Inventory Management & Asset Utilization- Key to Procurement Success

Transcription

1 WHITEPAPER December Inventory Management & Asset Utilization- Key to Procurement Success Author Arun MV 1 Copyright Beroe Inc, All Rights Reserved

2 Abstract The year 2014 saw mineral prices dropping, particularly gold prices touching USD 1250 per ounce (which is about 10% lower than the cash cost for most of the mining companies). An excess inventory pileup has been observed with various mining firms due to this drop in market prices for minerals. A mining firm has over 30% of its current assets and working capital invested in inventory and hence there is a need to optimize their inventory in reducing the holding cost. An improper procurement strategy may lead to operational downtime (due to capacity mismatch and sub optimal level of stock requiring storage) and a decentralized procurement leads to duplicate orders being placed, causing excess and redundant stock issues. A clear stock holding policy is a must for optimum working capital management. Similarly, efficient coordination between store department and facilities department is mandatory to ensure optimized inventory holding. Mathematical analysis of inventories held, such as ABC inventory classification, can be used by inventory managers to put their efforts where greatest benefits, in terms of cost reduction as well as maintaining a smooth availability of stock. This whitepaper reflects on the types, uses and cost associated with inventory along with explaining the various strategies that can be used by mining companies in determining absolute order quantities. The paper also reflects on why companies practicing an optimal order quantity may not succeed all the time. The paper includes excel based tools that illuminates calculation of order quantities based on requirement and an assessment of inventory management. The tool attached helps in calculating appropriate safety stock inventory policies including Minimum Cost Service Level, Inventory Reorder Point, One Time Buy Inventories and Economic Order Quantity (EOQ) Inventory Management & Asset Utilization Inventory comes in many shapes and sizes such as raw materials, components, work-in-process, finished goods and distribution inventory. With a plunge in demand metals and prices for minerals in 2014, it was observed that major mining companies are plagued by an excess inventory pile up. Most of these companies need to improve their inventory turnover so as to optimize their blocked working capital. If the turnaround time for a stock is longer than anticipated, the cost of stocking is high. But, in order to avoid a shortage related downtime, stocking is mandatory. Similarly, unstable demand of some stock items at certain season creates inadequate information on requirement for stocking decision. Stocking material comes at a price. The relevant inventory costs for a firm includes the item costs, holding costs and capital costs. Ordering cost, shortage costs, risk costs and storage costs are the other major costs associated with inventory holding. Thus, a system is required which can satisfy the necessities of a firm and that explained as 1. Providing cost-efficient operations 2. Minimum inventory investments 3. Maximum orders shipped on schedule 2 Copyright Beroe Inc, All Rights Reserved

3 Note: Item cost is the price paid for the item plus other direct costs associated with the purchase. Holding costs is the variable expenses incurred by the plant related to the volume of inventory held (15-25%) and capital cost is the higher of the two- cost of capital or the opportunity cost for the company. Ordering cost is the fixed amount incurred for each order placed. Shortage costs accounts for the loss of customer goodwill, back order handling, and lost sales, Risk costs takes into consideration the Obsolescence, damage, deterioration, theft, insurance and taxes and the storage costs includes variable expenses for space, workers, and equipment related to the volume of inventory held. Inventory Holding and Associated Cost The period between 2015 and 2017 will witness a significant increase in mine mechanization as the mining companies are facing multiple glitches of depleted resources, reduced output per man shift (OMS) and a regulatory glass ceiling on license approval. Capital shortages have impacted the entire mining value chain resulting in decreasing the overall efficiency of the supply chain and the mine output over a period of time. Efficient coordination between store department and user department is expected to optimize their inventory holding. This can be achieved through inventory planning, establishing order cycles, maintaining balanced inventory level and periodic review of stocks. Various mining companies are adopting competitive strategies to mitigate the inventory holding loss. This includes determining absolute order quantities, ABC inventory classification and accurate and dynamic inventory recording. Determining absolute order quantities Inventory management and control are managed with SKU (stock control units). There exist different mathematical models for determining order quantities. These include: Economic Order Quantity (EOQ) o This is an optimizing method used for determining order quantity and reorder points. It is a part of continuous review system which tracks on-hand inventory each time a withdrawal is made. o The EOQ model assumes that demand and lead time is known & constant, is known & constant. It also follows that no quantity discounts are available. The ordering costs are considered constant and all demand is satisfied. It also assumes that the order quantity arrives in a single shipment Economic Production Quantity (EPQ) o It is a model that allows for incremental product delivery Quantity Discount Model (QDM) o This model modifies the EOQ process to consider cases where quantity discounts are available 3 Copyright Beroe Inc, All Rights Reserved

