Mdc Lecture 4

Management Decisions and Control 22421/0

Management Decisions and Control Lecture 4 Operation Costing, Inventory Management and Just-in-Time (JIT) 1

Lecture Objectives 1.

Introduction

3.

Conventional Approaches to Inventory Management

5.

Economic Order Quantity (EOQ)

7.

Contemporary Approaches to Managing Inventory: MRPI and MRPII

9.

Just-in-Time (JIT) Inventory Management

11.

Performance Evaluation and Control in a JIT Environment

13.

Total Quality Management (TQM)

2 Management Decisions and Control 22421/0

Introduction 

Inventory management is the planning, coordinating and controlling of activities related to the flow of inventory into, through, and from the organisation.



Manufacturing, wholesale and retail businesses typically hold significant amounts of inventory, including raw materials, WIP and finished goods.



The reasons for carrying inventories vary from one business to the next, but the most common reasons include:    

To cope with uncertainties in customer demand and in production processes To qualify for quantity discounts To avoid future price increases in raw materials, and To avoid the costs of placing numerous small orders with suppliers

Conventional approaches to managing inventory have focused on minimising inventory costs by assessing how much inventory to purchase or to manufacture in-house, and how often. Managers 3 nowandrealise that inventory decisions affect the competitive stance Management Decisions Control 22421/0 

Conventional Approaches Conventional approaches to inventory management have focused on the delicate balance among three classes of costs: ordering costs, carrying costs and shortage costs where: 

Ordering Costs are the incremental costs of placing an order for inventory, or where manufactured in-house the costs of placing the work order and setting up the plant to produce the required inventory item.



Carrying Costs are the costs of carrying inventory in stock, including:  

Incremental costs, eg insurance, rent, obsolescence, spoilage and breakage Opportunity costs, eg capital invested in inventory, lost CM in existing sales due to stock-outs, and lost CM relating to future sales.

 Shortage or Management Decisions and Control 22421/0

4

Stock-out Costs refers to the costs of running out

Economic Order Quantity (EOQ) EOQ determines the optimal quantity of inventory to order or to produce, which minimise both total ordering and carrying costs. Basic assumptions underlying the EOQ model are:  Demand is known and constant  Same fixed quantity is ordered at each reorder point and the entire order is delivered at one time  Carrying costs and acquisition costs are known and constant per unit  Ordering costs are known and unaffected by the quantity ordered  No stock-outs occur  Ignore quality 2DP costs unless these affect either order costs or EOQ= costs carrying

C

Management Decisions and Control 22421/0

D = Annual requirement P = Costs per order C = Annual carrying costs per unit

5

Economic Order Quantity (EOQ) Timing of Orders under EOQ  Inventory re-order point (ROP) – the level of inventory on hand that triggers the placement of a new order (or setup). This decision depends on the lead time, which is the length of time between placing and order and receiving inventory. 

Safety stock – the extra inventory kept on hand to cover any above-average usage or demand. Although safety stock will increase inventory carrying costs, it will minimise the potential costs caused by shortage or stock-out: assuming uncertainty in demand and/or lead time or cycle time



Expediting costs – refers to the extra costs of processing purchase or production orders faster than normal

In EOQ the inventory re-order point is calculated as follows: ROP = (Inventory used per period of time * order lead time) + 6 Safety stock

Management Decisions and Control 22421/0

Economic Order Quantity (EOQ) There are a number of criticisms which have limited the practical application of the EOQ model. 

