Part III Information for Inventory Management

Part III Information for Inventory Management Chapter 6 Sources of Information 1

Aims of the Chapter After reading this chapter you should be able to do the following: discuss the information needed for inventory management; outline the design of an inventory management information system; consider the information supplied by accounting; do an ABC analysis of stock; describe the function of procurement and its role in inventory management; outline the impact of e-commerce; discuss the role of warehousing; describe important factors in the design of a warehouse. Systems: Types of Information Inventory managers need a huge amount of information: the items, their specification and use, business plans and strategies, suppliers, customers, promotions, storage requirements, constraints, prevailing conditions of trade, contract law, transport arrangements, competitors, Business environment, changing conditions, international trade, special requirements, and so on. This information is collected from many sources, and is presented by the organization s management information system (MIS). 2

Systems (MIS) The MIS controls the flow of information throughout an organization, and makes sure that everyone has the information they need to work properly. It collects, checks, organizes, stores, analyses and presents information in the most appropriate formats to everyone who needs it. Sometimes it is convenient to refer to an inventory management information system which consists of all the parts of an MIS that are specifically concerned with inventory management. This collects information from both within the organization and from external sources and presents it to inventory managers. Systems: Types of Information Business environment, which gives the overall context for stocks: the state of competition, changing circumstances, likely shortages or supply difficulties, state of the economy, government policies and legislation, inflation, exchange rates, tariffs, duties, taxes and quotas, and a range of other external factors that might affect stocks. Organizational strategies, which are the internal policies that show what the organization is doing in the long term and the support needed from inventory management: details of objectives, planned operations and products, priorities, financing arrangements, trading relationship, and a range of other internal factors that might affect stocks. 3

Systems: Types of Information Performance targets, which identify the factors that are important to the organization and consequently to inventory management and the levels of performance to be achieved: aims for customer service, productivity, stock turnover, return on inventory investment, overall investment in stock, improvements, balance between competing objectives, etc. Plans for operations and production. material requirements, new products, changes to existing products, promotions, size of demands, etc. Systems: Types of Information Costs. Our independent demand inventory models are based on reliable figures for the four cost components of unit, reordering, holding and shortage. Managers need detailed breakdowns of other relevant costs, such as opportunity costs, financial charges, transport, storage, packaging, handling, insurance, obsolescence, internal movement, delays, distribution, etc. 4

Systems: Types of Information Customer information. Inventory managers pass materials to customers (either internal or external). alliances, trading arrangements, identification of existing and new customers, contact details, salespeople used, locations, products demanded, size of orders, regular orders, preferred delivery modes, purchases from competitors, sensitivity to prices, returns, complaints, attitude towards shortages, back-orders, service level and lead times demanded, stocks held, purchasing system used, attitudes towards shared systems and integration, trading history, payment method, financial security, credit terms requested, etc. Systems: Types of Information Demand patterns. To have enough stock to meet likely patterns of future demand, we need forecasts for each period, complete histories of past demand, changing patterns over time, reasons for changes, amount of variation and uncertainty, factors that affect demand, special promotions and marketing campaigns, regular orders, advance sales, etc. Supplier information, which gives all relevant information about the supply of materials, including preferred suppliers, alliances and other trading arrangements, attitude towards shared systems and integration, locations, products supplied, quality, purchasing system used, lead times, reliability, trading history, financial security, alternative suppliers, process and purchase conditions, credit terms offered, attitude towards returns, payment method, etc. 5

