Detailed Scheduling and Planning (Lesson 2)

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Detailed Scheduling and Planning

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Unit 2Detailed Scheduling and

Planning

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Copyright Leading Edge Training Institute Limited i i


Unit2

2004 e -SCP -The Centre for Excellence in Supply Chain ManagementNo portion of this publication may be reproduced in whole or in part.The Leading Edge Group will not be responsible for any statements, beliefs, or opinions expressed by theauthors of this workbook. The views expressed are solely those of the authors and do not necessarilyreflect any endorsement by The Leading Edge Training Institute Limited.

This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA, CFPIM,CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and CertificationCouncil for use as study material for the APICS CPIM certification examination.

The Leading Edge Training Institute LimitedCharter House

CobhCo CorkIreland


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Unit2

Preface............................................................................................................4

Course Description................................................................................................................. 4

Lesson 2 Customer Service and Inventory Management...............................5Introduction and Objectives.................................................................................................. 5Safety Stock............................................................................................................................. 5Customer Service.................................................................................................................... 6Safety Stock and Statistical Formulae................................................................................ 11Inventory Valuation............................................................................................................. 18Types of Inventory Valuation.............................................................................................. 18Data Integrity and Inventory Accuracy............................................................................. 21ABC Classification and Inventory Analysis ...................................................................... 23Methods of Ensuring Inventory Accuracy......................................................................... 27Inventory Policy.................................................................................................................... 29Summary............................................................................................................................... 31Further Reading ................................................................................................................... 31Review ................................................................................................................................... 32Whats Next? ........................................................................................................................ 33

Appendix.......................................................................................................34

Answers to Review Questions .............................................................................................. 35Glossary........................................................................................................37


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Preface

Course Description

This document contains the second lesson in the Detailed Scheduling and Planning unit, which isone of five units designed to prepare students to take the APICS CPIM examination. Beforecompleting the Detailed Scheduling and Planning unit, you should complete the Basics ofSupply Chain Management unit or gain equivalent knowledge. The five units that cover theCPIM syllabus are:

Basics of Supply Chain Management


Master Planning of Resources

Execution and Control of Operations

Strategic Management of Resources

Please refer to the preface of Lesson 1 for further details about the support available to youduring this course of study.

This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA,

CFPIM, CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and

Certification Council for use as study material for the APICS CPIM certification examination.


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Lesson 2 Customer Service and Inventory Management

Introduction and ObjectivesThis lesson covers techniques related to the management of safety stock, valuation of inventory,preservation of data accuracy and inventory accuracy. It also reviews and expands on the ABCanalysis and cycle counting techniques. Finally, the lesson explores characteristics and featuresof inventory policies. The aim of this lesson is to review factors that may be input to materialrequirements planning (MRP), reviewing the techniques to ensure an accurate understanding ofeach.

On completion of this lesson you will be able to:

Describe safety-stock processes

Identify ways in which safety stock processes support customer service strategies

Identify the purpose of inventory valuation

Calculate safety stocks to support a required level of customer service using the table ofsafety factors

State the effect of inventory valuation on inventory investment

Describe inventory accuracy methodologies used to maintain and improve part-count andinventory valuation accuracy

Distinguish between various customer services measurements

Safety StockSafety stock is inventory held to support customer service level objectives, one of the primaryreasons for holding inventory. Safety stock is needed when there is uncertainty of demand orwhen the supply of parts or raw materials is unreliable. For example, safety stock of bespokepackaging materials may be held by a company to guard against time delays in replenishmentfrom the supplier.

Safety stock protects against stockouts up to a defined level. The higher the level of safety stock,the greater the chance that stock-outs will be prevented. However, as safety stock levels increase,costs to the company also increase.

For items that are subject to variable demand but where permanent safety

stock is undesirable, safety lead time may be an option. This ensures that allscheduled receipts for that item will arrive a specified length of time beforethey are actually needed. For example, a catering company that producesairline meals may order disposable crockery and hot food containers with adue date two days before the current stock is likely to run out. This reducesthe likelihood of a stock-out due to increased demand or late delivery of theorder.

Safety stock is the quantity of stock planned for inventory to protect against unforeseenfluctuations in either demand or supply


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Purpose of Holding Safety StockSafety stock is required to guard against stockouts. It is important for items of independentdemand as it is unlikely that forecasts will ever be 100% accurate. Therefore, to ensure customerservice levels are maintained, a safety stock must be available at times where demand is higherthan expected and the available stock may be depleted before replenishment can be realisticallyexpected.

Dependent Demand and Safety Stock

Safety stock may be planned for dependent demand items but usually only if the supply of thedemand item is subject to change, due to either unreliable delivery, or unreliable scrap or yieldratios in production. The demand for the product is totally dependent on the demand for itsparent and is calculated rather than forecast. Therefore, there is little chance that demand willexceed supply.

Dependent and Independent Demand for the Same Item

Some parts may be subject to both dependent and independent demand. In this case, safety stockmay be held to cover for the independent demand. In this case, the part should be divided intotwo categories in MRP so that gross requirements for the dependent demand can be calculatedseparately to those for the independent demand.

Customer Service

What it meansIn operational terms, customer service is the availability of items when they are required by thecustomer, whether that customer is a consumer, distributor, or internal company department.100% customer service level 100% of the time is rarely achievable, due to unanticipated largedemands, machine failures, late delivery of components or other causes. Despite thesedifficulties, the success of a company depends on it aiming for a high level of customer service,setting targets and measuring performance accordingly.

Measuring Customer Service

Customer service measurement should involve the monitoring of delivery performance relativeto promised dates, and the companies performance filling back orders and late deliveries. Thereare two types of measurement that can be used: percentage measurements and absolute valuemeasurements.

Some absolute value type measures are most useful when compared against a standard. Forexample, a company might set a target of not more than 12 order days out of stock in any 12month period. It could then record actual order days out of stock and compare on a rollingmonthly cycle.

Percentage Measurements Absolute Value Measurements

Orders shipped on schedule

Line items shipped on schedule

Total units shipped on schedule

Dollar volume shipped on schedule

Profit volume shipped on schedule

Order days out of stock

Line item days out of stock

Total item days out of stock

Dollar volume days out of stock

Idle time resulting from material orcomponent shortages


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Operating item days not out of stockOrdering periods without stockout

1. What are the main reasons for holding safety stock for dependent demanditems? (Choose more than one option)

A. To guard against fluctuation in demandB. To guard against changes in supply due to unreliable deliveryC. To guard against high levels of scrapReview QD. To protect against low production yields

Percentage Measurements

Percentage of orders shipped on schedule

This is a good measure of customer service when all customer orders are ofsimilar value and the value of the order is evenly distributed among the lineitems. However, if the few orders that did not ship on schedule were particularlyvaluable, for example, accounting for 40% of total dollar volume, then thepicture from this measure is misleading.

% line items shipped on schedule

This takes into account the fact that orders can have very few or a great many line items. To a

certain extent it ensures the size of the order is taken into account with large orders having agreater impact on the overall percentage than small orders. However, it does not take intoaccount the unit cost of each item. For example, the overall percentage might be high, but thefailures could all stem from the failure to ship high dollar value items, therefore the cost to thecompany is greater than that illustrated by this measure.

% total units shipped on schedule

This measure takes into account the differences in quantities in orders and line items. However,it does not take into account the dollar volume of orders. For example, Buzz Electronics sellsplasma televisions, hi-fi systems, and personal stereos to a particular distributor. It achieves 97%of total units shipped on schedule. On first examination, as this matches the target set by

management, there is cause for celebration. However, it later transpires that all the delayed unitswere plasma televisions. As these are by far the most expensive line items, the 3% delayed items,in terms of dollar volume, are significant.

