Inventory and Safety Stock
Explain why inventory costs and inventory levels have declined relative to GDP over the last 20 years. Is this beneficial to the economy? Why or why not?
Information technology has created a huge impact on the economy of different nations. For instance, the information for inventory has helped the United States to maintain high G.D.P while checking inflation. This condition has seen many organizations implementing this program to improve the flow in the supply chain.
Moreover, research shows that the value of the U.S. inventory increases with growth in the economy. Therefore, the total inventory increases at a slower rate than the GDP. This means that more revenue is generated with less working capital investment. This trend is exemplified in the declination of G.D.P between 1990 and 2006 from 17.9% to 14.1%. Therefore, the decline in the inventory cost has a positive metric to the economy.
What are the major components of inventory carrying cost? How would you measure capital cost for making inventory policy decisions?
Inventory carrying costs refer to costs incurred by inventories that are at rest or secured for the future use. While applying the finished goods inventory concept, inventory carrying costs represent those costs related to manufacturing and shifting inventory from the industry to supply chain to waiting center. The main components of inventory carrying cost include capital costs, storage space costs, inventory service costs, and inventory risk costs.
A standard approach for measuring the capital cost is finding out a hurdle rate. This is the lowest rate of returns on any investment, necessary for the business to break even. Economists utilize weighted average cost of capital (WACC) technique to attain the external source of financing. Accordingly, the method illustrates the direct debt incurred by keeping capital in stock.
How can inventory carrying cost be calculated for a specific product? What suggestions would you offer for determining the measure of product value to be used in this calculation?
Finding the cost to carry a particular item in inventory is done using three steps. First, calculate the value of the item stored in inventory. Each firm has a predetermined accounting practice to calculate the value of inventory for balance sheet purposes.
Second, find the cost of each carrying cost component and sum them to evaluate the total direct costs used by the commodity while being held in inventory. The two costs that should be calculated are variable-based costs and value-based costs.
Third, divide the total costs in the second step by the value of the product shown in the first step. This will give the annual inventory carrying the cost of that product. In these calculations, all value based costs must be prorated for each supply from the plant based on the time of supply.
Explain the differences between inventory carrying costs and ordering costs.
Ordering cost shows the cost of placing an order for an extra inventory, but it does not indicate the cost or expense of the item itself. Conversely, inventory, carrying cost indicates the costs incurred by inventory at rest and waiting to be used.
The carrying cost and ordering cost responds in opposite ways. The ordering cost decreases quicker than the carrying costs increase, which reduces the total costs.
Why is it usually more difficult to determine the cost of lost sales for finished goods than it is for raw materials inventories?
Calculating the safety stock and the inventory carrying value is straightforward, but this is not the case when determining the value of lost sales. The difference results from formulas and criteria that help to answer the inventory questions. Calculating the lost sales when the customer decides an alternative vendor is challenging.
Additionally, finished goods are associated with more fixed and variable costs compared to calculating the value of raw materials. Therefore, it is more unclear to determine the accurate value of lost sales compared to examining the value of finished goods.
How does inventory carrying cost for inventory in transit differ from the cost of inventory at rest?
The cost of carrying inventory in transit is ignored in many companies. Notably, someone might own the inventory while it is still in the transit process, therefore, incurring that cost. For instance, an organization selling an item “free-onboard” (FOB) destination is mandated to transport the item to its customer, since the ownership is not transferred until the customer acquires the item in his/her facility.
Since the ownership is invalid until the customer acquires the item, the shipper must consider the delivery time of the inventory, including the inventory carrying a cost. The transaction is completed with the speed at which the delivery occurs. It also means that the shipper attains temporal ownership of the product during this transit period.
What is the difference between independent and dependent demand items? Why is this distinction important to inventory managers?
When the demand for a given inventory is unrelated to the demand for other items, this demand is described as independent. In the contrast, dependent demand refers to the form of demand where the demand for an inventory is related to that of another inventory. For instance, the demand for a desktop computer is described as independent, while that of the computer chip is termed as dependent.
