Detailed Scheduling and Planning (Lesson 2)
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APICS. Certified production and inventory management (CPIM) Module 3 Detailed Scheduling and Planning...
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UUnit nit 22 DDetailed etailed SScheduling cheduling aand nd PPlanning lanning Lesson 2 Customer Service and Inventory Management
Unit 2
Detailed Scheduling and Planning
Unit 2
Detailed Scheduling and Planning
© 2004 e - SCP -The Centre for Excellence in Supply Chain Management No 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 the authors of this workbook. The views expressed are solely those of the authors and do not necessarily reflect 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 Certification Council for use as study material for the APICS CPIM certification examination.
The Leading Edge Training Institute Limited Charter House Cobh Co Cork Ireland
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Detailed Scheduling and Planning Preface............................................................................................................4 Course Description................................................................................................................. 4
Lesson 2 – Customer Service and Inventory Management...............................5 Introduction and Objectives.................................................................................................. 5 Safety Stock............................................................................................................................. 5 Customer Service.................................................................................................................... 6 Safety Stock and Statistical Formulae................................................................................ 11 Inventory Valuation............................................................................................................. 18 Types of Inventory Valuation.............................................................................................. 18 Data Integrity and Inventory Accuracy ............................................................................. 21 ABC Classification and Inventory Analysis ...................................................................... 23 Methods of Ensuring Inventory Accuracy......................................................................... 27 Inventory Policy.................................................................................................................... 29 Summary ............................................................................................................................... 31 Further Reading ................................................................................................................... 31 Review ................................................................................................................................... 32 What’s Next? ........................................................................................................................ 33
Appendix.......................................................................................................34 Answers to Review Questions .............................................................................................. 35
Glossary ........................................................................................................37
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Detailed Scheduling and Planning Preface Course Description This document contains the second lesson in the Detailed Scheduling and Planning unit, which is one of five units designed to prepare students to take the APICS CPIM examination. Before completing the Detailed Scheduling and Planning unit, you should complete the Basics of Supply Chain Management unit or gain equivalent knowledge. The five units that cover the CPIM syllabus are: Basics of Supply Chain Management Detailed Scheduling and Planning 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 you during 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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Detailed Scheduling and Planning Lesson 2 – Customer Service and Inventory Management Introduction and Objectives This 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 ABC analysis and cycle counting techniques. Finally, the lesson explores characteristics and features of inventory policies. The aim of this lesson is to review factors that may be input to material requirements planning (MRP), reviewing the techniques to ensure an accurate understanding of each. 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 of safety factors State the effect of inventory valuation on inventory investment Describe inventory accuracy methodologies used to maintain and improve part-count and inventory valuation accuracy Distinguish between various customer services measurements
Safety Stock Safety stock is inventory held to support customer service level objectives, one of the primary reasons for holding inventory. Safety stock is needed when there is uncertainty of demand or when the supply of parts or raw materials is unreliable. For example, safety stock of bespoke packaging materials may be held by a company to guard against time delays in replenishment from 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 all scheduled receipts for that item will arrive a specified length of time before they are actually needed. For example, a catering company that produces airline meals may order disposable crockery and hot food containers with a due date two days before the current stock is likely to run out. This reduces the likelihood of a stock-out due to increased demand or late delivery of the order. Safety stock is the quantity of stock planned for inventory to protect against unforeseen fluctuations in either demand or supply
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Purpose of Holding Safety Stock Safety stock is required to guard against stockouts. It is important for items of independent demand as it is unlikely that forecasts will ever be 100% accurate. Therefore, to ensure customer service levels are maintained, a safety stock must be available at times where demand is higher than expected and the available stock may be depleted before replenishment can be realistically expected. Dependent Demand and Safety Stock Safety stock may be planned for dependent demand items but usually only if the supply of the demand item is subject to change, due to either unreliable delivery, or unreliable scrap or yield ratios in production. The demand for the product is totally dependent on the demand for its parent and is calculated rather than forecast. Therefore, there is little chance that demand will exceed supply. Dependent and Independent Demand for the Same Item Some parts may be subject to both dependent and independent demand. In this case, safety stock may be held to cover for the independent demand. In this case, the part should be divided into two categories in MRP so that gross requirements for the dependent demand can be calculated separately to those for the independent demand.