% ordering periods not out of stock

If a product is ordered weekly and 3 stockouts are experienced during the year, the customerservice level would be 94.2% using this measurement (49 / 52). This measurement is useful indetermining reorder points to achieve specified customer service levels.

Absolute Value MeasurementsThe absolute value measurements such as order days out of stock, line item days out of stock,

total item days out of stock and dollar volume days out of stock are of limited use in isolation.They work best when they are tracked over time and the company sets objectives related to these


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measurements. For example, a company might aim to ensure that it neverexperiences more than 8 order days out of stock in any 12 month period.

Idle time due to material or component shortages

This is a useful measure of the level of control from between purchasingand PAC, particularly queue management and input/output control. It canbe used to compare similar facilities or the same facility over differentshifts. It is common among manufacturing plants operating against standardproduction times to maintain a record of non-productive hours with associated causes, so the datarequired to measure idle time is usually easily available.

Comparing Measurements

The importance of choosing the most appropriate measure or combination of measures forcustomer service cannot be underestimated. Consider the following example, which shows the

range of the different measurements for the same situation.ABC Beverages supplied 305,400 units of orange juice over 12 months to one of its key markets.It received 2,454 orders from that market. 92 of those orders could not be filled from stock. Thisrepresented a total of 11,120 units not shipped from stock. Over the 52 weeks, the company wasout of stock 9 times. Using this information, the following measurements can be calculated:

Percentage of orders shipped complete on schedule , (2,454 92) / 2,454 = 96.25 %

Percentage of items shipped on schedule , (305,400 11,120) / 305,400 = 96.36%

Percentage operating item days not out of stock, 1- (9 / 52) = 82.70%

Depending on the measurement chosen, the results vary widely. Thus it is important that a

company determines the most appropriate measurement for its particular circumstances. Allthese measurements are inadequate in terms of measuring exactly how the customer rates thecompany and its service. Ideally, opinions should be communicated directly to managers.

Delivery Performance and Backorders

When backorders occur, that is, the company has missed the original due date or promised datefor the customer; it must endeavour to retrieve the situation as soon as possible. The companymust measure its response to backorders to ensure they are filled quickly. Some of the measuresused in this situation are:

Average time and standard deviation of the time it takes to ship a backorder

% backorders shipped within a specified time period (e.g. 90% within 2 days, 100%within 5 days)

Age limit imposed on backorders with goals associated with each backorder age bracket(for example, 100% of backorders over 4 days old should be shipped the following day,90% of backorders 2 days old should be shipped the following day)

Selecting Customer Service Measurements


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Before deciding on the appropriate measure, a company must identify thetypes of data available. There is no point deciding to measure dollarvolume shipped on schedule if information on the dollar value of eachitem in each order is not available. Also, there is no point in choosing ameasurement which is costly in terms of time and resources to collectwhen there is little gain to be made from associated improvements.

In some cases, the ability to measure will have little impact on theoutcome. For example, where stockouts are experienced due to thescarcity of purchased items that cannot be produced in-house, there is littlethat can be done to remedy the situation.

To be valuable, the measurement chosen must relate productivity, profit and return oninvestment. This may vary from one product group to the next. Thus, it may be necessary tochoose different measurements depending on the type of order and the type of inventory beingmanaged. The choice of measurement will be affected by:

The nature of the inventory

The availability of data

The use of measures by management

The relation of measures to the business objectives

The cost of implementing the measures

Customer Service Objectives

When the appropriate customer service measures have been selected, performance objectives in

each area should be set. Often, different performance objectives may be set for each item family.These objectives will be influenced by the cost of carrying the item compared to the cost ofstockouts. When an item is inexpensive and easy to store, and the cost of a stockout in that itemis high, the company should aim for a high customer service target.

Component parts and subassemblies that have dependent demand should have a 100% servicelevel as delays or stockouts will have a strong knock-on effect on finished products. Forexample, if a finished product is assembled from 5 components, each with a service level of95%, the overall service level of that product is likely to be (0.95 x 0.95 x 0.95 x 0.95 x 0.95) or84%.

Appropriate and achievable customer service levels can be set by examining historical data on

customer service. Machine downtime and assembly line downtime is usually available andgenerally it is possible to calculate how much downtime was due to lack of materials.

In general, the provision of a higher level of customer service leads to an exponentially greaterinvestment in inventory. However, sometimes improvements in inventory management can leadto customer service improvements without the need for greater investment.

Customer Satisfaction

Customer satisfaction is an important factor in maintaining a customer base.As organizations demand more from suppliers, it is important to offer more tothe customer. Losing a customer due to lack of focus is a very expensive

proposition. Loss of current revenue and reputation does not reflect directly onthe profit and loss statement but will be evident through lower profitability in


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the longer term.

Measurements of the total customer experience can include measures of responsiveness, designsuggestions for cost reductions or cycle time improvements, service and warranty.

As many organizations today are now dealing with a global customer base, the logisticalchallenges associated with customer service are significant. Some ways in which customerservice may be improved are through service contracts and guaranteed access to computersystems. When such services are important to customers network downtime can be veryexpensive.

Transportation has a deep impact on customer satisfaction. It is very important that anorganization partners with a transportation company that can deliver product within defined timeframes.

Customer Service and Order Quantities

If customer service levels are expressed as performance goals for a specified period, forexample, every quarter, order quantity will have an impact on performance. The smaller theorder quantity, and therefore the shorter the order cycle, the more times per year there is anopportunity for a stock out to occur.

Small orders create risks of more frequent stockouts, but these are usually brief in comparison tothe less frequent stock-outs that may occur with large order quantities and which may last for asignificant period of time. Items should be assessed from a customer service perspective whenestablishing order quantities and safety stock levels.

2. Sparkle Cleaning Ltd produces a range of cleaning products for the hoteland catering industry. The overall size and value of orders varies significantlyalthough there is little range in the value of line items. The company keepsrecords of customer orders and line items in each order.

Which is likely to be the most appropriate customer service measurement?

A. Ordering periods without stockoutsB. Orders shipped on scheduleC. Line items shipped on schedule

Review Q

D. Profit volume shipped on schedule


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Safety Stock and Statistical Formulae

It is important to establish an appropriate safety stock level for every inventory item. Thisinvolves measuring the amount of demand variability relative to the average demand. This isoften known as forecast error. The usage data collected in issue transaction records is importantfor this. There are several statistical methods that can be used in the calculation of an appropriatesafety stock level. These are explained below.

Normal DistributionThe normal distribution curve assumes that demand variation is symmetrical around an averageor mean demand (often represented by the Greek letter (mu). The mean is calculated byadding the demand for several periods and dividing by the number of periods. In the normaldistribution curve, the mean is the center point. The variation of all demand values around the

mean is called the standard deviation (represented by sigma s). This measure of variability is thevalue that needs to be determined in order to calculate a safety stock value. An example of thenormal distribution curve is shown below.

Mean Absolute Deviation (MAD) and Standard Deviation

Either the MAD or the standard deviation method may be used to measure the degree of demandvariability. Standard deviation needs a longer history of forecast and demand than MAD.

Sum of squared deviations

Number of periods - 1vStandard Deviation =Sum of squared deviations

Number of periods - 1vSum of squared deviations

Number of periods - 1vStandard Deviation =

The mean absolute deviation is the average of the absolute deviations from the forecast averagedemand. It requires only the summary values from the previous month along with current values.

Sum of deviations

Number of periods

MAD =Sum of deviations

Number of periods

MAD =


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The table below shows the information needed to determine standard deviation and MAD.

