Chapter 7 Fundamentals of Inventory

7/29/2019 Chapter 7 Fundamentals of Inventory

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Michigan State University, 2013- # -

SCM 303

Chapter 7 (Pages 234-243)Managing Inventories


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Supply Chain Management and InventoryManagement

A major emphasis over the past two decadeshas been placed on reducing the amount ofinventory

There are many who argue that having

inventory is bad Their reasoning is based on the financial

implications of holding inventory


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Types of Inventory

Raw materials/Component Parts

Work-in-process

Finished goods

Maintenance, repair, and operating supplies

(MRO)

Transit Inventory


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Balance Supply and Demand

Seasonality

Production Processes

Provide Buffer against Uncertainty/Variability in

Supply and/or Demand (Buffer/Safety Stock) Basic Economics of Buying

Geographic Specialization

So, Why Carry Inventory?


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Financial Implications of Inventory

Inventory represents investment by the firm It is an asset on the firms balance sheet

Companies typically desire to keep their investmentin assets as low as possible

Maintaining inventory costs money on an on-going basis.

Thus, inventory also causes expenses to be incurred

These expenses show up on the firms income

statement

However, not having inventory when customerswant it results in negative financial

consequences as well


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Cost of capital (opportunity cost) Cost of owning and maintaining storage space Taxes

Insurance Costs of obsolescence and loss Costs of material handling, tracking, and

management

Inventory Holding/Carrying Cost


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AVERAGE PERCENT PERCENTELEMENT OF COST RANGE

Cost of Capital 15.0 8.0 30.0Taxes 1.0 0.5 2.0

Storage /handling/mgt. 2.0 2.0 6.0

Insurance 0.5 1.0 4.0

Obsolescence 1.2 0.5 8.0

Total 19.7 11.0 50.0Percentage is annual percent of average inventory value

INVENTORY HOLDING COST



Inventory Carrying Cost

Suppose average inventory for a firm is$3,500,00. The company has determined thatits inventory carrying cost is 25%. What is the

annual expense of holding inventory? The company is able to reduce inventory to an

average of $2,750,000? What is the savingsassociated with this reduction?



OTHER COSTS RELATED TO INVENTORY

Ordering Costs Preparation

Transmittal

Receiving

Payment processing

Stockout Costs



Inventory turnover Days of Supply Service level

Discussed in more detail in Chapter 9, but shouldunderstand the basic concept of a stockout

Measures of Inventory Performance



Inventory turnover= Net SalesAverage inventory at retail

Inventory turnover= Cost of goods soldAverage inventory at cost

Inventory turnover= Sales in Units

Average inventory in Units

Calculating Inventory Turnover



Company Cost ofGoods BeginningInventory EndingInventory AverageInventory InventoryCarryingCost*

InventoryTurnover

Boeing $55,867.00 $24,317.00 $32,240.00 $28,278.50 $5,665.70 1.98Deere 22,034.40 3,063.00 4,371.00 3,717.00 743.40 5.93Ford

113,345.00

5,917.00

5,901.00

5,909.00

1,181.80

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Hewlett-Packard 97,529.00 6,466.00 7,490.00 6,978.00 1,395.60 13.98Kellogg 7,750.00 1,056.00 1,132.00 1,094.00 218.80 7.08Procter &Gamble 40,768.00 7,379.00 6,384.00 6,881.50 1,376.30 5.92Target 48,306.00 7,596.00 7,918.00 7,757.00 1,551.40 6.23Wal-Mart 335,127.00 36,318.00 40,714.00 38,516.00 7,703.20 8.70HyattHotels 2,957.00 100.00 87.00 93.50 18.70 31.63Starwood 4,994.00 802.00 812.00 807.00 161.40 6.19

Table 7-1: Example Inventory Levels, Turnover, and Carrying Cost(Fiscal Year 2011, $ figures in millions)*Inventory Carrying Cost calculation assumes a 20% annual rate.



Turnover

Advantages of high turn over:Fresh inventory from high sales

Reduced risk or mark down from obsolescence

Reduced total carrying costs

Lower asset investment and higher productivity

Dangers of high turnover:

Stockouts may mean lower sales

Increased costs from missing quantity requirementsIncreased ordering costs

713

Turn over Turn over



Days of Supply

How many days of demand into the future can we satisfyfrom inventory on hand? Current Inventory/expected rate of daily demand

Suppose a firm currently has a total of $8,000 inventory of an

item. It expects demand to average $200 per day. What is thedays of supply of the item?

$8,000/$200 = 40 days

If the firm consistently maintains an average of 40 days ofsupply, what inventory turnover rate will it have for the year?

360 days/40days = 9 turns/year (It is convention to think of a yearas 360 days for this calculation just because its simpler arithmeticthan thinking about 365 days).


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Problems to work

Note: This is NOT a graded homeworkassignment, but you can expect that knowinghow to work these will be useful on the exam!!

Work problems 1-4 at the end of Chapter 7.

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Chapter 7 Fundamentals of Inventory