4 Note: Lot-for-lot gives the order exactly what is needed, Fixed order quantity specifies the number of units to order whenever an order is placed, Min-Max-system places a replenishment order when the on-hand inventory falls below the predetermined minimum level, Order n period provides the order quantity is determined by total demand for the item for the next n period. ABC inventory classification Case study on ABC inventory classification: Given below is a sample ABC classification of inventory holding of a global gold mining company. Sl. No Category Item Volume Stock Value Engine Caterpillar Engine Shaft Output Shaft Assembly Electric Cable 25mm2 x 4 core Swing Jaw Supper Tooth Shaft MBCR ,XA400S Intermediate Shaft part Ceramic Tile Size - 150mm x 50m 327 Chemicals Hydrochloric Acid Plate Liner Plate 169 Pipe Bar Seamless pipe ASTM A106 Rema Low Friction Bar SQR 19 Core 1.5mm SQR Galvanised Bolt M24 x 260mm Gloves Safety KEN K Cable 6mm Flexible Electric Cable A : Items have greater impact on purchasing spend, and should be managed more aggressively in terms of minimum and maximum inventory levels. The company needs to follow an order pattern (Just in Time) to avoid excess inventory of the products in Category A. B : Items with a medium consumption value that account for 30 % of stock volume and 30 % of stock value. Category B items can be less tightly controlled and can hold good records C : Items with the lowest consumption value fall into Category C which can be less tightly controlled and can hold good records Reordering C-items are made less frequently. C-items present both low demand and higher risk of excessive inventory costs. ABC classification is a method for determining level of control and frequency of review of inventory items. A Pareto analysis can be done to segment items into value categories depending on annual dollar volume. This is as follows: A Items 20% of the items accounting for 80% of the inventory value-use Q system B Items Additional 30% of the items accounting for 15% of the inventory value-use Q or P C Items Remaining 50% of the items accounting for only 5% of the inventory value-use P This helps in optimizing inventory holding thereby reducing blocked working capital and other risks associated. 4 Copyright Beroe Inc, All Rights Reserved

5 Accurate and dynamic inventory recording Inaccurate inventory records can cause lost sales, disrupted operations, poor customer service, lower productivity and planning errors. There are two methods for checking record accuracy which are as follows. Periodic counting, where physical inventory is taken periodically, usually annually Cycle counting - Daily counting of pre-specified items, providing the following advantages: o Timely detection and correction of inaccurate records o Elimination of lost production time due to unexpected stock outs o Structured approach using employees trained in cycle counting A periodic review system ensures orders are placed at specified, fixed-time intervals, for an order size (Q) to bring on-hand inventory (OH) up to the target inventory (TI), similar to the min-max system. The system has the following advantages / dis advantages Advantages No need for a system to continuously monitor item Items ordered from the same supplier can be reviewed on the same day saving purchase order costs Disadvantages Replenishment quantities (Q) vary Order quantities may not quality for quantity discounts On the average, inventory levels will be higher than Q systems-more stockroom space needed Inventory Planning is planning inventory in such a way that would arrange for arrival of new goods at the same moment the last item has been sold. This can be achieved through EOQ. Establishment of Order Cycles means recognizing and forecasting demand of goods effectively in case of business experiencing seasonal cycles is essential. Maintenance of Balanced Inventory Level helps ion maintaining an ideal inventory that do not lose profitable sales and can still justify the investment. Stock Review sums up stock turnover through sale of obsolete inventory. It helps to understand what the inventory level should be to achieve the desired sales level. Follow up and Control is essential means a Regular and Periodic review of inventories and reorder points is highly essential Optimal Order Quantity: A success? Companies don t always use optimal order quantity. It is not unusual for companies to order less or more than the EOQ for several reasons as they may not have a known uniform demand or some suppliers have minimum order quantity that are beyond the demand. JIT or Lean Systems would recommend reducing order quantities to the lowest practical levels. Benefits from reducing quantity involves improved customer responsiveness (inventory = Lead time), reduced cycle inventory and reduced raw materials & purchased components. Evaluating the options: Quantity discount procedure: Calculate the EOQ at the lowest price and determine whether the EOQ is feasible at that price. If the vendor sells that quantity at that price, stop calculation or else check the feasibility of EOQ at the next higher price. Calculate the total costs (including total item cost) for the feasible EOQ model and calculate the total costs of buying at the minimum quantity required for each of the cheaper unit prices. Compare the total cost of each option & choose the lowest cost alternative. 5 Copyright Beroe Inc, All Rights Reserved