Week Actual Sales Forecast Deviation Deviation2

1 9,800 10,000 -200 40,000

2 10,000 10,000 0 0

3 10,200 10,000 200 40,000

4 10,800 10,000 800 640,000

5 10,600 10,000 600 360,000

6 9,600 10,000 -400 160,000

7 10,400 10,000 400 160,000

8 10,000 10,000 0 0

9 9,800 10,000 -200 40,000

10 10,400 10,000 400 160,000

101,600 100,000 1600 2,560,000

Table 1 Actual Sales, Forecast Sales, Deviation and Deviation Squared

Note that the denominator n-1 for less than 30 periods and n for more than 30 periods. Forforecast purposes, the number of periods used is usually less than 30 so n-1 is appropriate.

Using the figures from the table above, the standard deviation formula is as follows:

2,560,000

9vStandard Deviation =

2,560,000

9vStandard Deviation =

So in this example, the Standard Deviation = 533.3

Using the same figures, the MAD is equal to 1600 divided by 10, or 160.

Implications of Forecast Bias

A forecast is not expected to be accurate. The actual value of one period may be greater thanforecast while the value for the next period may be less than forecast. Overall, the errors shouldfall equally either side of the forecast amount. However, this is not always the case. Some

forecasts err consistently on one side or other. This is known as bias.A forecast bias analysis is used to check if forecasting is consistently too high or low. In the tableused previously, the sum of the forecast figures was 1000,000, compared to an actual sales figureof 101,600. This indicates that there may be a negative bias in the forecasting process.

If the sum of the forecasts is very different from the sum of the actual sales values over aspecified period, the forecast is biased

If the sum of the forecasts over a period is consistently greater than actual sales, the biasis positive, or too optimistic, and should be scaled back

If the sum of the forecasts over a period is less than the actual sales, the forecast bias is

negative.


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Tracking Signals

Tracking signals are used to check the deviation between actual and forecast figures over time. Itprovides a numeric value that can be compared to a reference value or range, with optimal

performance close to zero. When the tracking signal is outside the acceptable range, the itemmay be reviewed by the planner.

Usually a tracking signal is a running sum of forecast errors divided by the mean absolutedeviation for the periods in question. However, some items may require different tracking signalsdepending on their cost or importance.

A tracking signal approaching +1 or 1 indicates a consistently negative or positive error. Manycompanies set a trip value which is some form of threshold beyond which forecast bias issuspected. When this is the case, the company can either search for the cause of the change indemand, for example, a data error, or place a stronger emphasis on more recent demand data toenable the system to correct itself. For important items, this trip value may be as low as 0.3 or

0.4. For less important items it may be more like 0.7.The following table illustrates the calculation of a tracking signal:

Actual Forecast Error Sum of error Absolute sumof errors

Trackingsignal

150

146

156

152

145146

153

157

153

155

147

145

155154

148

146

-3

-9

9

7

-10-8

5

11

-3

-12

-3

4

-6-14

-9

2

3

12

21

28

3846

51

62

-1.00

-1.00

-0.14

0.14

-0.16-0.30

-0.18

0.03

Initially, as all previous errors are assumed to be zero, the tracking signal looks very high. Thetracking signal is calculated as a ratio of the sums rather than of the averages.

3. To support a particular level of customer service, it is important to ensureappropriate safety stock by:

A. Setting an arbitrary safety stock levelB. Setting safety stock levels based on the level of demand variability and the

level of customer service required

C. Setting safety stock levels equal to the MADReview Q

D. Setting the safety stock level equal to the standard deviationUsing Variability Metrics

The traditional view of the standard variability curve (or bell curve) shows that the probability of

an event occurring with plus or minus one standard deviation from the mean is 68.26 %. Usingthe figures given previously in Table 1, page 12, the forecast value was 10,000 units and the


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standard deviation was 533.3. This means that there is a 68.26 percent probability that the actualusage will fall between 10,000 + 533.3 and 10,000 -533.3, or between 9,4667.7 and 10,533.3.

By maintaining a safety stock in finished goods equal to the forecast quantity, 50 percent of the

time there will be the correct amount of inventory to meet demand. By increasing safety stock,this percentage can be increased. By adding one standard deviation worth of inventory (533units) as safety stock, the customer service level will increase to around 84%. A safety stock oftwo standard deviations (1066 units) will result in a 98% service level as shown below. (Note:the horizontal lines in the bell curve refer to standard deviations from the mean (or center line).

50%

84.13%

97.72%

99.86%

50%

84.13%

97.72%

50%

84.13%

97.72%

99.86%

Figure 1 Standard Deviation and Customer Service

Table of Safety FactorsThe following table can be used to identify the level of service required and the correspondingsafety factor multiplier, which can be used to calculate the amount of safety stock required toprovide the chosen level of service. The safety stock is calculated by multiplying the amount in astandard deviation by the safety factor multiplier.

Desired Service Level (%) Standard Deviation SafetyFactor Multiplier

MAD SafetyFactor Multiplier

50 0.00 0.000

80 0.84 0.672

84.13 1.00 0.80090 1.28 1.024

95 1.65 1.320

97.72 2.00 1.600

98 2.05 1.640

99 2.33 1.864

99.87 3.00 2.400

99.93 3.20 2.560

99.99685 4.00 3.200Table 2 Table of Safety Factors


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For example, if you want to ensure a service level of 99%, you need to maintain a safety stocklevel equivalent to 2.33 times the standard deviation, remembering that the standard deviation isequal to the square root of the sum of the squared deviations divided by the number of periodsless 1.

In the example used for explaining standard deviation, the amount of one standard deviation wasequal to 533.3. Using the table of safety factors above, the amount of safety stock needed toensure 99% customer service is 533.3 x 2.33. The safety stock should be 1243 units.

Factors to consider when determining safety stock quantities:

Always round up the amount of safety stock required to the nearest whole unit

The correlation between MAD and standard deviation can be displayed as MAD =sigma/1.25

Further adjustments to the safety stock level must be made if the items replenishment

lead time is greater or less than the forecasting period. This is achieved by calculating alead time deviation.

4. If the standard deviation is 300 units and the target level of customer serviceis 98%, what amount of safety stock should be held?

A. 146 unitsB. 300 unitsC. 492 unitsReview Q

D. 615 unitsLead Time Deviation

If the forecast frequency and item lead time are different, the standard deviation should bereferred to as the lead time deviation. If the forecasting period is greater than the replenishmentlead time, less safety stock is needed. However, if the forecasting period is less than thereplenishment lead time for the item, a greater level of safety stock is required to achieve thesame service level.

The lead time deviation equation is used to compensate when the lead time does not equal theforecast interval. Standard deviation is based on the forecast interval period. There will be a

greater risk of stock out if the lead time exceeds the forecast period.Lead Time Deviation= Standard Deviation x (Lead Time / Forecast Interval)

Beta () is a range between zero and one, which typically falls between 0.5 and 0.7.The betafigure allows for lead times longer than the forecast period by increasing safety stock levels. Theworst case scenario is a beta factor of 1.

To continue the previous example, assuming the forecast interval is four weeks, thereplenishment lead time is 6 weeks, and is 0.5, the lead time deviation would be equal to 533.3multiplied by half of (6 divided by 4).


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Time Period Safety Stock

A time period safety stock provides an even amount of safety stock, equal to usage, over aspecified time period or days, weeks or months. The company works out how much of an item it

is likely to use in a given period, for example, a week, and sets that as the safety stock level. Incontrast to statistical safety stock calculation, where the level of safety stock is based on thedeviation from demand, time period safety stock changes in tandem with changes to dependentor independent demand.

For example, SugarnSpice Ltd, manufacturers of a range of herbs, spices andcondiments, use small plastic containers to package their produce. Thesecontainers are a low-cost C class inventory item, bought in units of 100 andreviewed monthly. The company anticipates demand over the coming month andmaintains a safety stock equal to that amount.