Systems: Types of Information Product details, which identify the exact item and include identification codes, description, design features and specifications, limitations, unit prices, discounts available, special conditions for storage or supply, quality available, weight and size, packaging, available suppliers, order restrictions, relative make/buy costs, and alternative products. Warehousing information, which shows where stocks are held, including locations, stock levels in each location, space available, facilities and conditions, material handling equipment, security, ownership, restricted access, costs and performance. Systems: Types of Information Transport, including the types of transport available, types of vehicle, special requirements and facilities, access, speed of delivery, scheduled services and frequency, reliability, costs, capacities, back-hauls and reverse logistics. Stock information. This gives the details of all current stocks held: identification codes, current holdings, locations, inventory policies, reorder levels and quantities, deliveries due, suppliers, quality, costs, units reserved for known orders, allowed variation in stock, maximum and minimum levels, age of units, obsolescent and slow moving items, insurance, special conditions, allocation of stocks to orders, back-orders, etc. 6

Systems: Types of Information Orders outstanding, which are all the orders with deliveries expected in the near future, details of materials in transit (coming from suppliers, going to customers, or moving between facilities), routes, transport operators, current locations, quantities, due dates, reliability, special handling required, potential difficulties, back-orders, urgent deliveries, etc. Systems: Types of Information Orders outstanding, which are all the orders with deliveries expected in the near future, details of materials in transit (coming from suppliers, going to customers, or moving between facilities), routes, transport operators, current locations, quantities, due dates, reliability, special handling required, potential difficulties, back-orders, urgent deliveries, etc. 7

Systems: Types of Information Systems: Transaction Recording Inventory MIS has to track every detail of stock movement, from orders sent to suppliers, through to payments received, for finished products delivered to customers. A typical transaction recording system might do the following: maintain accurate records of current stocks, customers, suppliers, etc.; update these records after each order, delivery, withdrawal or other transaction; check and validate all data used by the system. 8

Systems: Transaction Recording Systems: Transaction Recording The information can be passed to the inventory control system, for example, to do the following: calculate variables, including forecasts of demand and lead time, reorder levels, order quantities, costs, etc.; prepare and transmit orders when stocks fall to reorder levels; monitor order progress, with follow-up and expediting of overdue orders; check orders, credit and payment facilities of customers; check deliveries, clear of invoices from suppliers and arrange payment; report exceptional circumstances that need management attention; summarize data in management reports; update all parameters used by the system. 9

Systems: Transaction Recording The information flow through an organization is usually separated from the material flow. The two are obviously connected, but managers have to control operations and check that the transactions reported actually happen. One facet of these checks are periodic, manual counts of stock called stocktaking to find differences between recorded and actual stock levels. Systems: Transaction Recording There are several reasons why actual stock may differ from recorded stock: records may not have been updated with recent transactions; stock is mislaid (particularly when an item is kept in several locations) and will turn up later; emergency or hurried withdrawals from stock may incur errors or not be recorded; deliveries or withdrawals are recorded more than once by mistake; cancelled orders or withdrawals are not recorded; poor quality and returned items (either from customers or to suppliers) are not recorded; stock become obsolete and is discarded; stock is stolen, damaged or deteriorates while in store. 10

Systems: Transaction Recording There are several ways of encouraging this, and perhaps the most important is to restrict access to stores. Since stocktaking is an expensive and inconvenient, some only do one check at the end of the financial year. A more useful approach uses cycle-counting, where stock is checked at regular intervals. Typically, a small proportion of items is checked every week, with high usage items checked every month and less widely used items every three months. Checks may be triggered by specific conditions such as a reported discrepancy in stock, an item with zero or low stock, an item with very high stock, a back-order placed for an item that is recorded as being in stock, or a period with no recorded demand. One common suggestion is that important items should have discrepancies of less than 0.2% in stock levels, others 1%. Information from Accounting Accountants supply data about the four cost components unit, reorder, holding and shortage costs. They also provide more detailed costs information and a lot of transactional data. This information appears in records of individual transactions, and is also summarized in the organization s accounts. Gross profit = net sales revenue cost of products sold Cost of products sold = opening stock + net purchases closing stock 11