6 Inventory Management Assessment Tool: Inventory Control Performance Metrics: Inventory Management Assessm Sl. No KPI Explanation 1 Inventory Turnover Inventory Turnover measures how fast the company turns over its inventory within a year. Based on critical assets revealed by Failure Mode Effects and Criticality Analysis (FMECA), inventory turnover for standard spares and critical spares needs to be analyzed. Industry standard value: Cycle Time Cycle time is the time taken from when an order is first issued until it is completed. Cycle times apply to many types of orders such as customer orders, purchase orders and manufacture orders. Supply chain cycle time indicates the overall efficiency of the supply chain. Short cycles make for a more efficient and agile supply chain. 3 Item Fill Rate Item fill rate is the percentage of items a customer ordered that the company is able to ship. Fill Rate is directly proportional to the inventory performance and is important for customer satisfaction and has implications for transportation efficiency. Fill Rate should be tracked not only for the each individual order but for all orders to calculate the % of orders go out completely filled and % of items missing. 4 Inventory Levels Inventory Levels track how much a company has of a given consumable or a product in a given time. Tracking inventory levels how much inventory you should have on hand, and it is used to calculate seasonality and to understand other important aspects of your processes. 5 Supplier Lead Time The time lag at the supplier between receiving the purchase order and shipping the order. This metric is often overlooked because of the assumption that the supplier owns the inventory at this stage, so there is nothing one can do as a customer to improve the supplier s turnaround of an order. In fact, one s ability to respond to changes in demand is directly proportionate to the supplier s ability to quickly deliver orders on a consistent basis. Also, the supplier s inventory turns affect their financial health, so there is dual motivation to collaborate to improve a supplier s performance. 6 Transit Time Time taken from supplier shipment until the company receives the order. Transit time includes the time to move goods from dock to stock. Transit times might be slower and unpredictable which can translate to higher inventory and lower Inventory ratio. In order to save time, mining companies purchase spare parts and equipment freight prepaid, so suppliers pass on freight charges in their invoices. Optimizing inbound freight moves is a freight savings opportunity for many mining companies with a possible savings of up to 15%. 7 Variability of Demand 8 Carrying Cost This is a measure of how much variability there is in customer demand. Mining Companies follow different methods to meet the requirements based on the demand as follows: High and Consistent demand : Pull replenishment Medium and Inconsistent demand : Schedule based ordering policy Low or lumpy demand : As needed basis and will not be stocked Carrying cost of inventory that includes taxes, employee cost, depreciation, storage and handling cost etc. helps to figure out profit made on current inventory and if there is a need to produce more or less to maintain the expenses 6 Copyright Beroe Inc, All Rights Reserved

7 9 Stock outs Keeping a record of stock outs, thus ensuring a proper system at place to collect feedback about inventory demand and how well the demand is met. Mining Supply Chain Conclusion: Better supply chain management can address these issues for mining organisations, to target and capture tangible financial benefits: Greater levels of revenue through increased throughput; Reduced working capital through quicker inventory turnover; Reduced demurrage costs through optimised ship queues. Mining sector is poised at an interesting juncture, with an ever increasing cash cost and reducing market prices. Industry is constrained by lack of adequate resources and organized work methodology. Globally, it has been noted that the inventory of major mining companies are piling up. Moving up the Value Chain Inventory analytics such as ABC Inventory classification, determining economic order quantity (EOQ), minimum cost service level (MCSL), one time buy inventories (OTBI) and inventory reorder point (IRP) delivers values by Highlighting inventory exceptions and identifying slow moving merchandise stock. Identifying items that have been out of stock and the length of time they have been in this condition. Identifying items that have been constantly in stock where the inventory held could be reduced without any impact to turnover or profit. Identifying items that seem to have a strong correlation with each other. This will help solve the excess inventory pileup that has been observed with various mining firms during the course of a low product demand. 7 Copyright Beroe Inc, All Rights Reserved

8 References Beroe Internal data Primary Interaction About the Author Arun MV Senior Research Analyst Arun M.V is a Senior Research Analyst with the Mining domain at Beroe Inc. He has worked on multiple market research projects for many Fortune 500 mining companies in the above category. He is a Mining engineer from National Institute of Technology, Nagpur, with insitu experience in underground coal / metal mining and has an MBA in project financing. Disclaimer: Strictly no photocopying or redistribution is allowed without prior written consent from Beroe Inc. The information contained in this publication was derived from carefully selected sources. Any opinions expressed reflect the current judgment of the author and are subject to change without notice. BeroeInc accepts no responsibility for any liability arising from use of this document or its contents. 8 Copyright Beroe Inc, All Rights Reserved For more information, please contact info@beroe-inc.com.