Customer Service What it means In operational terms, customer service is the availability of items when they are required by the customer, 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 large demands, machine failures, late delivery of components or other causes. Despite these difficulties, 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 relative to promised dates, and the companies performance filling back orders and late deliveries. There are two types of measurement that can be used: percentage measurements and absolute value measurements. Some absolute value type measures are most useful when compared against a standard. For example, a company might set a target of not more than 12 order days out of stock in any 12 month period. It could then record actual order days out of stock and compare on a rolling monthly cycle. Percentage Measurements
Absolute Value Measurements
Orders shipped on schedule
Order days out of stock
Line items shipped on schedule
Line item days out of stock
Total units shipped on schedule
Total item days out of stock
Dollar volume shipped on schedule
Dollar volume days out of stock
Profit volume shipped on schedule
Idle time resulting from material or component shortages
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Unit 2
Detailed Scheduling and Planning Operating item days not out of stock Ordering periods without stockout
1. What are the main reasons for holding safety stock for dependent demand items? (Choose more than one option) A. To guard against fluctuation in demand Review Q
B. To guard against changes in supply due to unreliable delivery C. To guard against high levels of scrap D. 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 of similar value and the value of the order is evenly distributed among the line items. However, if the few orders that did not ship on schedule were particularly valuable, for example, accounting for 40% of total dollar volume, then the picture 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 a greater impact on the overall percentage than small orders. However, it does not take into account the unit cost of each item. For example, the overall percentage might be high, but the failures could all stem from the failure to ship high dollar value items, therefore the cost to the company 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 sells plasma 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 units were 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 customer service level would be 94.2% using this measurement (49 / 52). This measurement is useful in determining reorder points to achieve specified customer service levels. Absolute Value Measurements The 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 © Copyright Leading Edge Training Institute Limited
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Detailed Scheduling and Planning measurements. For example, a company might aim to ensure that it never experiences 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 purchasing and PAC, particularly queue management and input/output control. It can be used to compare similar facilities or the same facility over different shifts. It is common among manufacturing plants operating against standard production times to maintain a record of non-productive hours with associated causes, so the data required to measure idle time is usually easily available. Comparing Measurements The importance of choosing the most appropriate measure or combination of measures for customer 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. This represented a total of 11,120 units not shipped from stock. Over the 52 weeks, the company was out 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. All these measurements are inadequate in terms of measuring exactly how the customer rates the company 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 date for the customer; it must endeavour to retrieve the situation as soon as possible. The company must measure its response to backorders to ensure they are filled quickly. Some of the measures used 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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Detailed Scheduling and Planning Before deciding on the appropriate measure, a company must identify the types of data available. There is no point deciding to measure dollar volume shipped on schedule if information on the dollar value of each item in each order is not available. Also, there is no point in choosing a measurement which is costly in terms of time and resources to collect when there is little gain to be made from associated improvements. In some cases, the ability to measure will have little impact on the outcome. For example, where stockouts are experienced due to the scarcity of purchased items that cannot be produced in-house, there is little that can be done to remedy the situation. To be valuable, the measurement chosen must relate productivity, profit and return on investment. This may vary from one product group to the next. Thus, it may be necessary to choose different measurements depending on the type of order and the type of inventory being managed. 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 ha ve 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 of stockouts. When an item is inexpensive and easy to store, and the cost of a stockout in that item is high, the company should aim for a high customer service target. Component parts and subassemblies that have dependent demand should have a 100% service level as delays or stockouts will have a strong knock-on effect on finished products. For example, if a finished product is assembled from 5 components, each with a service level of 95%, 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) or 84%. 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 and generally 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 greater investment in inventory. However, sometimes improvements in inventory management can lead to 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 to the customer. Losing a customer due to lack of fo cus is a very expensive proposition. Loss of current revenue and reputation does not reflect directly on the profit and loss statement but will be evident through lower profitability in © Copyright Leading Edge Training Institute Limited
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Detailed Scheduling and Planning the longer term. Measurements of the total customer experience can include measures of responsiveness, design suggestions for cost reductions or cycle time improvements, service and warranty. As many organizations today are now dealing with a global customer base, the logistical challenges associated with customer service are significant. Some ways in which customer service may be improved are through service contracts and guaranteed access to computer systems. When such services are important to customers network downtime can be very expensive. Transportation has a deep impact on customer satisfaction. It is very important that an organization partners with a transportation company that can deliver product within defined time frames. Customer Service and Order Quantities If customer service levels are expressed as performance goals for a specified period, for example, every quarter, order quantity will have an impact on performance. The smaller the order quantity, and therefore the shorter the order cycle, the more times per year there is an opportunity for a stock out to occur. Small orders create risks of more frequent stockouts, but these are usually brief in comparison to the less frequent stock-outs that may occur with large order quantities and which may last for a significant period of time. Items should be assessed from a customer service perspective when establishing order quantities and safety stock levels. 2. Sparkle Cleaning Ltd produces a range of cleaning products for the hotel and catering industry. The overall size and value of orders varies significantly although there is little range in the value of line items. The company keeps records of customer orders and line items in each order. Review Q Which is likely to be the most appropriate customer service measurement? A. Ordering periods without stockouts B. Orders shipped on schedule C. Line items shipped on schedule D. Profit volume shipped on schedule
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Detailed Scheduling and Planning Safety Stock and Statistical Formulae It is important to establish an appropriate safety stock level for every inventory item. This involves measuring the amount of demand variability relative to the average demand. This is often known as forecast error. The usage data collected in issue transaction records is important for this. There are several statistical methods that can be used in the calculation of an appropriate safety stock level. These are explained below. Normal Distribution The normal distribution curve assumes that demand variation is symmetrical around an average or mean demand (often represented by the Greek letter µ (mu). The mean is calculated by adding the demand for several periods and dividing by the number of periods. In the normal distribution 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 the value that needs to be determined in order to calculate a safety stock value. An example of the normal 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 demand variability. Standard deviation needs a longer history of forecast and demand than MAD.