  

 

There is a preference for long production runs because of high ordering (batch-related) costs, leading to high inventory levels and high carrying costs – Fordism: mass production and economics of scale Large quantities of inventory are held because of the long lead time Hold safety stocks to minimise the costs of stock-out, given uncertainty in delivery and demand Hold safety stocks to enable assembly line to continue to operate even when one or more stations at the assembly line have stopped due to breakdowns or rework There is very little focus on quality factors Managers tend to understate the cost of carrying stocks because the opportunity cost of carrying stocks is not included in the assessment of managerial performance: ‘what gets measured gets done’ 7

Management Decisions and Control 22421/0

Contemporary Approaches - MRP 





Material requirements planning (MRP) is an operations management tool that assists managers to estimate inventory requirements and schedule production. MRP is particularly useful in complex manufacturing operations, where there are several production stages. The early versions of MRP (now called MRPI) focused on inventory management. More recent versions also include the planning for major manufacturing resources, such as labour and machine capacity, the distribution of final products, and in addition some of these systems include financial planning. These systems, called manufacturing resource planning (or MRPII) systems, enable managers to link production planning to the overall planning for the business. Benefits of MRP:

Increased customer responsiveness  Increased labour productivity  Reduced inventory levels  MRPII improved the capacity planning and financial planning of Management Decisions business. and Control 22421/0 

8

Just-in-Time (JIT) Inventory Management 

JIT inventory and production system is a comprehensive system for controlling the flow of manufacturing in a multistage production environment. The underlying philosophy is the simplifying of the production process by removing non-value-added activities (see lecture 3).



JIT production is a demand pull system - each component in the production line is produced immediately as needed by the next step in the production line.



Key features of JIT production

A pull method of co-ordinating production, uses kanbans  Simplified production processes  Purchase of materials, and manufacture of sub-assemblies and products in small lots  Quick and inexpensive setups of production machinery  High-quality levels for raw materials, components and finished products 9  Effective preventive maintenance of equipment Management Decisions and Control 22421/0 



Just-in-Time (JIT) Inventory Management

JIT purchasing     



Only a few suppliers Long-term contracts with suppliers Materials and parts delivered in small lots as needed Minimal inspection of delivered materials and parts Electronic ordering and payments

Benefits of JIT

Reductions in inventory-carrying and handling costs  Lower insurance and inventory costs (no opportunity costs of high inventory)  Reduces costs of spoilage and obsolescence as a result of improved quality  Elimination of non-value-added activities  Higher revenues as a result of meeting customers’ needs more effectively  Reduction in paperwork  Lower investment in plant space for inventory and production 10  The use of flexible manufacturing, reduces the need for setups and Management Decisions and Control 22421/0 

Just-in-Time (JIT) Inventory Management 



Costs of JIT 

Substantial investment to change the production to minimise nonvalue-added activities



An increase in the risk of inventory shortages and the associates loss of production, expediting materials costs and loss of sales

JIT and ‘backflush’ costing 

The absence of inventories reduces the requirement to track costs. So, while conventional costing tracks costs sequentially through the physical flow of manufacturing, backflush costing waits until the manufacturing sequence is complete and then works backwards to flush the product costs out of the system. Hence, products are not costed until they are completed or sold.

11 Management Decisions and Control 22421/0

Just-in-Time (JIT) Inventory Management

Conventional vs JIT Inventory Management

12 Management Decisions and Control 22421/0

Performance Evaluation & JIT Performance evaluation and control in a JIT environment builds on personal observation by production line workers and team leaders. Hence, compared to the conventional inventory systems, which used mainly financial measures such as inventory turnover ratio, variance analysis, JIT requires the use of both financial and non-financial measures for performance evaluation and control. Non-Financial Measures used in JIT includes;  Manufacturing lead time  Number of defects per part million  Number of orders meeting customers delivery requirement  On time delivery  Days’ inventory on hand 13  Total non-productive time (eg. set-up time): Total manufacturing Management Decisions and Control 22421/0

Total Quality Management TQM is a management approach that focuses on meeting customers requirements by achieving continuous improvement of product or services. Key features of TQM:  TQM is holistic and requires a change in organisational culture  Customer –driven  Involves empowerment  Has a process perspective  Is supported by quality management system  Involves continuous improvement Quality Accreditation Organisations may achieve quality accreditation by meeting a series of quality standards set out in the ISO 9000 series. However, ISO 9000’s are both expensive to 14 implement and to maintain, and Management Decisions and Control 22421/0