prints a parts usage report from the company's manufacturing resources planning system that only shows the cost of those items that are in stock and have not been used for at least two years.

43. Topic 2 Lecture Notes
12/3/2017
CONTINIUED
The total cost listed on this report is $182,000, which is 19% of the total book value of the entire inventory. The warehouse manager brings this high percentage to the attention of the purchasing manager, who immediately contacts suppliers to see if they will take back the obsolete items in exchange for a restocking fee.

44. Topic 2 Lecture Notes
12/3/2017
The End