Standard Deviation =
v
Sum of squared deviations Number of periods - 1
The mean absolute deviation is the average of the absolute deviations from the forecast average demand. It requires only the summary values from the previous month along with current values. MAD =
Sum of deviations Number of periods
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Detailed Scheduling and Planning The table below shows the information needed to determine standard deviation and MAD. Week
Actual Sales
Forecast
Deviation2
Deviation
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. For forecast 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:
Standard Deviation =
v
2,560,000 9
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 than forecast while the value for the next period may be less than forecast. Overall, the errors should fall 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 table used previously, the sum of the forecast figures was 1000,000, compared to an actual sales figure of 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 a specified period, the forecast is biased If the sum of the forecasts over a period is consistently greater than actual sales, the bias is 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. © Copyright Leading Edge Training Institute Limited
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Detailed Scheduling and Planning Tracking Signals Tracking signals are used to check the deviation between actual and forecast figures over time. It provides 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 item may be reviewed by the planner. Usually a tracking signal is a running sum of forecast errors divided by the mean absolute deviation for the periods in question. However, some items may require different tracking signals depending on their cost or importance. A tracking signal approaching +1 or – 1 indicates a consistently negative or positive error. Many companies set a ‘trip value’ which is some form of threshold beyond which forecast bias is suspected. When this is the case, the company can either search for the cause of the change in demand, for example, a data error, or place a stronger emphasis on more recent demand data to enable the system to correct itself. For important items, this trip va lue 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 sum of errors
Tracking signal
150
153
-3
-3
3
-1.00
146
155
-9
-12
12
-1.00
156
147
9
-3
21
-0.14
152
145
7
4
28
0.14
145
155
-10
-6
38
-0.16
146
154
-8
-14
46
-0.30
153
148
5
-9
51
-0.18
157
146
11
2
62
0.03
Initially, as all previous errors are assumed to be zero, the tracking signal looks very high. The tracking 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 ensure appropriate safety stock by: A. Setting an arbitrary safety stock level Review Q
B. 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 MAD D. Setting the safety stock level equal to the standard deviation
Using Variability Metrics The traditional vie w 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 %. Using the figures given previously in Table 1, page 12, the forecast value was 10,000 units and the © Copyright Leading Edge Training Institute Limited
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standard deviation was 533.3. This means that there is a 68.26 percent probability that the actual usage 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 (533 units) as safety stock, the customer service level will increase to around 84%. A safety stock of two 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).
99.86% 97.72% 84.13% 50%
Figure 1 Standard Deviation and Customer Service
Table of Safety Factors The following table can be used to identify the level of service required and the corresponding safety factor multiplier, which can be used to calculate the amount of safety stock required to provide the chosen level of service. The safety stock is calculated by multiplying the amount in a standard deviation by the safety factor multiplier. Desired Service Level (%)
Standard Deviation Safety Factor Multiplier
MAD Safety Factor Multiplier
50
0.00
0.000
80
0.84
0.672
84.13
1.00
0.800
90
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
3.200
Table 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 stock level equivalent to 2.33 times the standard deviation, remembering that the standard deviation is equal to the square root of the sum of the squared deviations divided by the number of periods less 1. In the example used for explaining standard deviation, the amount of one standard deviation was equal to 533.3. Using the table of safety factors above, the amount of safety stock needed to ensure 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 item’s replenishment lead time is greater or less than the forecasting period. This is achieved by calculating a lead time deviation. 4. If the standard deviation is 300 units and the target level of customer service is 98%, what amount of safety stock should be held? A. 146 units Review Q
B. 300 units C. 492 units D. 615 units
Lead Time Deviation If the forecast frequency and item lead time are different, the standard deviation should be referred to as the lead time deviation. If the forecasting period is greater than the replenishment lead time, less safety stock is needed. Howeve r, if the forecasting period is less than the replenishment lead time for the item, a greater level of safety stock is required to achieve the same service level. The lead time deviation equation is used to compensate when the lead time does not equal the forecast 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
ß (Lead Time / Forecast Interval)
Beta (ß) is a range between zero and one, which typically falls between 0.5 and 0.7.The beta figure allows for lead times longer than the forecast period by increasing safety stock levels. The worst case scenario is a beta factor of 1. To continue the previous exa mple, assuming the forecast interval is four weeks, the replenishment lead time is 6 weeks, and ß is 0.5, the lead time deviation would be equal to 533.3 multiplied by half of (6 divided by 4).
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Detailed Scheduling and Planning Time Period Safety Stock A time period safety stock provides an even amount of safety stock, equal to usage, over a specified 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. In contrast to statistical safety stock calculation, where the level of safety stock is based on the deviation from demand, time period safety stock changes in tandem with changes to dependent or independent demand. For example, Sugar’n’Spice Ltd, manufacturers of a range of herbs, spices and condiments, use small plastic containers to package their produce. These containers are a low-cost C class inventory item, bought in units of 100 and reviewed monthly. The company anticipates demand over the coming month and maintains 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 of inventory levels will not take place until the end of the month so the safety stock will provide a buffer. 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 as follows: 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 there will be a higher level of safety stock in January than in February. With a safety stock time period of 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 4 weeks/month
Time Period Safety stock
= 20 units
40 units month
Time Period safety stock is useful for items that are delivered daily or weekly. The time period safety stock protects against stockouts due to delays in delivery. When demand varies, perhaps due to seasonality, the time period safety stock totals the precise dependent and independent demand 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 any system calculations. It may be used when A new part is introduced: as there is no history of use statistical safety stock cannot be calculated A part with a long history of use is being phased out: safety stock should be set to zero and usage should be manually checked. © Copyright Leading Edge Training Institute Limited
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Detailed Scheduling and Planning Dependent demand items are completely planned by MPS and MRP and are never impacted by unplanned usage. Safety stock should be set to zero. Safety Stock Analysis Alternative
Required
Appropriate
Create individual-part safetystock quantities based on statistical, fixed, or timeperiod techniques
Set a safety-stock level for each part independent of any product relationships. Calculate the quantity of safety stock required.
Independent-demand part
Set up the value of having safety stock by product or product line
Allocate the cost among various parts. Calculate the quantity of safety stock required
Dependent-demand parts
Establish an arbitrary dollar level for safety stock
Allocated among parts When amount of money through using some of the available to invest in safety methods described previously? stock is limited
Safety stock should generally be held for independent demand items where the demand is uncertain and any item where other issues may affect supply, for example, variable quality or unreliable delivery dates. Policy on safety stocks are usually set at executive level, depending on the expected customer fill rate, the inventory stock levels to be achieved. Actual safety stock levels for individual items will probably be set and modified at materials management or planning level.