This protects against end-of-month reviews that do not generate a new order for material while

the level drops below the reorder point very shortly after. In this case, a formal review ofinventory levels will not take place until the end of the month so the safety stock will provide abuffer.

Time period safety stock is projected based on actual demand, forecast demand, or both.Assuming a monthly usage rate is known, the time period safety stock can be calculated asfollows:

Time Period Safety Stock = Forecast Monthly Usage x Safety Stock Time Period

The forecast should be normalized to fit the number of working days in each period so that therewill be a higher level of safety stock in January than in February. With a safety stock time periodof 2 weeks and a forecast monthly usage of 40 units over a month containing 20 working days,the time period safety stock would be equal to 20 units.

Time Period Safety Stock Example

Safety stock time period: 2 weeks

Forecast monthly usage (normalised at 20 days per month): 40 units

Time Period Safety stock = . 2 weeks . x 40 units4 weeks/month month

Time Period Safety stock = 20 units

Time Period safety stock is useful for items that are delivered daily or weekly. The time periodsafety stock protects against stockouts due to delays in delivery. When demand varies, perhapsdue to seasonality, the time period safety stock totals the precise dependent and independentdemand for each period and the safety stock level varies accordingly.

Fixed Safety Stock

Fixed safety stock allows the planner to determine the safety stock level for an item without anysystem calculations. It may be used when

A new part is introduced: as there is no history of use statistical safety stock cannot becalculated

A part with a long history of use is being phased out: safety stock should be set to zeroand usage should be manually checked.


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Dependent demand items are completely planned by MPS and MRP and are neverimpacted by unplanned usage. Safety stock should be set to zero.

Safety Stock Analysis

Alternative Required Appropriate

Create individual-part safety-stock quantities based onstatistical, fixed, or time-period techniques

Set a safety-stock level foreach part independent of anyproduct relationships.Calculate the quantity ofsafety stock required.

Independent-demand part

Set up the value of havingsafety stock by product orproduct line

Allocate the cost amongvarious parts. Calculate thequantity of safety stock

required

Dependent-demand parts

Establish an arbitrary dollarlevel for safety stock

Allocated among partsthrough using some of themethods described previously?

When amount of moneyavailable to invest in safetystock is limited

Safety stock should generally be held for independent demand items where the demand isuncertain and any item where other issues may affect supply, for example, variable quality orunreliable delivery dates.

Policy on safety stocks are usually set at executive level, depending on the expected customer fillrate, the inventory stock levels to be achieved. Actual safety stock levels for individual items willprobably be set and modified at materials management or planning level.


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Inventory Valuation

Inventory refers to all raw materials, work in process, and finished goods owned by a company

and is treated as an asset in financial reports. Therefore it is important to determine the value ofinventory held in order to determine the asset level, cost of goods sold, return on investment,turnover, and strategy of a company.

Inventories may be valued at cost (the amount they cost to buy) or by marketvalue (the amount the inventory would fetch if sold in its present state). As thevalue of an inventory item may change over time, the age of the inventory is alsoa factor.

Purpose of Inventory Valuation

Inventory is a relatively short term asset as it is usually sold or used within a

short time frame. MRO inventories are usually classified as expenses ratherthan assets because they do not contribute to the final product but are usedup in the production of the final product. Similarly equipment and vehiclesowned by a company are not inventory as they do not contribute to the finalproduct. They are classified as capital equipment, subject to depreciationover time, as specified in Internal Revenue Service rulings.

Inventory valuation is important as it establishes the asset value of thecompany. It also enables average inventory value, and therefore inventory turns, to be calculated.This gives a company a good picture of how efficiently they are using their inventories. Note thatMRO inventories are not included when calculating inventory turns.

Cost of Goods Sold

When goods are transformed from raw material to finished product they are sold on to thecustomer. Once sold, the materials used to make these products are subtracted from the inventoryand are included in the income statement as the cost of goods sold.

Types of Inventory Valuation

There are various inventory valuation methods to use, depending on the nature of the business.For example, a company specializing in one-off bespoke automation solutions in the beverageindustry may stock standard components at standard cost and use actual cost for items purchasedspecifically for a customer order.

The types of inventory valuation commonly used include:

First-in-First-out (FIFO)

Last-in-First-out (LIFO)

Transfer Valuation

Standard Cost

Actual Cost

Project Cost

Process Cost


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FIFO

This method assumes that the oldest inventory items are issued for use first. As the cost of theinventory items changes over time, this would keep the total inventory value on the balance sheet

close to the current market value. It would also result in the cost of goods sold equating to theleast recent cost values. In a period of rising costs this will work to the companys advantage.

The table below is an example of FIFO valuation

Date Units Receipts

Unit cost

Total

Cost

Units Issues

Unitcost

Total

Cost

Units Balance*

unit cost

Total

cost

Jan 1 800 $6.00 $4,800

Jan 10 600 $6.00 $3,600 200 $6.00 $1,200

Jan 25 600 $6.60 3960 200

600

$6.00

$6.60 $5,160

Feb 3 200 $6.00 $1,200 600 $6.60 $3,960

Feb

18

400 $6.60 $2,640 200 $6.60 $1,320

Mar 1 800 $6.70 $5,360 200

800

$6.60

$6.70 $8,000

Mar10

200

400

$6.60

$6.70 $4,000 400 $6.70 $2,680

Mar25

800 $6.80 $5,440

$11,440

400

800

$6.70

$6.80 $8,120

*Quarter cost of goods sold = $11,440; asset value = $8,120

Table 3 FIFO Inventory Valuation

LIFO

This method assigns the cost of goods sold based on the most recent cost of the inventory item. It

assumes that the most recently arrived inventory items are the first to be issued for use. If thecost of inventory items is constantly rising, this will lead to an undervaluing of the totalinventory held. The cost of goods sold would more accurately reflect current market values.

During a period of inflation, LIFO results in:

Higher cost of goods sold Decreased earnings before taxes

Decreased taxes Increased cash flow compared to other methods

The following table is an example of LIFO valuation


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Date Units ReceiptsUnit cost

TotalCost

Units IssuesUnit

cost

TotalCost

Units Balance*unit cost

Totalcost

Jan 1 800 $6.00 $4,800Jan 10 600 $6.00 $3,600 200 $6.00 $1,200

Jan 25 600 $6.60 3960 200

600

$6.00

$6.60 $5,160

Feb 3 200 $6.00 $1,320 200

400

$6.00

$6.60 $3,840

Feb

18

400 $6.60 $2,640 200 $6.00 $1,200

Mar 1 800 $6.70 $5,360 200

800

$6.00

$6.70 $8,000

Mar10

600 $6.70 $4,020 200

200

$6.00

$6.70 $2,540

Mar25

800 $6.80 $5,440

$11,580

200

200

800

$6.00

$6.70

$6.80 $7,980

*Quarter cost of goods sold = $11,580; asset value = $7,980

Table 4 LIFO Inventory Valuation

Table 3 and Table 4 value the same inventory. Using FIFO, the cost of goods sold comes to$$11,440 while the asset value is $8,120. The same valuation based on LIFO results in $11,580cost of goods sold and an asset value of $7,980.

Transfer

The inventory that is moved from one location to another is usually transferred at cost value.

Generally it is relocated from storeroom to warehouse or between divisions. It may also bemoved because it requires repair.

Standard Cost

In a standard cost system, a single value is selected for an inventory item, generally based on anaverage of historical costs or anticipated costs. The difference between the standard cost and theactual cost would be recorded as a variance from standard. This technique consistently reportsthe inventory asset and the cost of goods sold. The standard cost is generally updated annually.

Actual Cost

This method is rarely used, although some government contracts may require it. It is alsooccasionally required where lot traceability is also important for reasons such as safety or


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warranty cover. For example, actual cost may be suitable in the purchase of meat products in theUK and Ireland where it is now important that meat can be traced back to the farm of origin.

