METHODOLOGY OF CALCULATING THE FIXED COST OF PALLET SPACE SVOČ FST 2012

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1 METHODOLOGY OF CALCULATING THE FIXED COST OF PALLET SPACE SVOČ FST 2012 Tomáš Čechura, Skupova 23, Plzeň Czech Republic ABSTRACT This paper describes a methodology of calculating the fixed costs of pallet space. The proposed methodology consists of six steps. It is based on a stock analysis, which is used not only to describe the present situation, but also to obtain all necessary data for steps that follow. At first storage lagers are identified and then optimal inventory levels are calculated. These values are then compared with the recent of inventory levels. The next step is identification of those items for which this level is too small or too large. The output of the methodology is a specific value of the fixed costs of pallet space and a percentage surcharge to the purchase price. The entire methodology has been practically verified in a case study. Data for the case study have been provided by the company XYZ. KEYWORDS Logistics, inventories, warehousing, cost management INTRODUCTION The well known fact is that stocks bind financial resources. These financial resources do not add any value to the company. The goal is therefore to reduce their volume. Basically there are to ways how to accomplish this. The first option is to reduce inventory levels. The desired ideal condition is zero inventory levels and thus the bounded capital is equal to zero. However, companies usually can not work properly without at least a minimal level of inventories. The second option is to increase inventories turnover. The result is that capital turns faster and can be used efficiently. Both options highlight the importance of inventory management in the company. The focus on inventory management enables the company to reduce inventory levels and thus to release capital which is bounded in inventories. However we must not forget another important fact associated with holding inventories - storage costs. They are related to inventory holding and storing. For the management it is very important to know the real values of these costs. DESCRIPTION OF THE METHODOLOGY The proposed methodology consists of six steps. The main focus was given to the practical usability. This means that results are expected to be understandable and clear for the company management. The goal of this methodology is to calculate fixed costs of pallet space. The additional goal is to calculate a percentage surcharge to the purchase price. The whole methodology uses only those data which could be easily obtained from information system. For this reason the advantage is that this methodology is not theoretical but it is oriented practically. The methodology steps are: 1) Stock analysis. 2) Identification of storage lagers. 3) Determination of minimal inventory levels which are needed to protect the delivery time. 4) Calculation of inventory levels (in days). 5) Calculation of the fixed cost of pallet space. 6) Calculation of a percentage surcharge to the purchase price. These steps are described in detail below. Stock analysis The first step is to analyze inventories. All necessary data for the further calculations are gathered here. There are used only data directly obtainable from information system. This includes the following: Material number (material name), Material group, Date of the last movement, Recent amount (kg, pieces, ), Consumption, sale and purchase during a specific time period, Delivery time (days), Warehouse capacity (max number of pallet spaces).