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Detailed Scheduling and Planning 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 of inventory 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 market value (the amount the inventory would fetch if sold in its present state). As the value of an inventory item may change over time, the age of the inventory is also a 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 rather than assets because they do not contribute to the final product but are used up in the production of the final product. Similarly equipment and vehicles owned by a company are not inventory as they do not contribute to the final product. They are classified as capital equipment, subject to depreciation over time, as specified in Internal Revenue Service rulings. Inventory valuation is important as it establishes the asset value of the company. 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 that MRO inventories are not included when calculating inventory turns. Cost of Goods Sold When goods are transformed from raw ma terial to finished product they are sold on to the customer. Once sold, the materials used to make these products are subtracted from the inventory and 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 beverage industry may stock standard components at standard cost and use actual cost for items purchased specifically 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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Detailed Scheduling and Planning FIFO This method assumes that the oldest inventory items are issued for use first. As the cost of the inventory 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 the least recent cost values. In a period of rising costs this will work to the company’s advantage. The table below is an example of FIFO valuation Date
Units Receipts Unit cost
Total Cost
Units
Issues Unit cost
Total Cost
Jan 1 Jan 10
600
Jan 25 600
$6.60
$6.00
$3,600
3960
Units
Balance* Total unit cost cost
800
$6.00
$4,800
200
$6.00
$1,200
200
$6.00
600
$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
200
$6.60
800
$6.70
$8,000
400
$6.70
$2,680
400
$6.70
800
$6.80
Mar 1
800
$6.70
$5,360
Mar 10 Mar 25
800
$6.80
200
$6.60
400
$6.70
$4,000
$5,440
$8,120
$11,440 *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 the cost of inventory items is constantly rising, this will lead to an undervaluing of the total inventory 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 taxe s
Decreased taxes
Increased cash flow compared to other methods
The following table is an example of LIFO valuation © Copyright Leading Edge Training Institute Limited
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Date
Units Receipts Unit cost
Total Cost
Units
Issues Unit cost
Total Cost
Jan 1 Jan 10
600
Jan 25 600
$6.60
200
Feb 18
400 800
$6.70
600 800
$6.80
$6.00 $6.60
$1,320 $2,640
$5,360
Mar 10 Mar 25
$3,600
3960
Feb 3
Mar 1
$6.00
$6.70
$4,020
$5,440
Units
Balance* Total unit cost cost
800
$6.00
$4,800
200
$6.00
$1,200
200
$6.00
600
$6.60
200
$6.00
400
$6.60
$3,840
200
$6.00
$1,200
200
$6.00
800
$6.70
200
$6.00
200
$6.70
200
$6.00
200
$6.70
800
$6.80
$5,160
$8,000 $2,540
$7,980
$11,580 *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 $11,580 cost 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 be moved because it requires repair. Standard Cost In a standard cost system, a single value is selected for an inventory item, generally based on an average of historical costs or anticipated costs. The difference between the standard cost and the actual cost would be recorded as a variance from standard. This technique consistently reports the 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 also occasionally required where lot traceability is also important for reasons such as safety or © Copyright Leading Edge Training Institute Limited
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Unit 2
Detailed Scheduling and Planning
warranty cover. For example, actual cost may be suitable in the purchase of meat products in the UK 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 be complex and cumbersome to manage. Project Cost In shipbuilding, large engineering construction projects, and public accounting firms, for example, 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 per product. The system is used with either actual or standard costs in manufacturing companies that produce a large number of identical units. Comparison of Costs The most effective way of illustrating the differences between the various costing methods is to input the same data to each method and comparing the results. Table 5 below displays the results of using various costing methods on the same inventory item. FrescaFruits Ltd are working on costings for the 3rd quarter of the year. They buy grapes in small units with a standard 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 2nd quarter is 0. The requirement for grapes in the 3rd quarter is expected to be 70 units per month, a total 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
$2,700
Table 5 Comparison of Costing Methods
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Unit 2
Detailed Scheduling and Planning
Unit 2
Detailed Scheduling and Planning 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. As the Master Production Schedule, bills of material, inventory levels, work center data, and process information are all inputs into MRP, the accuracy and integrity of these data will be directly impact on the effectiveness of the resulting MRP. The maintenance of accurate data requires strict discipline within and between all departments of an organization. Not only must the data be maintained in an accurate and timely manner, but the system must be such that the finding and fixing of inaccuracies is encouraged, rather than ignored. Definition and Purpose of Inventory Accuracy In accounting, the only measure of inventory accuracy that matters is the dollar value. The planning department is concerned with maintaining an acceptable percentage of inventory accuracy. However, production demands absolute count accuracy. The most stringent requirement is the count accuracy required from production. If this is correct, the other forms of inventory accuracy (percentage and dollar accuracy) will also be correct. The aim of any company should be to ensure 100% inventory accuracy on all items at all times, using inventory accuracy logic that supports this aim and ensuring that any inaccuracies made are recorded and corrected immediately. Perpetual inventory systems record the balance of inventory on hand at each stock location. Due to mistakes and failures of security, transaction processing, and recording of inventory location, it is easy for the physical inventory balance and the recorded balance to become out of sync. One way to alleviate this is to support inventory record systems with physical counts. Another way of dealing with potential inaccuracies is to design the system so that inaccuracies are impossible. For example, when designing software to maintain inventory records, checks and filters should be used to ensure that the system user does not unknowingly enter a wrong figure. Types and sizes of inventory items should be available to choose 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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Unit 2
Detailed Scheduling and Planning Inventory Accuracy and Cycle Counts Inventory accuracy can be improved by cycle-counting analysis. Once a level of 100% accuracy has 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 are avoided.