Information from Accounting Opening stock 2,500.00 Sales 22,100.00 Purchases 13,000.00 less returns 600.00 Less returns 500.00 Net sales 21,500.00 Net purchases 12,500.00 Total stock 15,000.00 Less closing stock 3,000.00 Cost of products sold 12,000.00 Gross Profit 9,500.00 21,500.00 21,500.00 Information from Accounting Raw materals Opening stock of raw materials $ 60,000 Purchase $ 225,000 returns and allowances $ 10,500 purchase discount $ 4,500 $ 15,000 Net purchase $ 210,000 Inward transport $ 15,000 Cost of material purchased $ 225,000 Cost of material available $ 285,000 Closing stock of raw materials $ 105,000 Cost of raw material used $ 180,000 12

Information from Accounting Work in progress Raw materals used $ 180,000 Staff $ 390,000 Overheads $ 125,000 Total cost of operations $ 695,000 Opening stock of work in progress $ 45,000 Total work in progress $ 740,000 Closing stock of work in progress $ 75,000 Total cost of production $ 665,000 Finished goods Opening stock of finished goods $ 135,000 Cost of production $ 665,000 Products available for sale $ 800,000 Closing stock of finished goods $ 180,000 Total cost of products sold $ 620,000 Information from Accounting: Value of Stock An obvious problem with accounting information is that it depends on the conventions used. The usual practice is to value stock at the lesser of unit cost or realizable value. Value of stock = number of units in stock unit value We can avoid the problem of variable stock levels by counting the number of units held at a specific time, usually the end of the financial year. If there are enough items in the stock, this gives a reasonable overall average (providing the demands for items are more or less independent, and do not all follow the same strongly seasonal variation). 13

Information from Accounting: Value of Stock The other problem is variable unit cost. There are four main options for dealing with this: Actual cost identifies each unit in stock with the price actually paid for it. First-In-First-Out (FIFO) This assumes that the first units arriving in stock are the first sold, so the value of remaining stock is set by the amount paid for the last units bought. Last-In-First-Out (LIFO) assumes that the latest units added to stock are used first, so the value of remaining stock is set by the amount paid for the earliest units bought. Weighted average cost finds the average unit cost over a typical period from: Average cost = Total cost of units Number of units bought Information from Accounting: Value of Stock The method chosen should give the fairest match of costs to revenues. FIFO is the most widely used method, while LIFO is often expressly prohibited, especially when it would artificially reduce tax liabilities. Another consideration is that accounting conventions should be consistent, so that organizations should not look for a short-term gain by changing the basis of calculations. 14

Worked Example #1 During her first job on a graduate trainee scheme, Madeleine Fraser was given the following record of transactions for an item and asked for her views on the profit. What answer could she give? Date Purchases number Unit cost ( ) Sales number Unit price ( ) Opening stock 80 20 January 20 30 February 40 40 March 60 30 April 50 50 May 80 40 June 20 60 Worked Example #1 Date Purchases number Unit cost Sales number Unit price Inventory Stock Value (FIFO) Stock Value (LIFO) Opening stock 80 20.00 80 1,600.00 1,600.00 January 20 30.00 60 1,200.00 1,200.00 February 40 40.00 20 400.00 400.00 March 60 30.00 80 2,200.00 2,200.00 April 50 50.00 30 900.00 700.00 Stock Value (Wt. Avg.) May 80 40.00 110 4,100.00 3,900.00 June 20 60.00 90 3,500.00 3,100.00 2,700.00 Total 220 130 Total Cost 6,600.00 Wt. Avg. 30.00 Revenue 5,900.00 Cost of products 3,100.00 3,500.00 3,900.00 Gross Profit 2,800.00 2,400.00 2,000.00 15