Actual cost involves implementing a form of lot control so that materials withdrawn from

inventory can be traced directly to a specific purchase order or production run. This can becomplex and cumbersome to manage.

Project Cost

In shipbuilding, large engineering construction projects, and public accounting firms, forexample, project cost is used. This is an accounting method that sets valuations for each project.Each project is unique and is costed separately.

Process Cost

Costs are collected according to time period and averaged over all the units produced during the

time period in question. This gives a reasonably accurate indicator of the cost of processing perproduct. The system is used with either actual or standard costs in manufacturing companies thatproduce a large number of identical units.

Comparison of Costs

The most effective way of illustrating the differences between thevarious costing methods is to input the same data to each method andcomparing the results.

Table 5 below displays the results of using various costing methods onthe same inventory item. FrescaFruits Ltd are working on costings forthe 3rd quarter of the year. They buy grapes in small units with astandard cost of $12.50 dollars per piece.

At the end of the 2nd quarter the unit cost was $10. The inventory level at the end of the 2ndquarter is 0. The requirement for grapes in the 3rd quarter is expected to be 70 units per month, atotal of 210 units. The cost of the item is rising, and is expected to be $16 in October.

The record of purchases for the 3rd quarter is as follows:

July $10 100 units

August $12 100 units

September $14 100 units

Costing Method Inventory Value Cost of Goods Sold

Actual Cost $1,080.00 $900.00

Replacement Cost $1,440.00 $3,360.00

Standard Cost $1,125.00 $2,625.00

Average Cost $1,080.00 $2,520.00

FIFO $1,260.00 $2,340.00

LIFO $900.00 $2,700Table 5 Comparison of Costing Methods


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Data Integrity and Inventory Accuracy

MRP, capacity requirements planning, process flow scheduling, enterprise resource planning,advanced planning and scheduling, all rely on the data that is input. When inaccuracies are

introduced into these systems, the calculations of the systems themselves will be inaccurate. Asthe Master Production Schedule, bills of material, inventory levels, work center data, and processinformation are all inputs into MRP, the accuracy and integrity of these data will be directlyimpact on the effectiveness of the resulting MRP.

The maintenance of accurate data requires strict discipline within and between all departments ofan organization. Not only must the data be maintained in an accurate and timely manner, but thesystem must be such that the finding and fixing of inaccuracies is encouraged, rather thanignored.

Definition and Purpose of Inventory Accuracy

In accounting, the only measure of inventory accuracy that matters is the dollar value. Theplanning department is concerned with maintaining an acceptable percentage of inventoryaccuracy. However, production demands absolute count accuracy. The most stringentrequirement is the count accuracy required from production. If this is correct, the other forms ofinventory accuracy (percentage and dollar accuracy) will also be correct.

The aim of any company should be to ensure 100% inventory accuracy onall items at all times, using inventory accuracy logic that supports this aimand ensuring that any inaccuracies made are recorded and correctedimmediately.

Perpetual inventory systems record the balance of inventory on hand at each

stock location. Due to mistakes and failures of security, transactionprocessing, and recording of inventory location, it is easy for the physicalinventory balance and the recorded balance to become out of sync. One wayto alleviate this is to support inventory record systems with physical counts.Another way of dealing with potential inaccuracies is to design the systemso that inaccuracies are impossible.

For example, when designing software to maintain inventory records, checksand filters should be used to ensure that the system user does not unknowinglyenter a wrong figure. Types and sizes of inventory items should be available tochoose from a list rather than input by the operator.

Cost of Inaccuracy

Some of the consequences of inaccurate inventory records include:

Shortages Missed schedules

Excess production Low productivity

Lost sales High inventory levels

High levels of obsolescence Excess freight costs

Excessive expediting


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Inventory Accuracy and Cycle Counts

Inventory accuracy can be improved by cycle-counting analysis. Once a level of 100% accuracyhas been achieved and sustained, the cost options and savings are analyzed. Cycle-counting is in

itself costly to implement. However, the trade off is that the costs of inaccurate records areavoided.

ABC Classification and Inventory Analysis

ABC classification, based on Paretos principle or the 80/20 rule, assumes that 20% of the itemsin a list will account for 80% of the significant measurement.

For example, in a shopping list, 80% of the cost will be due to only a few high-cost purchasessuch as fillet steak, red wine, washing powder. Other items such as bread, milk, tins of beans,pasta etc will be relatively low in cost.

While the exact percentages may vary, a useful general classification is to assume the following:

20% of all inventory items will be A class items and willaccount for 80% of the total inventory value.

A further 30% of the inventory items will account for 15%of the remaining cost. These items fall into the B category.

Finally, C items, although numerous (accounting for 50% ofall inventory items) will account for only 5% of the totalinventory value.

100%

95%

80%

20% 50% 100%Percentage of total number of items

Percentageof

totalvalue

A items B items C items

100%

95%

80%

20% 50% 100%Percentage of total number of items

Percentageof

totalvalue

A items B items C items

Each class of inventory items will be treated differently. A items, the most significant from a

financial perspective, will be most tightly controlled. Minimal effort will be expended oncontrolling inventories of C class items. The table below outlines uses of ABC classification.


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Area of Use Benefit of ABC Classification

Cycle Counting

Frequency

Using ABC classification in cycle counting, A class items will be counted

more frequently than B or C class itemsCustomerService

Order quantity and safety stock levels are established according to thecriticality and cost of each item. Generally this is approached from a dollaraccuracy perspective. It may also be a recognition that A items take longer toprocure when an unplanned stockout occurs.

EngineeringPriorities

The engineering department may use ABC classification to identify items ofhigh cost or high usage and concentrate their efforts accordingly. There islittle point re-engineering products of little value or low usage.

ReplenishmentSystems

Inventory replenishment systems will vary according to the importance ofthe inventory items. For example, C class items may be controlled with asimple two-bin system if they are not particularly bulky. This minimizes thecost of control and replenishment and does not significantly increaseinventory carrying costs.

InvestmentDecisions

As A class items form a larger investment in inventory, these items areclosely analyzed to ensure appropriate order quantities and safety stocks areused. A class items are always the focus of attempts to improve inventoryturns as changes in the way A class items are procured and managed willhave the most significant effect on the overall inventory investment level.

ABC Classification Method

For each inventory item, you record its annual usage in units, the cost of a unit and the totaldollar usage for the year. You then calculate the cumulative usage in dollars, the cumulativepercentage dollars usage, and the cumulative percent of items. Next, you rank the part numbersin order.

ABC Classification Steps

1. Find the annual demand in units for each item2. Record the unit cost for each item3. Calculate annual usage value of each item by multiplying the unit cost of the item by the

level of annual demand

4. Rank the annual usage values from highest to lowest5. Calculate the cumulative annual usage value6. Calculate, for each item, the percentage of the total cumulative usage value7. Calculate the percentage of the total number of items8. Evaluate relationships and assign categories

FrameIt Ltd provides a fairly broad product range from relatively fewinventory items (10 in total). However, as a means to minimize costs they arenow looking at ways to streamline their inventory investment without affecting

customer service levels. As a first step, the company uses ABC classification todetermine on which inventory items, the main effort should be expended.


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The table on the following page shows the calculation of the annual dollar usage for each partnumber, which is calculated by multiplying the annual unit usage rate by the unit cost in dollars.