ABC Classification and Inventory Analysis ABC classification, based on Pareto’s principle or the 80/20 rule, assumes that 20% of the items in 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 purchases such 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 will account 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% of all inventory items) will account for only 5% of the total inventory value.
100% 95%
Percentage of total value
80%
A items
B items
C items
20% 50% Percentage of total number of items
100%
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 on controlling inventories of C class items. The table below outlines uses of ABC classification. © Copyright Leading Edge Training Institute Limited
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Area of Use
Unit 2
Detailed Scheduling and Planning 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 items
Customer Service
Order quantity and safety stock levels are established according to the criticality and cost of each item. Generally this is approached from a dollar accuracy perspective. It may also be a recognition that A items take longer to procure when an unplanned stockout occurs.
Engineering Priorities
The engineering department may use ABC classification to identify items of high cost or high usage and concentrate their efforts accordingly. There is little point re-engineering products of little value or low usage.
Replenishment Systems
Inventory replenishment systems will vary according to the importance of the inventory items. For example, C class items may be controlled with a simple two-bin system if they are not particularly bulky. This minimizes the cost of control and replenishment and does not significantly increase inventory carrying costs.
Investment Decisions
As A class items form a larger investment in inventory, these items are closely analyzed to ensure appropriate order quantities and safety stocks are used. A class items are always the focus of attempts to improve inventory turns as changes in the way A class items are procured and managed will have the most significant effect on the overall inventory investment level.
ABC Classification Method For each inventory item, yo u record its annual usage in units, the cost of a unit and the total dollar usage for the year. You then calculate the cumulative usage in dollars, the cumulative percentage dollars usage, and the cumulative percent of items. Next, you rank the part numbers in order. ABC Classification Steps 1. Find the annual demand in units for each item 2. Record the unit cost for each item 3. 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 lowest 5. Calculate the cumulative annual usage value 6. Calculate, for each item, the percentage of the total cumulative usage value 7. Calculate the percentage of the total number of items 8. Evaluate relationships and assign categories FrameIt Ltd provides a fairly broad product range from relatively few inventory items (10 in total). However, as a means to minimize costs they are now looking at ways to streamline their inventory investment without affecting customer service levels. As a first step, the company uses ABC classification to determine on which inventory items, the main effort should be expended. © Copyright Leading Edge Training Institute Limited
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The table on the following page shows the calculation of the annual dollar usage for each part number, 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
6,000
9
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 cumulative percentage usage rate is calculated by firstly adding together the annual dollar usage rates at each level in the part number ranking (see column 3 below), then converting each figure into a percentage of the overall usage rate in dollars. Finally, the cumulative percentage of each item is calculated 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 dollar usage rate and cumulative percentage of items. The top items are most significant and therefore should be classified as A items. The items at the bottom of the list are B items. Part Number
Annual $ Usage
Cumulative $ Usage
Cumulative % $ Usage
Cumulative % of Items
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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Unit 2
Detailed Scheduling and Planning
5. Using the table below, calculate the ABC classification for each of the 10 items listed, based on their annual dollar ($) usage. Record your results in the empty table beneath. Review Q Item Annual unit Number usage cost in units 1 15000 50 2 140000 75 3 1500 50 4 55000 25 5 2000 25 6 110000 50 7 7500 25 8 45000 25 9 30000 75 10 4000 50
Part Number
Annual Unit unit Cost Usage
Annual $ Cumulative Usage $ usage
Percentage $ usage
Rank
ABC Class
1 2 3 4 5 6 7 8 9 10 Total Extending ABC Analysis By including the number of units on hand for each inventory item and dividing the inventory on hand into the annual usage (in units), the resulting figures show the amount of inventory on hand as a percentage of the total year’s 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 high stock. © Copyright Leading Edge Training Institute Limited
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Unit 2
Detailed Scheduling and Planning
Unit 2
Detailed Scheduling and Planning Methods of Ensuring Inventory Accuracy Counts of inventoried items and the cost of each item must be recorded accurately in order to support production scheduling, customer service and the management of financial statements. Cycle counting and periodic inventory counting are the two main methods of verifying the accuracy of inventory records. Periodic Inventory Audit Periodic audits are large scale physical counts of all inventory in a plant. This type of audit usually takes place annually and is primarily concerned with verifying the financial value of the inventory. Periodic audits are disruptive to production and are expensive in terms of time and administration. Accuracy is poor as many of those taking part in the exercise may be inexperienced 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 times per 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 experienced personnel throughout the year
Inefficient use of many inexperienced people in a short time once a year
Timely detection and correction of problems
No correction of errors
Fewer mistakes in item identification
Many mistakes in identifying items
Minimal loss of production time
Shutdown of plant and warehouse may be needed
Systematic inventory record accuracy improvement
Inventory accuracy is improved only once in the year
Reconciliation When inventory audits (either cycle counting or periodic) have been completed, discrepancies between the count and the inventory record for each item should be reviewed. Where
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Unit 2
Detailed Scheduling and Planning discrepancies occur, the item should be recounted if the variance is large, or the recorded value should 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 many potential 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 times an item is counted may be in direct proportion to the importance of that item or it may be triggered by some external event. Some examples of ways in which a cycle count for a particular item 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 frequently on items most often used. As many inaccuracies are due to inventory transactions, this method is useful as there will only ever be a set number of transactions to check if an error has occurred. When a record indicates a zero balance, a count should verify that there is no inventory available Just before reordering the item in question, assuming that the inventory level will be low and therefore quicker and easier to count. When a replenishment lot is received. The lot should be counted anyway as part of the receiving process, and the rest of the stock should be at its lowest level and easy to count.