2 Identification of storage lagers In this step "storage lagers" are identified. Sometimes they are in the literature called as "dead stocks". Lambert marks as storage lagers those items for which there have not been any demands for a certain period of time. [1] The occurrence of storage lagers in the production is undesirable. The reason is that they take up a space that could be used in better way and they bind funds. Process of their identification is as follows: Create a list of all stocks located in the warehouse. Identification of those stocks which had no movement for a certain time period (e.g. 12 months) Identification of lagers to the place of storing (only if there is more than one warehouse) All lagers must be then individually evaluated according to their specific conditions. We have basically two options what to do with storage lagers. Either we keep them in the warehouse (or move within it and try to gradually consume them) or we can try to sell them. But both possibilities are associated with certain losses. If we keep them, they will take up space. Selling is usually possible only under their price. So it is necessary to pay attention to decide whether to hold them in the warehouse or not. Sometimes we have to store them. For example we are forced to store them because the company offers several years of service, emergency reasons, etc. Determination of minimal inventory levels which are needed to protect the delivery time The third step is to calculate the optimal level of inventory that should be kept in the warehouse. The calculated level must be sufficient to cover the delivery time. We assume that the delivery time is constant and without any fluctuations and we assume that there is no safety stock. The purpose of this step is rather than determination of the level of needed inventories, identification of those items with too big or too low inventory levels. The calculation is as follows: Calculation of the average daily consumption by the formula: (1) Determination of the delivery time (obtained from IS). Calculation of necessary inventory level: (2) The calculated inventory levels are then compared with current levels. The comparison is used to quick identification of those items which values differ significantly. The next step is finding specific reasons why this is so. And after this corrective measures are applied. Calculation of inventory levels (days) The aim of this step is to calculate for how many days we have enough inventories. The calculation is similar as in previous step. We are trying to determine the optimal inventory levels once again. But this time different data are required. The calculation is as follows: Calculation of the average daily consumption see equation (1) Determination of current inventory levels; e.g. how many pieces, kilos we have (obtained from IS). Calculation of the necessary inventory levels: (3) The calculated inventory levels are then compared with the delivery time. After this items for which this level is too high or too low levels are identified and evaluated. Calculation of the fixed cost of pallet space We assume that the fixed rate is unique for entire warehouse. If we have more warehouses we will have to calculate fixed rate for each of them separately. Because the calculation is general it is also possible to consider more storage areas within one warehouse. Then we have to calculate fixed rate for each of them. The calculation is as follows: Determination of cost categories. Assigning specific values to cost categories. Elimination of negligible (or zero) categories. Determination of the number of pallet spaces in the warehouse (obtained from IS). Calculation of the fixed rate.

3 First we have to define cost categories. This was done by modifying the basic scheme originated from Sixta and Mačát into the following form [2]: Costs associated with storage activities: o Wages, o Buildings depreciation, o Storage and handling equipment depreciation, o Renting or leasing of external equipment (buildings, logistics facilities, etc.), o Logistics facilities maintenance and repairs (including security), o Energy (fuel, electricity, heating, lighting, etc.), o Costs of logistic materials (costs for packaging, transport packaging, labels, etc.), o Costs of acceptance, inspections. Cost of services: o Taxes and insurance (property tax, road tax), o Costs of external services - such as carriers (renting, leasing) o Costs of information system, planning, designing. Cost of capital: o Cost of capital bounded in inventories (minimum rate is usually the interest rate). Cost of risk: o Inventory obsolescence costs, o Costs of loss, damage, o Costs of extra movements. The next step is to assign specific values to categories. Variable and fixed costs are distinguished. All values should be related to the same time period, for example one year. At this stage it is possible to eliminate the zero and negligible costs (and therefore whole categories). An example is unheated warehouse, where only 10 light bulbs are used. Energy costs are represented only by costs of electricity. This value will be probably negligible in comparison to other costs. Elimination of this group will simplify the calculation model. The main advantage of simplification lies in narrowing data requirements. On the other hand, however, this will result a loss of precision. We have to decide whether is worth it. The calculation of fixed rate is done by dividing total fixed costs by the number of pallets in the warehouse. Mathematically we can write it as follows:, where (4) FC fixed rate for pallet space FN i individual values of fixed costs n number of cost categories np number of pallets in the warehouse Calculation of a percentage surcharge to the purchase price The last step is calculation of a percentage surcharge to the purchase price of a put-away. For example, we buy goods for 1000 and store it. Thus logically some associated costs will appear. After some time we want to sell this goods. But the question is for how much we should do this to cover at least our own expenses. The goal of this step is to find the answer to this question. We calculate a percentage surcharges according to the following formula:, where (5) PP percentage surcharge to the purchase price FC fixed rate for pallet space s average number of pallet places which are occupied by materials at given value t average inventory level in days

