14 ) WCM- Inventory

Question 1

What is the inventory balancing act?

Answer 1

Liquidity vs profitability

L- Reducing inventory to the lowest possible amount to minimise the level of capital employed to be funded

P- Ensuring that sufficient inventory is held so that it does not run out and disrupt business

Question 2

What are the costs of low levels of stock?

Answer 2

▪ Increased chances of stock outs (Particular product used in manufacturing)and as a result lost contribution, sales, production stoppages (Idle time, stockpiling of WIP), emergency order of more expensive or poorer quality supplier

▪ High re-order/setup costs as you will need to stock frequently resulting in high order and delivery costs

▪ Lost quantity discounts- Bulk discounts are missed

Question 3

What are the costs of high levels of stock?

Answer 3

▪ Tied up capital- capital is tied until it is sold. The lost return is an opportunity cost

▪ Financing cost - high levels in stock need to be financed by means of overdraft/loan and the interest will be payable on the financing used.

▪ Holding costs of storage, insurance, managing, risk of theft / damange /obsolesence and the net realisable value being lower than the cost

Question 4

What is the objective of good inventory management?

i.e. what must be determined in order to have a good management

Answer 4

To determine the:

▪ the optimum re-order level – how many items are left in inventory when the next order is placed, and

▪ the optimum re-order quantity – how many items should be ordered when the order is placed

Question 5

What is lead time?

Answer 5

The lag between when an order is placed and the item is delivered

Question 6

What is buffer inventory?

Answer 6

the basic level of inventory kept for emergencies. A buffer is required because both demand and lead-time will fluctuate and predictions can only be based on best estimates.

Question 7

What is the economic order quantity?

the aim and how does it accomplish this

Answer 7

This is an optimum order quantity for inventory for businesses that do not use JIT inventory management system.

The aim of EOQ model is to minimise the total cost of holding and ordering inventory. It does this by balancing the variable costs of holding the inventory and the fixed costs of placing the order

Question 8

What is the relationship between the reorder quantity and holding costs?

Answer 8

It is linear. As the re order quantity increases, the holding cost increases

Question 9

What is the relationship between the reorder quantity and fixed costs?

Answer 9

As the number of re order quantity increases, the level of ordering cost increases

Question 10

What are the assumptions for EOQ?

Answer 10

▪ Demand for inventory is constant- we’re using it up at a constant rate.

▪ lead time are constant and known. (means that the we assume the time between an order being placed and the date it is delivered is the same for every order) We can deal with this in the questions

▪ Purchase price is constant- (no change in the cost of purchasing new inventory

▪ No buffer inventory is held (not needed)- BECAUSE the demand is constant and we know the lead time, there is no need to hold buffer inventory

use this to discuss the validity of the model and it’s conclusions e.g. in practice, demand and/or lead time may vary

Question 11

..How do you deal with bulk discounts?

Answer 11

Step 1: Calculate EOQ, ignoring discounts.

Step 2: If the EOQ is below the quantity qualifying for a discount, calculate the total annual inventory cost arising from using the EOQ:

Total annual inventory cost = purchase costs (D × P where P is purchase price) + ordering costs (CO × D/Q) + holding costs (CH × Q/2)

Step 3: Recalculate total annual inventory costs using the order size required to just obtain each discount. Take the available discount into account within the purchase costs.

Step 4: Compare the totals from steps 2 and 3 and select the lowest cost option.

Step 5: Repeat for all discount levels.

Question 12

What is the re order level?

how is this calculated when two factors are known

Answer 12

After identifying how much to reorder, the next thing a company needs to figure out is what level of inventory level needs to be reached before an order is placed.

This is the quantity of inventory on hand when an order is placed.

When demand and lead time are known with certainty, the ROL may be calculated exactly i.e. = demand in the lead time

Question 13

.What is the re order level when lead time and demand are known?

Answer 13

the ROL may be calculated exactly i.e. = demand in the lead time

Question 14

.What is the re order level when lead time and demand are not known?

Answer 14

ROL = demand during lead-time.

Where there is uncertainty, an optimum level of buffer inventory must be found.

This depends on:
variability of demand
cost of holding inventory
cost of stockouts.

You will not be required to perform this calculation in the examination.

Question 15

What are some inventory management systems?

Answer 15

Periodic review

Just in time

Question 16

What is the periodic review system (Constant order cycle system)?

Answer 16

Inventory levels are reviewed at fixed intervals, e.g. every four weeks. The inventory in hand is then made up to a predetermined level, which takes account of:

likely demand before the next review
likely demand during the lead-time.

So for e.g. Thus a four-weekly review in a system where the lead time was two weeks would demand that inventory be made up to the likely maximum demand for the next six weeks.