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Unit 2
Detailed Scheduling and Planning Inventory Policy Inventory policies must strike a balance between the conflicting objectives required by Sales (high customer service), Operations (efficient plant operation), and finance (lowest overall inventory investment). All inventory policies should therefore aim to maximize customer service with minimal plant costs and inventory investment while maintaining operational efficiency. Customer Service Objectives Objectives for achieving customer service vary from company to company. They include delivery on time, buffering against uncertain demand and provision of sufficient variety to meet customer 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 require from 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 customer service. Most companies gauge their customer service levels through performance measures such as percentage measures and absolute measures as shown in the table below. Percentage Measures
Absolute Value Measures
% of orders shipped on schedule
Order days out of stock
% line items shipped on schedule
Line items out of stock
% total units shipped on schedule
Total item days out of stock
% dollar volume shipped on schedule
Dollar volume days out of stock
% profit volume shipped on schedule
Idle time due to material and component shortages
% operating days in stock % ordering days in stock Measuring Customer Service Internally
Most measurements of customer service are internal rather than from the customer. These are therefore 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 the replenishment of raw materials and components. Forecasting is an inexact science which generally includes variations from the norm: resulting in a level of uncertainty. By maintaining © Copyright Leading Edge Training Institute Limited
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inventories, a company ensures that delivery is possible even when demand exceeds expectations. Transportation, quality problems, excessive scrap and supplier lead time factors contribute to the level of uncertainty. Safety stock protects against fluctuating demand or supply. Variety As well as uncertainty about the timing of demand for goods there is usually uncertainty about which 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 be necessary to maintain inventories of each different product configuration. This will result in greater expense in terms of tying up capital, particularly where money must be borrowed to facilitate extra inventory, and inventory carrying costs. Company objectives are generally clear that 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, if 1 order out of 100 orders is late, the orders shipped measurement will be 99% However, if the one late order accounted for 20% of the value of the total orders shipped then the 1% error is much 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 than others. However, it still does not take into account the dollar value of the orders; neither does it measure how late an order is. Total Units Shippe d on Schedule This measurement deals with the number of units shipped on schedule but again does not recognize 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 order documentation. This is a more complete measure of the value of the order to the company and to the customer. But if some large orders consist mainly of materials that have been bought by the company and sold to the customer with little added value, it may still distort the value of the order as the actual profit margin on such an order would be minimal.
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Unit 2
Detailed Scheduling and Planning
Unit 2
Detailed Scheduling and Planning Summary This lesson covered safety stock techniques, the importance of inventory valuation, data and inventory accuracy, ABC analysis, cycle counting, and inventory policies are examined The main aim of this lesson was to review all factors that are potential inputs or affect inputs to Material Requirements Planning (MRP) and review techniques to ensure the accuracy of suc h inputs. 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 of safety factors State the effect of inventory valuation on inventory investment Describe inventory accuracy methodologies used to maintain and improve part-count and inventory valuation accuracy Distinguish between various customer services measurements
Further Reading Introduction to Materials Management, JR Tony Arnold, CFPIM, CIRM and Stephen Chapman CFPIM 5th edition, 2004, Prentice Hall APICS Dictionary 10th 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. CFPIM 2nd edition, 1991, South-Western Publishing Co., Cincinnati, Ohio
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Unit 2
Detailed Scheduling and Planning Review The following questions are designed to test your recall of the material covered in lesson 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 plant B. 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 group D. 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 does not, which of the following may be an appropriate measure of customer service? A. % on-time orders B. % line items shipped on schedule C. % Total items shipped on schedule D. % 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 efficiency C. To calculate the expenses of the company D. 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 most recently arrived items will be used first B. Sets a value for an inventory item based on an average of historical costs or anticipated costs and uses this to calculate cost of goods sold and inventory value C. Relies on lot control to ensure that materials withdrawn from inve ntory can be traced directly to a specific purchase order or production run D. Assumes the oldest items are used first. Uses least recent cost values to calculate the cost of goods sold and sets inventory values close to current market rates
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Unit 2
Detailed Scheduling and Planning What’s Next? Lesson 2 a variety of techniques for customer service and inventory management. At this point you 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 Information Requirements
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Unit 2
Detailed Scheduling and Planning Appendix
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Unit 2
Detailed Scheduling and Planning Answers to Review Questions 1. B, C, and D Demand is unlikely to exceed supply as items with dependent demand are required solely for the production of a parent item. Instead, safety stock may be held to guard against delivery delays, or ensure 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 easily available. It is possible to measure the percentage of orders shipped on schedule. However, as order sizes vary greatly this could be misleading. For example if there is a 99% success rate but the one order that was delayed accounts for 10% of total sales volume, then customer service is actually 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 the extra 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 the desired level of customer service. Both MAD and standard deviation are measures of demand variability and can be used to calculate appropriate safety stock levels. However, the safety stock level is not necessarily equal to the MAD or the standard deviation and is more likely to be a multiple of the standard deviation. 4. D To support a customer service level of 98% the safety stock level should be equal to the amount of standard deviation multiplied by 2.05. 5. ABC Classification Part Annual Number unit Usage
Unit Cost
Annual $ Usage
Cumulative $ usage
Percentage $ usage
Rank
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 B
8
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
ABC Class
$22,012,500
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Unit 2
Detailed Scheduling and Planning 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 inve ntory record for each item should be reviewed. Where discrepancies occur, the item should be recounted if the variance is large, or the recorded value should be changed. The number of times an item is counted may be in direct proportion to the importance of that item, for example, its ABC classification or it may be triggered by some external event such as a reorder of the item or a set number of item transactions. Periodic audits are large scale physical counts of all inventory in a plant. This type of audit usually takes place annually and is primarily concerned with verifying the financial value of the inventory. 7. C When 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 % of orders 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 enables average inventory value, and therefore inventory tur ns, to be calculated. This gives a company a good picture of how efficiently they are using their inventories. Note that MRO inventories are not included when calculating inventory turns. 9. D FIFO assumes that the oldest inventory items are issued for use first. As the cost of the inventory 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 the least recent cost values. LIFO 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. The standard cost system, sets a single value for an inventory item, generally based on an average of historical costs or anticipated costs, and uses that value in all calculations. The actual cost method uses lot control to trace the actual cost of each material. It is cumbersome and rarely used unless when required by regulations, such as in the tracing of the origin of meat products.