In many companies, the primary demand for raw materials, subassemblies, and parts is based on the demand for the end products. Conversely, the demand for the final product is independent of the demand for a more advanced product. Managers should predict the demand for independent and dependent items to create inventory policies for those products.
Compare and contrast the fixed quantity version of EOQ with the fixed interval version. In which situations would each be used?
Fixed quantity model entails ordering sizable level of items each time reordering happens. The real amount of product to be ordered relies on the product’s cost and demand traits and relevant inventory carrying and reordering costs. Companies utilizing this model should create a minimum stock level to examine when to reorder the fixed quantity, what is known as reordering point.
Fixed order model is also applied in the inventory management. It engages ordering inventory at constant rates, where the orders made depend on the quantity that is in stock or what is available during the review period. A fixed approach does not involve close supervision of inventory levels compared to EOQ model. In fact, EOQ model is suitable for inventory products that have a relatively stable demand.
Why has the JIT approach to inventory control become popular in some industries? How does the JIT approach compare to the EOQ approach to inventory manage- meant? Should JIT be adopted by all inventory managers? Why or why not?
Just in time (JIT) approach is a typical model for inventory management. In the modern business environments, debates majors on JIT manufacturing practices, JIT inventories, and JIT delivery approaches. The phrase, “just in time,” implies that inventories should be available when the firm requires them. This approach is becoming more popular with organizations since it reduces time wastage and minimizes lead time with the help of advanced communication techniques. The relationship between suppliers and buyers is maintained as both parties can keep track of the condition of the inventories.
JIT adopts short production runs, therefore, eliminating excess inventories. Conversely, EOQ has long production runs that tolerate high lead time. Moreover, JIT system ensures immediate inspection of incoming components to maintain quality, but EOQ only inspects fundamental components. Since JIT minimizes economies of scale that arise from long production runs, it would be prudent for inventory managers to adopt it in the production line.
Explain the essential characteristics of MRP, DRP, and VMI. How do they operate with each other to provide a systematic approach to managing supply chain inventories?
MRP are used to manage raw materials and product inventories from inside the manufacturing facility. The system calculates the net features and coverage due to changes in the master production scheme, inventory status, and product composition. The system meets these objectives through recalculating net requirements for each inventory, lead time, and the coverage needed. Material availability and timely delivery are fundamental to support these objectives.
Inventory managers apply DRP to manage finished goods inventories between the plant and supply chain. DRP shows replenishment schedules between a company’s manufacturing facilities and its distribution points. This system is known for its ability to improve organization’s services, minimize the levels of finished goods inventories, and strengthen the distribution operations.
VMI is applied when the organization is trying to manage inventories held at the distribution points. DRP is coupled with MRP and VMI to manage the flow and timing of both inbound products and outbound final products. The underlying rationale for these concepts is the ability to accurately predict the change in demand and utilize this information in creating production schedules.
What are the benefits of classifying inventory using ABC analysis? What are the different types of criteria that could be used to classify inventory?
The ABC analysis adopts the Pareto’s Law to categorize the inventories. The classification concept assigns inventory items to one of the three groups (ABC) depending on the relative value of the items that make up the group. This strategy ensures managers place their priorities where both the management and the customers will be satisfied. Some criteria of how inventory items may be classified include item revenues and returns per item.
What is the underlying principle of the square-root rule? How do inventories change as the number of warehouses in a logistics network changes?
The square-root rule suggests that total safety stock inventories in the future number of the facilities are calculated by multiplying the total amount of inventory in the current facilities by the square root of the number of future facilities divided by the number of the existing facilities. This mathematical concept is represented as (y=x*sqrt(yy/xx)), where X= total existing inventory, y=future inventory, xx=number of existing facilities, and yy= future.
The square-root rule assists in determining the extent to which inventories might be minimized through a consolidation approach. Assuming that customer demand is fixed, the square-root rule forecasts the degree to which aggregate inventory needs will vary as the number of stocking locations within the organization changes. Finally, inventory required to maintain customer service levels increases with increase in stocking locations. In contrast, a decrease in aggregate inventories reduces the inventories in stocking locations.