Information from Accounting: Value of Stock It is often expensive, difficult or impossible to count the actual number of units in stock. We can estimate the value of stock without actually counting it, by using the gross profit as a percentage of sales. If we assume this remains constant from one period to the next, we can work backwards to estimate the value of closing stocks. There are variations on this approach for estimating the value of closing stock, but they all rely on conventions and assumptions and are clearly less reliable than methods based on actual stock counts. Information from Accounting: Value of Stock It is often expensive, difficult or impossible to count the actual number of units in stock. We can estimate the value of stock without actually counting it, by using the gross profit as a percentage of sales. If we assume this remains constant from one period to the next, we can work backwards to estimate the value of closing stocks. There are variations on this approach for estimating the value of closing stock, but they all rely on conventions and assumptions and are clearly less reliable than methods based on actual stock counts. 16

Worked Example #2 Last year PiHo Industries made a gross profit of 30% of sales. This year they know that the opening stock of an item was $8,000 with purchases of $22,000. If sales of the item were $40,000, what is the value of closing stock? Sales $ 40,000 Cost of products sold: Opening stock $ 8,000 Purchases $ 22,000 Cost of products available $ 30,000 Estimated closing stock??? Total cost of products sold $ 28,000 Gross Profit $ 12,000 Estimated closing stock = 30,000 28,000 = $2,000 Information from Accounting: ABC Analysis of Stocks The origin of the ABC analysis ( Pareto analysis, or the rule of 80 20 ) came in the nineteenth century when Vilfredo Pareto found that 20% of the population owned 80% of the wealth. In inventory control terms it means that 20% of the inventory items need 80% of the attention, while the remaining 80% of items need 20% of the attention. In particular, ABC analyses define the following: A items are the few most expensive ones that need special care. B items are ordinary ones that need standard care. C items are the large number of cheap items that need little care. 17

Information from Accounting: ABC Analysis of Stocks Typically an organization might use an automated system to deal with all B items. A items are more important, and although the automated system might make some suggestions, managers make the final decisions after a thorough review of circumstances. C items are very cheap and are usually left out of the automatic system, to be dealt with by ad hoc procedures. An ABC analysis starts by taking each item and multiplying the number of units used in a year by the unit cost. This gives the total annual use of items in terms of value. Usually, a few expensive items account for a lot of use, while many cheap ones account for little use. If we list the items in order of decreasing annual use by value, A items are at the top of the list and C items are at the bottom. Information from Accounting: ABC Analysis of Stocks Because an item is cheap or has low demand, it does not mean that it is not important. organizations need stocks of all items including those that are cheap or not often used to continue their smooth operations. They typically hold C items in stock because they: are more important than their classification suggests like spare parts; allow continued sales of an old item which may no longer be made; Are associated with sales of some A items; give high profits in relation to their low costs; are new items which have not yet established a history of use; are expected by customers like ink cartridges for old printers. 18

Information from Accounting: ABC Analysis of Stocks If the three categories are not descriptive enough, managers might add extra ones. A fourth category is sometimes used, where D items are used so infrequently they are dead and are being considered for withdrawal. And sometimes a special category is used for important spare parts or other items that have a combination of high importance and low use. Information from Accounting: ABC Analysis of Stocks Category % of items Cum. % % of use Cum.% A 10 10 70 70 B 20 30 20 90 C 70 100 10 100 19

Worked Example #3 A small store with 10 categories of item has the following costs and annual demands: Item X1 Y7 W4 X2 X3 Y9 W5 Z3 Z4 X4 Unit Cost 3 2 3 8 2 10 1 5 20 4 Weekly demand 2 25 1 30 10 10 5 2 1 3 Do an ABC analysis of these items. How might stocks of each category be controlled? Item X2 Y9 Y7 X3 Z4 X4 Z3 X1 W5 W4 Cum. Item # 1 2 3 4 5 6 7 8 9 10 Cum. Item % 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Unit Cost 8 10 2 2 20 4 5 3 1 3 Weekly demand 30 10 25 10 1 3 2 2 5 1 Weekly use 240 100 50 20 20 12 10 6 5 3 Cum. Use 240 340 390 410 430 442 452 458 463 466 Cum. Use in % 52% 73% 84% 88% 92% 95% 97% 98% 99% 100% Category A B B C C C C C C C Information about Supply and Demand: Demand Forecasting The pattern of demand is perhaps the most important single factor for inventory management. In general, there are two sources for demand data. For the first, an organization supplies products directly to customers and has historical sales figures that it can use to forecast future demand. (Chapter 7) For the second, an organization supplies materials to support internal operations and can use the planned operations to give a timetable for demands. (Chapters 8 and 9). 20