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Unit 2
Detailed Scheduling and Planning 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 dollar volume) and listed in descending order. The top group of items (usually around 20%) are classed as A items and account for around 50-70% of the critical measurement. The next 30% or so of items are B items and are responsible for around 20% of the critical measurement. The rest are C items 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
Anticipation inventory
Additional inventory above the baseline stock to cover projected sales increases, planned sales promotions, seasonality, plant shutdowns and vacations
Backorder
A customer order or commitment to a customer that has not been fulfilled by 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 forecasts
Buffer
A quantity of material waiting for further processing. This may be raw material, partially completed material in stores, or a work backlog that is purposely maintained beside a work center.
Carrying cost
Cost or carrying inventory. This is defined usually as a percentage of the monetary value of the inventory per unit of time (usually a year). Carrying cost depends on the cost of capital invested and on costs of maintaining the inventory, paying tax on it, insuring it, spoilage, storage space, and obsolescence.
Consignment
A shipment that is handled by a common carrier or the process of a supplier placing goods at a customer location without receiving payment for the goods until after they are used or sold
Constraint
An element or factor that prevents a system from achieving a higher level of performance with respect to its goal. Constraints can be physical, such as a machine center or lack of material, or managerial, as defined in policies or procedures.
Cumulative lead time
The longest planned length of time needed to complete a particular activity. It may be calculated in MRP by reviewing the lead time for each BOM path below the item. The longest BOM path is equal to the cumulative lead time
Customer service
A measure of a company’s 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 the needs of its customers. Customer service level or ratio
A measurement of delivery of finished goods performance, usually a percentage such as the number of items or dollars shipped on schedule during a specified time period, compared to the total that should have been shipped. In a make-to-order environment it may be measured by the number of jobs or dollars shipped in a particular period compared with the total number required.
Cycle
The interval of time during which a system or process, periodically returns to similar initial conditions. It is also the interval of time during which an event 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 moving items. Each item is counted in isolation at regular intervals throughout the year as often as specified for each item. Many items may be counted very working day. Cycle counting is used to identify items in error. This may lead to research, identification, and elimination of the causes of the errors.
Demand
A need for a particular product or component which could come from a customer order, forecast of market requirements, interplant requirement, or a request from a branch warehouse for a service part
Demand
The need for a product of component. Demand may be generated from customer 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 the plastic monitor case will be entirely dependent on the demand for monitors. Distribution
The activities associated with the movement of material, usually finished goods or service parts from production plant to the customer. Distribution incorporates functions such as transportation, warehousing, inventory control, material handling, order administration, location analysis, packaging, data processing, and communications networks.
Economic order quantity (EOQ)
Reducing setup time and inventory to the point where it is economical to produce in batches of one.
Excess inventory
Inventory that exceeds the minimum amount required to achieve a desired throughput rate, or inventory over and above the minimum amount needed to ensure desired due date performance
Expedite
To speed up production orders or purchase orders that are required in a shorter time than the usual lead time.
First-in-first-out (FIFO)
A calculation of inventory value that assumes, for the purposes of valuation, that the oldest inventory will be used first.
Finished goods or end items
A product sold as a completed item or repair part. This term refers to any item that is subject to a customer order or sales forecast
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Fixed order quantity
À lot sizing technique in MRP or inventory management that will always cause an order to be generated for a fixed quantity or multiples of that fixed 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 speculation related to potential strikes, price increases, government unrest, or other external events that could severely impair a company’s strategic initiatives.
Inactive inventory
Stock that is in excess of consumption within a defined period of time or stocks of items that have not been used within a defined time frame.
Independent demand
Demand for an item that does not depend on the order of other items. Demand for finished goods, parts required for destructive testing, and service parts are examples of independent demand.
Independent demand
The demand for an item that is derived from customer orders, forecasts, or internal 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 (Finished goods and spare parts). Demand for inventory may be dependent or independent. Inventory functions are anticipation, hedge, cycle (lot size), fluctuation (safety, buffer, or reserve), transportation (pipeline), and service 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-added costs, whereas traditionally, direct labor and overhead costs were attributed to the items as they went through the productio n process.
Inventory turns
The number of times that an inventory turns over during a year. This is calculated by dividing the average inventory level into the annual cost of sales. For example, an average inventory of $600,000 divided into an average cost of sales of 1,800,000 means that inventory turned over 3 times 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 or sign. 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 the time 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 material received will be the first to be used. LIFO does not relate to the physical use of goods. It is required solely for accounting purposes.