Part Number Annual Unit Usage Unit Cost ($) Annual $ Usage

1 2200 2 4,400

2 1200 40 48,000

3 200 4 800

4 2600 1 2600

5 200 60 12,000

6 20 25 500

7 200 2 400

8 3000 2 6,0009 400 2 800

10 1000 1 1,000

Total $76,500

Figure 2 Annual Usage Rate in $

The part numbers are ordered according to their annual dollar usage rate. The cumulativepercentage usage rate is calculated by firstly adding together the annual dollar usage rates at eachlevel in the part number ranking (see column 3 below), then converting each figure into apercentage of the overall usage rate in dollars. Finally, the cumulative percentage of each item iscalculated in terms of the total number of items held in inventory.

In the table below, the part numbers have been ranked according to cumulative percentage dollarusage rate and cumulative percentage of items. The top items are most significant and thereforeshould be classified as A items. The items at the bottom of the list are B items.

PartNumber

Annual $Usage

Cumulative $Usage

Cumulative % $Usage

Cumulative % ofItems

2 48,000 48,000 63% 10

5 12,000 60,000 78% 20

8 6,000 66,000 86% 30

1 4,400 70,400 92% 40

4 2,600 73,000 95% 50

10 1,000 74,000 97% 60

3 800 74,800 98% 70

9 800 75,600 99% 80

6 500 76,100 99% 90

7 400 76,500 100% 100

Figure 3 Cumulative % of Items


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Review Q

5. Using the table below, calculate the ABC classification for each of the 10items listed, based on their annual dollar ($) usage. Record your results in theempty table beneath.

ItemNumber

Annualusagein units

unitcost

1 15000 502 140000 753 1500 504 55000 255 2000 25

6 110000 507 7500 258 45000 259 30000 75

10 4000 50

PartNumber

Annualunit

Usage

UnitCost

Annual $Usage

Cumulative$ usage

Percentage $usage

Rank ABCClass

12

3

4

5

6

7

89

10

Total

Extending ABC Analysis

By including the number of units on hand for each inventory item and dividing the inventory onhand into the annual usage (in units), the resulting figures show the amount of inventory on handas a percentage of the total years supply. When these figures are high, they should prompt

review of the inventory on-and to ensure there are valid reasons for maintaining such a highstock.


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Methods of Ensuring Inventory AccuracyCounts of inventoried items and the cost of each item must be recorded accurately in order tosupport production scheduling, customer service and the management of financial statements.

Cycle counting and periodic inventory counting are the two main methods of verifying theaccuracy of inventory records.

Periodic Inventory Audit

Periodic audits are large scale physical counts of all inventory in a plant. This type of auditusually takes place annually and is primarily concerned with verifying the financial value of theinventory. Periodic audits are disruptive to production and are expensive in terms of time andadministration. Accuracy is poor as many of those taking part in the exercise may beinexperienced and error prone. Some items may be counted twice, others not at all.

Cycle Counting

Cycle counting is concerned with a specific set of inventory items and usually takes place daily,or at the start and end of each production run. Each item is counted a specified number of timesper year depending on its importance. Cycle counting relies on trained and dedicated personnel.

The following table compares the characteristics of cycle counting with periodic counting

Timely detection and correction of problems

Finding and correcting causes of error

Little impact on production time

ABC classification is used to determine the frequency of the cycle count. The frequency should

increase as the value of the item and the number of transactions for that item increases.Generally, A class items will be counted more frequently than B or C class items.

The following table compares the characteristics of cycle counting with periodic counting.

Cycle Counting Periodic Inventory Audit

Efficient use of a few experiencedpersonnel throughout the year

Inefficient use of many inexperiencedpeople in a short time once a year

Timely detection and correction ofproblems

No correction of errors

Fewer mistakes in itemidentification

Many mistakes in identifying items

Minimal loss of production time Shutdown of plant and warehouse maybe needed

Systematic inventory recordaccuracy improvement

Inventory accuracy is improved onlyonce in the year

ReconciliationWhen inventory audits (either cycle counting or periodic) have been completed, discrepanciesbetween the count and the inventory record for each item should be reviewed. Where


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discrepancies occur, the item should be recounted if the variance is large, or the recorded valueshould be changed.

Identifying Causes of Problems

One of the main objectives of cycle-counting is to identify the root causes of any errors,especially recurring errors, and subsequently correct both the error and its cause. There are manypotential sources of error including:

Untrained personnel Carelessness

Inaccurate supplier receipts Poor document control

Poor form design Inadequate storage space

Inadequate security of inventory Inadequate identification of items

Options for Cycle Counting

It is important to have a system in place for triggering cycle count activity. The number of timesan item is counted may be in direct proportion to the importance of that item or it may betriggered by some external event. Some examples of ways in which a cycle count for a particularitem may be triggered are:

ABC classification. As previously explained, A class items are counted most frequently.

After a set number of transactions. This allows cycle counting to occur more frequentlyon items most often used. As many inaccuracies are due to inventory transactions, thismethod is useful as there will only ever be a set number of transactions to check if anerror has occurred.

When a record indicates a zero balance, a count should verify that there is no inventoryavailable

Just before reordering the item in question, assuming that the inventory level will be lowand therefore quicker and easier to count.

When a replenishment lot is received. The lot should be counted anyway as part of thereceiving process, and the rest of the stock should be at its lowest level and easy to count.


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Inventory PolicyInventory policies must strike a balance between the conflicting objectives required by Sales

(high customer service), Operations (efficient plant operation), and finance (lowest overallinventory investment). All inventory policies should therefore aim to maximize customer servicewith minimal plant costs and inventory investment while maintaining operational efficiency.

Customer Service Objectives

Objectives for achieving customer service vary from company to company. They includedelivery on time, buffering against uncertain demand and provision of sufficient variety to meetcustomer needs. As many of these objectives increase the pressure to maintain larger inventories,they are in direct conflict with the objectives of inventory management. All customers requirefrom their suppliers the following:

High quality

Flexibility in terms of volume, specification and delivery dates

High service levels

Committed lead times

Reliability in meeting targets

Low cost

Production planning and scheduling has an influence on all of these elements of customerservice. Most companies gauge their customer service levels through performance measures suchas percentage measures and absolute measures as shown in the table below.

Percentage Measures Absolute Value Measures

% of orders shipped on schedule

% line items shipped on schedule

% total units shipped on schedule

% dollar volume shipped on schedule

% profit volume shipped on schedule

% operating days in stock% ordering days in stock

Order days out of stock

Line items out of stock

Total item days out of stock

Dollar volume days out of stock

Idle time due to material andcomponent shortages

Measuring Customer Service Internally

Most measurements of customer service are internal rather than from the customer. These aretherefore indicators of customer service rather than true measures of customer satisfaction.Internal measurements may cover uncertainty of demand or supply, product mix or variety,orders, line items, total units or dollar volume delivered on time.

Uncertainty

Inventories are held due to uncertainty in either the demand for finished goods or thereplenishment of raw materials and components. Forecasting is an inexact science whichgenerally includes variations from the norm: resulting in a level of uncertainty. By maintaining


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inventories, a company ensures that delivery is possible even when demand exceedsexpectations. Transportation, quality problems, excessive scrap and supplier lead time factorscontribute to the level of uncertainty. Safety stock protects against fluctuating demand or supply.

VarietyAs well as uncertainty about the timing of demand for goods there is usually uncertainty aboutwhich goods are required. When a product is available in a range of options, colors, or flavours,the precise breakdown of demand for each of these options may be difficult to predict. It may benecessary to maintain inventories of each different product configuration. This will result ingreater expense in terms of tying up capital, particularly where money must be borrowed tofacilitate extra inventory, and inventory carrying costs. Company objectives are generally clearthat inventory levels should be as low as possible to avoid such costs.

Orders Shipped

For an order to be considered on schedule, all line items on that order must be shipped before the

due date. Using this measurement assumes that all orders are equally important. For example, if1 order out of 100 orders is late, the orders shipped measurement will be 99% However, if theone late order accounted for 20% of the value of the total orders shipped then the 1% error ismuch more significant than the order shipped measurement suggests.

