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Chapter Nine – Inventory Fundamentals

CPIM Exam – Basics of Supply Chain Management Practice Study Sheet  Ch... thumbnail 1 summary

CPIM Exam – Basics of Supply Chain Management Practice Study Sheet 

Chapter Nine – Inventory Fundamentals

• Inventories usually represent between 20 and 60 percent of total assets

Aggregate inventory management works according to their classification (raw material, work in progress, and finished goods) and the function they perform rather than at the individual unit level. It involves 1) flow and kinds of inventory needed 2) supply and demand patterns 3) functions that inventories perform 4) objectives of inventory management 5) costs associated with inventories

Item inventory management is also managed at the item level. Management rules include 1) which individual items are most important 2) how individual items are to be controlled 3) how much to order at one time 4) when to place an order

Raw Materials are purchased goods received which have not entered the production process, including materials, component parts and subassemblies

WIP is raw materials that have entered the manufacturing process and are being worked on

Finished goods are ready to be sold as competed items

Distribution inventories are finished goods located in the distribution system

Maintenance, repair and operational supplies (MRO) are items that are used in production but don’t become part of the final product, including hand tools, spare parts, etc…

Anticipation inventories are built up in anticipation of future demand (i.e. created ahead of xmas)

• Safety stock is to cover unpredictable fluctuations in supply, demand or lead time. It prevents stockouts

• cycle stock Lot-sized inventory are items purchased or manufactured in quantities greater than needed immediately. This is done to take advantage of shipping discounts or minimize setup costs. This is also called
• Transportation inventories exist due to the time needed to move inventories. They are also called pipeline or movement inventories. The average amount = (transit time in days) * annual demand / 365

Hedge inventory (usually done with commodities) is done if prices fluctuate and buyers expect prices to rise, so they buy more now

• Inventory management objectives include 1) maximum customer service (orders shipped on schedule, stockouts) 2) operating efficiency (build seasonal inventories, larger production runs, but in larger quantities). Balance this against costs, and tied up $$ in assets

• Item cost is the price paid for a purchased item (includes direct costs like transportation, customs and insurance) also called landed price. Can also be determined in house including direct material, direct labor and factory overhead

Carrying costs include all expenses incurred by the firm due to volume. 1) capital costs or opportunity cost of $$ tied up in inventory 2) storage costs including space workers, and equipment 3) risk costs include obsolescence, damage, theft and deterioration. Typically 20%-30% of inventory costs are carrying costs

• Ordering costs are associated with placing an order either with the factory or a supplier. Does not depend on quantity ordered. 1) production control costs 2) setup and teardown costs 3) lost capacity cost 4) purchase order costs

• Average cost = (fixed cost / number of orders) + variable cost

Stockout costs expensive due to back order costs, lost sales and lost customers

Inventory turns = annual cost of goods sold / average inventory

ABC inventory determines the relative importance of items and then has different levels of controls

        1. A items – 20% of items account for 80% of dollars
        2. B items – 30% of items account for 15% of dollars
        3. C items – 50% of items account for 5% of dollars
• To calculate ABC use 1. determine annual usage 2) multiple annual usage by cost to get total dollars 3) list items by annual usage 4) calculate cumulative annual dollar usage and percentages 5) group ranked items into A, B and C categories

• ABC rules are 1) have plenty of low-value “C” items (order a years at a time and carry plenty of safety stock) 2) use money and control effort saved to reduce inventory of high-value items (A items)

• A items – high priority – tight control and frequent review, expedite when needed

• B items – medium priority – good controls with normal attention and processing

• C items – low priority – use simple controls and order many items

• Summary – need to balance cost of carrying inventory against 1) customer service 2) operating efficiency (longer production runs and fewer setups) 3) cost of placing orders (decrease with less orders) 4) transportation and handling costs (smaller orders cost more per item)