Information about Supply and Demand: Supply and Procurement Procurement is responsible for acquiring all the materials needed by an organization. It consists of all the related activities needed to get materials, services and any other materials from suppliers into an organization. The overall aim of procurement is to guarantee a reliable supply of materials to an organization. Information about Supply and Demand: Supply and Procurement working closely with user departments, developing relationships and understanding their needs; finding good suppliers, working closely with them and developing beneficial relationships; buying the right materials and making sure that they have acceptable quality, arrive at the time and place needed, and meet any other requirements; negotiating good prices and conditions; keeping stocks low, considering inventory policies, investment, standard and readily available materials, etc.; moving materials quickly through the supply chain, expediting deliveries when necessary; keeping abreast of conditions, including pending price rises, scarcities, new products, etc. 21

Worked Example #2 Last year Lavender Spartak Limited had total sales of $216 million. Their direct costs were $116 million for materials, $54 million for employees and $24 million for overheads. What is the effect of reducing the cost of materials by 1%? in Millions$ Original Cost reduced by 1% Change Total sales $ 216.00 $ 216.00 Direct cost $ 116.00 $ 114.84-1.00% Employees $ 54.00 $ 54.00 Overhead $ 24.00 $ 24.00 Total cost $ 194.00 $ 192.84 Gross profit $ 22.00 $ 23.16 5.27% Information about Supply and Demand: Procedure for Procurement Procurement looks for two factors: materials that satisfy their requirements; and a supplier who can guarantee to deliver the agreed materials. A useful approach for choosing the best supplier has the following steps. Look for alternative suppliers and build a long list of qualified suppliers who can deliver the materials. Compare organizations on this long list and eliminate those who are, for any reason, less desirable. Continue eliminating organizations until you have a shortlist of four or five of the most promising suppliers. Prepare an enquiry, or request for quotation, and send it to the shortlist. ž Collect the bids returned by the shortlist, do a preliminary evaluation, and eliminate those with major problems. ž Do a technical evaluation to see if the materials meet all specifications. ž Do a commercial evaluation to compare the costs and other conditions. 22

Information about Supply and Demand: Procedure for Procurement Collect the bids returned by the shortlist, do a preliminary evaluation, and eliminate those with major problems. Do a technical evaluation to see if the materials meet all specifications. Do a commercial evaluation to compare the costs and other conditions. Arrange a pre-award meeting to discuss bids with the remaining suppliers. At this point you should have enough information to make a final choice of supplier, so arrange a pre-commitment meeting to sort-out any last minute details. Award orders to the preferred supplier. Information about Supply and Demand: Procedure for Procurement This procedure should give a supplier who is financially secure, with good long-term prospects, can supply the necessary materials, guarantees quality, is reliable, has short lead times, quotes reasonable prices and finance arrangements, is responsive to customers needs, has necessary the skills and experience, has a good reputation, uses convenient procurement systems and probably has many more enviable qualities. 23

Information about Supply and Demand: Structure of a Purchasing Cycle Information about Supply and Demand: Information Flows for Order Processing 24