Line Items Shipped on Schedule

This measurement recognizes that some orders may contain a greater number of items thanothers. However, it still does not take into account the dollar value of the orders; neither does itmeasure how late an order is.

Total Units Shipped on Schedule

This measurement deals with the number of units shipped on schedule but again does notrecognize dollar volume or the length of delay in delivery.

Dollar Volume Shipped on Schedule

Generally, the dollar volume of an order will be readily available and recorded on the orderdocumentation. This is a more complete measure of the value of the order to the company and tothe customer. But if some large orders consist mainly of materials that have been bought by thecompany and sold to the customer with little added value, it may still distort the value of theorder as the actual profit margin on such an order would be minimal.


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Summary

This lesson covered safety stock techniques, the importance of inventory valuation, data andinventory accuracy, ABC analysis, cycle counting, and inventory policies are examined Themain aim of this lesson was to review all factors that are potential inputs or affect inputs toMaterial Requirements Planning (MRP) and review techniques to ensure the accuracy of suchinputs.

You should be able to:

Describe safety-stock processes

Identify ways in which safety stock processes support customer service strategies

Identify the purpose of inventory valuation

Calculate safety stocks to support a required level of customer service using the table ofsafety factors

State the effect of inventory valuation on inventory investment

Describe inventory accuracy methodologies used to maintain and improve part-count andinventory valuation accuracy

Distinguish between various customer services measurements

Further ReadingIntroduction to Materials Management,

JR Tony Arnold, CFPIM, CIRM and Stephen Chapman CFPIM

5th edition, 2004, Prentice Hall

APICS Dictionary10th edition, 2002

Manufacturing Planning and Control Systems,

Vollmann, T.E.; W.L. Berry; and D.C. Whybark

5th

edition, 2004, McGraw-Hill

Production & Inventory Management,Fogarty, Donald W. CFPIM; Blackstone, John H. JR. CFPIM; and

Hoffmann, Thomas R. CFPIM2nd edition, 1991, South-Western Publishing Co., Cincinnati, Ohio


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ReviewThe following questions are designed to test your recall of the material covered inlesson 2. The answers are available in the appendix of this workbook.

6. Which is the most accurate description of cycle counting?

A. Annual physical counts of all inventory in a plantB. Each inventory item is counted a specified number of times per year depending on its

importance. Often, cycle counts take place daily

C. Monthly physical counts of all inventory items in a groupD. Each week a different inventory item is counted and reconciled

7. When the value of orders varies significantly but the cost of individual line items doesnot, which of the following may be an appropriate measure of customer service?

A. % on-time ordersB. % line items shipped on scheduleC. % Total items shipped on scheduleD. % Dollar volume shipped on schedule

8. What is the main purpose of inventory valuation?

A. To establish the asset value of the company.B. To give an insight into inventory management efficiencyC. To calculate the expenses of the companyD. To keep the total inventory value on the balance sheet close to the current market value

9. Which is the most accurate description of FIFO costing?

A. Uses most recent item costs to calculate cost of goods sold and assumes that mostrecently arrived items will be used first

B. Sets a value for an inventory item based on an average of historical costs or anticipatedcosts and uses this to calculate cost of goods sold and inventory value

C. Relies on lot control to ensure that materials withdrawn from inventory can be traceddirectly to a specific purchase order or production run

D. Assumes the oldest items are used first. Uses least recent cost values to calculate the costof goods sold and sets inventory values close to current market rates


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Whats Next?

Lesson 2 a variety of techniques for customer service and inventory management. At this pointyou have completed two of the 9 lessons in the Detailed Scheduling and Planning unit.

You should review your work before progressing to the next lesson which is:

Detailed Scheduling and Planning Lesson 3 Materials Planning InformationRequirements


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Appendix


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Answers to Review Questions

1. B, C, and D

Demand is unlikely to exceed supply as items with dependent demand are required solely for theproduction of a parent item. Instead, safety stock may be held to guard against delivery delays, orensure there is sufficient material available should production yields decrease.

2. C

Although option A is a possible answer, there is no evidence that the necessary data is easilyavailable. It is possible to measure the percentage of orders shipped on schedule. However, asorder sizes vary greatly this could be misleading. For example if there is a 99% success rate butthe one order that was delayed accounts for 10% of total sales volume, then customer service isactually lower than the measurement. It is better to measure the percentage of line items shipped

on schedule. As the costs and margins of all line items are similar there is no need to go to theextra effort of calculating the profit on each line item.

3. B

Safety stock should be set at a level that is appropriate, given the demand variability and thedesired level of customer service. Both MAD and standard deviation are measures of demandvariability and can be used to calculate appropriate safety stock levels. However, the safety stocklevel is not necessarily equal to the MAD or the standard deviation and is more likely to be amultiple of the standard deviation.

4. D

To support a customer service level of 98% the safety stock level should be equal to the amountof standard deviation multiplied by 2.05.

5.ABC Classification

PartNumber

Annualunit Usage

UnitCost

Annual $Usage

Cumulative$ usage

Percentage $usage

Rank ABCClass

2 140000 $75 10,500,000 10,500,000 47.70% 1 A

6 110000 $50 5,500,000 16,000,000 72.69% 2 A

9 30000 $75 2,250,000 18,250,000 82.91% 3 B

4 55000 $25 1,375,000 19,625,000 89.15% 4 B8 45000 $25 1,125,000 20,750,000 94.26% 5 B

1 15000 $50 750,000 21,500,000 97.67% 6 C

10 4000 $50 200,000 21,700,000 98.58% 7 C

7 7500 $25 187,500 21,887,500 99.43% 8 C

3 1500 $50 75,000 21,962,500 99.77% 9 C

5 2000 $25 50,000 22,012,500 100.00% 10 C

Total $22,012,500


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6. B

Cycle counting is concerned with a specific set of inventory items and usually takes place daily,or at the start and end of each production run. Each item is counted a specified number of times

per year depending on its importance. When inventory audits (either cycle counting or periodic)have been completed, discrepancies between the count and the inventory record for each itemshould be reviewed. Where discrepancies occur, the item should be recounted if the variance islarge, or the recorded value should be changed. The number of times an item is counted may bein direct proportion to the importance of that item, for example, its ABC classification or it maybe triggered by some external event such as a reorder of the item or a set number of itemtransactions.

Periodic audits are large scale physical counts of all inventory in a plant. This type of auditusually takes place annually and is primarily concerned with verifying the financial value of theinventory.

7. CWhen all line items are of a similar value it is a waste of effort to calculate the dollar volume.However, as the value of orders varies significantly it is not sufficient to measure only the % oforders or line items shipped on schedule. For example, if 1 line item out of 100 is delayed, the %line items shipped on schedule will be 99% whether that line item was for 10 units or 200 units.In this case, the percentage of total units shipped on schedule provides the most accurate picture.

8. A

Inventory valuation is important as it establishes the asset value of the company. It also enablesaverage inventory value, and therefore inventory turns, to be calculated. This gives a company agood picture of how efficiently they are using their inventories. Note that MRO inventories arenot included when calculating inventory turns.

9. D

FIFO assumes that the oldest inventory items are issued for use first. As the cost of the inventoryitems changes over time, this would keep the total inventory value on the balance sheet close tothe current market value. It would also result in the cost of goods sold equating to the least recentcost values. LIFO assigns the cost of goods sold based on the most recent cost of the inventoryitem. It assumes that the most recently arrived inventory items are the first to be issued for use.The standard cost system, sets a single value for an inventory item, generally based on anaverage of historical costs or anticipated costs, and uses that value in all calculations. The actualcost method uses lot control to trace the actual cost of each material. It is cumbersome and rarelyused unless when required by regulations, such as in the tracing of the origin of meat products.