Question 17

.What is slow moving inventory? and what method can be used to help with this

Answer 17

Certain items may have a high individual value, but be subject to infrequent demand. Management need to review inventory usage to identify slow-moving inventory. An aged inventory analysis should be produced and reviewed regularly so that action can be taken.

Question 18

For slow moving inventory, actions include?

Answer 18

Actions could include:
 elimination of obsolete items
slow-moving inventory items only ordered when actually needed (unless a minimum order quantity is imposed by the supplier)
review of demand level estimates on which re-order decisions are based.

A regular report of slow-moving items is useful in that management is made aware of changes in demand and of possible obsolescence. Arrangements may then be made to reduce or eliminate inventory levels or, on confirmation of obsolescence, for disposal.

Question 19

What is just in time system?

Answer 19

Some manufacturing companies have sought to reduce their inventories of raw materials and components as low as possible. This helps improve profitability by reducing financing costs.

JIT describes a policy of obtaining goods from suppliers at the latest possible time (i.e. only when they are needed in manufacturing)

Question 20

What are the aims of just in time?

Answer 20

a smooth flow of work through the manufacturing plant
a flexible production process, which is responsive to the customer’s requirements
reduction in capital tied up in inventory.

AND This involves the elimination of all activities performed that do not add value = waste.

Question 21

What is waste and the examples?

Answer 21

Waste is defined as any activity performed within a manufacturing company that doesn’t add value to the product. examples are:

 raw material inventory 
 WIP inventory       
finished goods inventory 
 materials handling       
quality problems (rejects and reworks, etc.) 
queues and delays on the shop floor 
long raw material lead times 
long customer lead times 
unnecessary clerical and accounting procedures.

Question 22

How does JIT attempt to eliminate waste at every stage of the manufacturing process?

Answer 22

notably by the elimination of:

WIP, by reducing batch sizes (often to one)
raw materials inventory, by the suppliers delivering direct to the shop floor JIT for use
scrap and rework, by an emphasis on total quality control of the design, of the process, and of the materials
finished goods inventory, by reducing lead times so that all products are made to order
material handling costs, by re-design of the shop floor so that goods move directly between adjacent work centres.

Question 23

What does a JIT manufacturer look for in a supplier? and in return what can the supplier expect?

Answer 23

looks for a single supplier who can provide high quality, frequent and reliable deliveries, rather than the lowest price. In return, the supplier can expect more business under long-term purchase orders, thus providing greater certainty in forecasting activity levels. Very often, the suppliers will be located close to the company.

Question 24

What does single sourcing and long term contacts achieve?

Answer 24

Long-term contracts and single sourcing strengthen buyer-supplier relationships and tend to result in a higher quality product. Inventory problems are shifted back onto suppliers, with deliveries being made as required.

Question 25

How does JIT affect those in delivery and transportation?

Answer 25

Smaller, more frequent loads are required at shorter notice. The haulier is regarded as almost a partner to the manufacturer, but tighter schedules are required of hauliers, with penalties for non-delivery.

Question 26

at the EOQ level, holding vost and ordering cost are?

Answer 26

equal

Question 27

what is over capitalisation

Answer 27

excess inventory/receivables and cash - investment in WC is too high.

& Low payables

This means you have over invested (over capitalized) which will reduce profit.

Question 28

what is over trading

Answer 28

where there is high growth and the business runs out of cash.

This arises from a lack of investment in working capita. the reason this happens is because the company is growing fast. It maybe hasn’t got the resources in place to manage the working capital properly so it all gets out of control.

so e.g. receivables are increasing significantly as a result of not having someone to chase people to get the money.

doesn’t mean the level of WC is low but it’s more the lack of investment in WC MANAGEMENT is missing/Goes wrong because they’re worried about other things.

Question 29

what is the holding cost

Answer 29

FINANCE & storage/warehouse costs

Question 30

what is the relationship between holding and ordering cost

Answer 30

inverse relationship.

If high inventory= High holding but low order
If low inventory= Low holding but high order

This relationship is where the EOQ is based on

Question 31

what is the annual holding cost formula

and the formula for when working out the annual cost without the EOQ

Answer 31

(EOQ/2)*HOLDING COST

we’re going to be looking at the average position of the inventory (divide by 2) because one of the things we assume is that inventory is used up equally throughout the year at a constant rate (unrealistic).

when working out the total cost in general (without EOQ) use for the average demand make sure to include buffer

average demand = (buffer + max inventory) /2

Question 32

what is the annual Ordering cost formula

Answer 32

Number of order (demand for inventory/ EOQ) * Cost per order

Question 33

if given the buffer, what is used in the annual holdingn cost formula

Answer 33

average demand = (buffer + max inventory) /2

Question 34

what is maximum inventory

Answer 34

buffer plus the inventory held (EOQ)

Question 35

what is the total inventory cost?

Answer 35

Purchase Cost
holding cost
ordering cost