Information about Supply and Demand: e-procurement Changing patterns of procurement, Supply chains getting shorter, More customers use the Web, Alliances are reducing the number of suppliers used by each organization, Amounts purchased are increasing as companies focus on their core activities and outsource more, and Customers are demanding more from products and conditions of purchase. e-procurement. Surveys (see, Cummings, 2002) suggest that over 60% of UK companies were using e-procurement by 2002 57% of corporate buyers have purchased goods online, and 37% percent expect to increase the amount of their budget spent online http://www.acquitygroup.com/news-and-ideas/news/study-finds-more-than-1-3-of-corporate- Buyers-Expe#sthash.n2DgDYSe.dpuf Information about Supply and Demand: Advantages of e-procurement allowing instant access to suppliers anywhere in the world; creating a transparent market where product details are readily available and easily compared; Allowing comparison of standard terms of trade and rapid negotiation of details; automating procurement with standard procedures; greatly reducing the time needed for transactions; reducing costs, typically by 12 15%; allowing outsourcing of some procurement activities to suppliers or third parties; integrating seamlessly with suppliers information systems. 25

Warehousing: Purpose of Warehouses A warehouse is any place for storing materials. Different terms: distribution centres and logistics centres. Inventory management is the management function associated with decisions about stock, while warehousing is the operational function that physically looks after it. Main aims of a warehouse: providing necessary storage at key points in a supply chain, giving secure storage of the type needed by materials, keeping materials in good condition with little damage or loss, having low costs with high productivity and utilization of resources, and giving safe working conditions. Warehousing: Warehousing Activities receiving materials from upstream suppliers; identifying the materials delivered, matching them to orders and finding their intended user; unloading materials from delivery vehicles; doing necessary checks on quantity, quality and condition; labelling materials (usually with bar codes or magnetic stripes) so they can be identified and monitored; sorting materials as needed; moving materials to a bulk storage area; holding them in stock until needed; when necessary, moving materials from bulk storage to a smaller picking store; 26

Warehousing: Warehousing Activities picking materials from this store to meet orders; moving the materials to a marshalling area; assembling materials into orders; packing and packaging as necessary; loading delivery vehicles and dispatching the order; controlling all communications and related systems, such as inventory control and finance. Warehousing: New Warehousing Activities Consolidating: Warehouses are places where small loads from different suppliers are combined to give full vehicle loads for delivery to customers. This is the basis of postponement, where the final steps of production are left to the last possible moment. Bulk-breaking: Here a supplier sends all the demand for a particular area in a single delivery to a local warehouse. The warehouse breaks this delivery into the separate orders and passes them on to each customer. Cross-docking The arrival of materials at a warehouse is coordinated with its departures to customers, so that they are transferred directly from the arrival area to the loading area, and immediately sent for delivery to downstream customers. 27

Warehousing: Warehouse Design Essential elements in a warehouse are: an arrival bay, or dock, where materials coming from suppliers are delivered, checked and sorted; a storage area, where materials are kept in stock; a departure bay, or dock, where customers orders are assembled and sent out; a material handling system, for moving materials around; an information system, which records the location of all materials, arrivals from suppliers, departures to customers, and other relevant information. Warehousing: Warehouse Design 28

Warehousing: Warehouse Design Warehousing: Warehouse Design Material handling equipment 1. Manual warehouses: trolley, handtrucks, and carousels Manual warehouses only work if the items are small and light enough to lift, with shelves that are low enough to reach and close together to reduce walking. 2. Mechanized warehouses: reach trucks, order-picking machines, forklift trucks, cranes, towlines, conveyors, tractors or trains, and carousels. 3. Automated warehouses. High storage areas, AGVs, high speed stacker cranes, robots, and a warehouse management system to record material locations, and control all movements. 29

Warehousing: Packaging Collecting together materials into these standard packages is called unitization to form unit loads. Packaging serves four basic functions: identifies the product and gives basic information; protects items while moved through the supply chain; makes handling easier; Assists in marketing, promoting the product, advertising and giving information to customers. 2 types of packaging: the interior, or consumer packaging, is designed for the customer and includes the marketing and promotional materials. the exterior, or industrial packaging, is designed to identify the contents, give information to organizations in the supply chain, protect the contents, and make handling easier. 30