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Glossary

Term Definition

ABC Classification The grouping of items in a list in order depending on their importance.First, the items are measured against the critical criteria (for example dollarvolume) and listed in descending order. The top group of items (usuallyaround 20%) are classed as A items and account for around 50-70% of thecritical measurement. The next 30% or so of items are B items and areresponsible for around 20% of the critical measurement. The rest are Citems and are of least value in terms of the critical measurement.

ABC classification is used to focus management on the most important

items. It is usually applied to inventories, purchasing and sales.Actual cost The labor, material, and associated overhead costs that are charged against

a job s it moves through the production process

Anticipationinventory

Additional inventory above the baseline stock to cover projected salesincreases, planned sales promotions, seasonality, plant shutdowns andvacations

Backorder A customer order or commitment to a customer that has not been fulfilledby the promised date due to inventory stockout.

Bias A consistent deviation from the average, either too high or too low. Bias is

an undesirable trait in forecastsBuffer A quantity of material waiting for further processing. This may be raw

material, partially completed material in stores, or a work backlog that ispurposely maintained beside a work center.

Carrying cost Cost or carrying inventory. This is defined usually as a percentage of themonetary value of the inventory per unit of time (usually a year). Carryingcost depends on the cost of capital invested and on costs of maintaining theinventory, paying tax on it, insuring it, spoilage, storage space, andobsolescence.

Consignment A shipment that is handled by a common carrier or the process of asupplier placing goods at a customer location without receiving paymentfor the goods until after they are used or sold

Constraint An element or factor that prevents a system from achieving a higher levelof performance with respect to its goal. Constraints can be physical, suchas a machine center or lack of material, or managerial, as defined inpolicies or procedures.

Cumulative leadtime

The longest planned length of time needed to complete a particularactivity. It may be calculated in MRP by reviewing the lead time for eachBOM path below the item. The longest BOM path is equal to thecumulative lead time

Customer service A measure of a companys ability to delivery the right product at the right


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time to the right place of the required quality and in the desired quantities.In other words, customer service is the ability of a company to meet theneeds of its customers.

Customer servicelevel or ratio A measurement of delivery of finished goods performance, usually apercentage such as the number of items or dollars shipped on scheduleduring a specified time period, compared to the total that should have beenshipped. In a make-to-order environment it may be measured by thenumber of jobs or dollars shipped in a particular period compared with thetotal number required.

Cycle The interval of time during which a system or process, periodically returnsto similar initial conditions. It is also the interval of time during which anevent or set of events is completed

Cycle counting An inventory accuracy audit technique. Each inventory item is allocated a

cycle count frequency, usually more frequent for high value or fast movingitems. Each item is counted in isolation at regular intervals throughout theyear as often as specified for each item. Many items may be counted veryworking day. Cycle counting is used to identify items in error. This maylead to research, identification, and elimination of the causes of the errors.

Demand A need for a particular product or component which could come from acustomer order, forecast of market requirements, interplant requirement, ora request from a branch warehouse for a service part

Demand The need for a product of component. Demand may be generated fromcustomer orders, forecasts, or internal requests.

Dependent demand Demand for an item that is wholly influenced by demand for another item.For example, in the manufacture of computer monitors, the demand for theplastic monitor case will be entirely dependent on the demand formonitors.

Distribution The activities associated with the movement of material, usually finishedgoods or service parts from production plant to the customer. Distributionincorporates functions such as transportation, warehousing, inventorycontrol, material handling, order administration, location analysis,packaging, data processing, and communications networks.

Economic orderquantity (EOQ)

Reducing setup time and inventory to the point where it is economical toproduce in batches of one.

Excess inventory Inventory that exceeds the minimum amount required to achieve a desiredthroughput rate, or inventory over and above the minimum amount neededto ensure desired due date performance

Expedite To speed up production orders or purchase orders that are required in ashorter time than the usual lead time.

First-in-first-out(FIFO)

A calculation of inventory value that assumes, for the purposes ofvaluation, that the oldest inventory will be used first.

Finished goods orend items

A product sold as a completed item or repair part. This term refers to anyitem that is subject to a customer order or sales forecast


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Fixed orderquantity

lot sizing technique in MRP or inventory management that will alwayscause an order to be generated for a fixed quantity or multiples of thatfixed quantity, if net requirements for the period are higher than the fixed

order quantity.Hedge inventory An amount of inventory built up to guard against a particular event that

may or may not occur. Hedge inventories are the result of speculationrelated to potential strikes, price increases, government unrest, or otherexternal events that could severely impair a companys strategic initiatives.

Inactive inventory Stock that is in excess of consumption within a defined period of time orstocks of items that have not been used within a defined time frame.

Independentdemand

Demand for an item that does not depend on the order of other items.Demand for finished goods, parts required for destructive testing, andservice parts are examples of independent demand.

Independentdemand

The demand for an item that is derived from customer orders, forecasts, orinternal requirements, and is not dependent on the demand for other items.

Inventory Stocks or items used to support production (raw materials and WIP items),supporting activities (MRO supplies), and customer service (Finishedgoods and spare parts). Demand for inventory may be dependent orindependent. Inventory functions are anticipation, hedge, cycle (lot size),fluctuation (safety, buffer, or reserve), transportation (pipeline), andservice parts.

In the theory of constraints, inventory refers to items purchased for resale

and includes finished goods, WIP and raw materials. In this approach,inventory is always valued at purchase price and includes no value-addedcosts, whereas traditionally, direct labor and overhead costs were attributedto the items as they went through the production process.

Inventory turns The number of times that an inventory turns over during a year. This iscalculated by dividing the average inventory level into the annual cost ofsales. For example, an average inventory of $600,000 divided into anaverage cost of sales of 1,800,000 means that inventory turned over 3times during the year.

Kanban A JIT production method that uses standard lot sizes. Material is pulled to

the work center according to demand. A Kanban is a card, billboard orsign. When a work station requires material it sends some form of sign,such as an empty container, up the chain.

Lead time The amount of time required to perform an operation. In logistics, it is thetime between identifying the need for an order and the receipt of that order.Components of lead time may include order preparation time, queue time,processing time, move time, receiving, and inspection time.

Last-in-first-out(LIFO)

A calculation of inventory value that assumes the most recent materialreceived will be the first to be used. LIFO does not relate to the physicaluse of goods. It is required solely for accounting purposes.

Lot-for-lot A lot sizing technique that generates planned orders in quantities equal tothe net requirements in each period.


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Maintenance,repair, andoperating supplies

(MRO)

Items used to support operations and maintenance, including for examplemaintenance supplies, spare parts, consumables used during manufacturingand supporting operations.

Manufacturingenvironment

The framework in which a manufacturing strategy is developed andimplemented. It includes external environmental forces, corporate strategy,business unit strategy, product selection, process technology, andmanagement competency. It is often used to refer to whether a company ismake-to-stock, make-to-order, or assemble-to-order.

Materialrequirementsplanning (MRP)

A set of techniques that use bill of material information, inventory data,and the master production schedule to calculate requirements for materials.MRP recommends replenishment orders and order dates for materials andhelps to reschedule open orders when due dates and need dates are not in

line. MRP takes the items listed on the MPS and determines the quantity ofall components and materials required to make those items and the datesby which those materials are required. It explodes the bill of material foreach item, takes into account inventory on hand or on order and offsets thenet requirements by the lead time for each item.

Mean absolutedeviation (MAD)

A figure calculated by averaging the sum of the absolute values of eachdeviation of an actual from an expected figure. This can be used to trackthe accuracy of a forecast.

Normal distribution A commonly known statistical distribution pattern where most events areclose to a mean and

Documents

Detailed Scheduling and Planning (Lesson 2)