Lot-for-lot
A lot sizing technique that generates planned orders in quantities equal to the net requirements in each period.
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Maintenance, repair, and operating supplies (MRO)
Items used to support operations and maintenance, including for example maintenance supplies, spare parts, consumables used during manufacturing and supporting operations.
Manufacturing environment
The framework in which a manufacturing strategy is developed and implemented. It includes external environmental forces, corporate strategy, business unit strategy, product selection, process technology, and management competency. It is often used to refer to whether a company is make-to-stock, make-to-order, or assemble-to-order.
Material requirements planning (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 and helps 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 of all components and materials required to make those items and the dates by which those materials are required. It explodes the bill of material for each item, takes into account inventory on hand or on order and offsets the net requirements by the lead time for each item.
Mean absolute deviation (MAD)
A figure calculated by averaging the sum of the absolute values of each deviation of an actual from an expected figure. This can be used to track the accuracy of a forecast.
Normal distribution A commonly known statistical distribution pattern where most events are close to a ‘mean’ and only occasional events stray far from that mean. Obsolete inventory
Inventory that is out of date or no longer required in the manufacturing process, or made worthless due to the appearance of a better or more economical alternative
Open order
A manufacturing or purchase order that has been released or an unfilled customer order
Opportunity cost
The return on capital that would have resulted had the capital been available for some purpose other than what it has been used for
Order point or reorder point
A predefined inventory level, which if it is higher than the stock on hand and stock on order combined, will trigger an action to replenish the stock.
Order Quantity or Lot size
The amount of an item that is ordered from a supplier or from the plant or is issued as a standard quantity to the production process.
Period order quantity
A lot-sizing technique which equates the lot size to the net requirements for a specified number of periods in the future. The number of periods to order is variable. The order size should equalize the holding costs and ordering costs for the time interval
Periodic inventory audit
A physical count of all inventory undertaken either monthly, quarterly or annually.
Periodic review
A fixed reorder cycle inventory model
Periodic review system
This is also called fixed reorder cycle inventory model. It is a form of independent demand item management in which an order has a fixed
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quantity. The reorder point will be large enough to cover the maximum expected demand during the replenishment lead time. Process cost
A system of cost accounting that collects cost by time period and calculates the average for all units produced during that time period.
Procurement
A fussiness function of planning, purchasing, inventory control, traffic, receiving, incoming inspection, and salvage operations
Product group
A number of similar products. Generally they are grouped according to the process or materials required to make them
Project cost
A method of costing used in project-based industries. Each assignment is costed as a standalone project without reference to other assignments.
Raw material
Purchased items or extracted materials that are converted via the manufacturing process into components and produc ts.
reconciliation
Comparison of physical inventory figures with perpetual inventory records followed by appropriate adjustments to correct the records.
Reserve
Material on hand or on order that is assigned to specific future production or customer orders
Safety stock
This is a quantity of stock that is planned for inventory to protect against fluctuations in demand or supply. In the context of master production scheduling, the additional inventory and capacity planned as protection against forecast errors and short term changes in the backlog. Overplanning can be used to create safety stock. Safety stock is also known as buffer or reserve stock.
Scheduled receipt
An open order with an assigned due date
Scrap
Material outside specifications for which rework is not possible or practical
Seasonality
A pattern of demand that repeats from year to year (or other identified season) where some periods have very high demand compared to others
Service level
A desired measure (usually a percentage) of satisfying demand through inventory or by the current production schedule in time to satisfy the customers’ requested delivery dates and quantities. In a make-to-stock environment, level of service is sometimes the percentage of orders picked complete from stock upon receipt of customer order.
Service parts
Parts (modules, components or elements) that are planned to be used without modification to replace an original part
Shelf life
The amount of time an item may be stored before becoming unusable.
Spare parts or service parts
These are modules, components or elements that may be used without modification to replace an original part
Standard cost
An accounting system that determines cost by using set cost units for estimating the cost of an order. The standard cost is regularly compared against actual costs.
Stock
Items in inventory or stored products / service parts ready for sale, as
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A lack of required materials components or finished goods.
Time period safety stock
An amount of safety stock that covers requirements for a set period of time.
Time-phased order Similar to MRP planning logic for independent demand items, where gross point (TPOP) requirements come from a forecast. The TPOP may be used to plan distribution center inventories and repair parts. The TPOP approach uses time periods, allowing for lumpy withdrawal instead of average demand. Tracking signal
A signal used to highlight when the forecasting method is inaccurate. It is usually the ratio of the cumulative sum of deviations between forecast and actual values compared to the mean absolute deviation (MAD)
Two -bin system
A type of fixed order system in which inventory is carried in tow bins. A replenishment quantity is ordered when the first bin is empty. During the replenishment lead time, material is used from the second bin. When the material is received, the second bin, which contains a quantity to cover demand during the lead time plus some safety stock, is refilled and the excess is put into the working bin. AT this time, stock is drawn from the first bin until it is empty again. The bins may be metaphorical only.
Unit cost
Total labor, material, and overhead cost for one unit of production.
Visual review system
A simple inventory control system which involves looking at the amount of inventory on hand before reordering. It is used for low value items
Work-in-process (WIP)
A product or products in various stages of completion throughout the plant. This includes all material from raw material that has been released for processing, up to completely processed material that is awaiting final inspection and approval as finished goods.
Yield
The amount of usable output from a process as compared to its input. This is usually expressed as a percentage of the input.
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