4 The formula mentioned above shows that the calculation must be performed gradually to all materials. However to calculate a surcharge for each material extra is unpractical. Therefore it proves to be effective to choose typical materials and create some groups. Then we can solve all materials in one group together. For example we can consider categories like: materials, coats, packages, purchased plastic parts, etc. VERIFICATION OF THE METHODOLOGY The methodology has been practically verified in a case study performed in the company XYZ. This company has provided to us real data. XYZ Company is an engineering company producing plastic parts. It is a medium sized company with approximately employees working in three shifts. Production is focused mainly on the production of components for the automotive, cosmetic and telecommunication industry. Typical products are: elements of the switches, key components, body parts, packages for cosmetics, etc. This company has four warehouses. Warehouses I and II are located right next to the production. Therefore they are mainly used to store materials for production. Stock III is located in few kilometres distance, so it is used to store lagers. Stock IV is a rented warehouse, where the company pays for constant number of rental pallets. The text below shows the results of application of this methodology in the company XYZ. 2) Identification of storage lagers In total we have analyzed 1532 items. The appropriate time period was considered one year. We have found that 52% of items located in warehouses are storage lagers. The same analysis was then performed for manufacturing warehouses I and II only. We have found that 39% of items are lagers. These numbers are very high and indicate inefficient usage of available capacities. Generally, in manufacturing warehouses shouldn t be stored storage lager. Based on this results the company management can more efficiently organize warehouses. 3) a 4). Identification of materials for which we have too high or low inventory levels Both steps are very similar and were dealt together. So the results are also shown together. Table 1 shows five representatives. Both calculations of inventory levels are shown there. material number material name sells comsumpt ions total (6 month) avg. per day current amount delivery time [days] Table 1: Identification of materials which have the inventory level too low or too high inventory levels which are needed to protect the delivery time inventory level [days] BOLZEN XX / Zust , ,43 14, POLYSTYROL 143 E KG , ,57 467, MB ALBIS WEISS B 7500/ , ,52 8, TASTE PSA B , ,38 357, BAYBLEND T 85 NATUR , ,16 74,6 The table 1 shows that some materials (100355, , ) have its inventory level too high. However, we cannot simply look only at calculation results. For each material it is necessary to reasonably justify why this is so. Large inventory level may be hold on purpose for many reasons. For example due to stockpiling, volume discounts from suppliers, etc. 5) Calculation of the fixed cost of pallet space Table 2 shows various categories, including the specific values of individual costs. The lowest fixed costs has warehouse III while the highest costs has warehouse I. This confirms that storing lagers in warehouse III is the cheapest option.

5 Total Warehouse I Warehouse II Warehouse III Warehouse IV Number of pallet places personal costs / wages Kč Kč Kč 0 Kč 0 Kč depreciation of buildings Kč Kč Kč 0 Kč 0 Kč storage facilities depreciation Kč Kč Kč 0 Kč 0 Kč handling equipment depreciation 0 Kč 0 Kč 0 Kč 0 Kč 0 Kč rental and leasing of external devices (buildings) Kč 0 Kč 0 Kč Kč Kč maintenance and repair costs (logistics facilities) Kč Kč Kč 0 Kč 0 Kč energy Kč 0 Kč 0 Kč 0 Kč Kč the cost of logistics material, foils, Kč Kč Kč Kč Kč costs of inspection and acceptance 0 Kč 0 Kč 0 Kč 0 Kč 0 Kč taxes, duties and insurance fees - road fee Kč Kč Kč Kč Kč taxes, duties and insurance fees - property fee Kč Kč Kč 0 Kč 0 Kč taxes, duties and insurance fee - insurance Kč Kč Kč 0 Kč 0 Kč inventory holding costs rate 5,35% Kč Kč Kč 0 Kč Kč inventory obsolescence lossts and damages Kč Kč Kč 0 Kč Kč Fixed costs of a pallet space / day: 6,49 Kč 9,14 Kč 6,47 Kč 4,73 Kč 5,25 Kč Table 2: Calculation of the fixed cost of pallet space 6) Calculation of a percentage surcharge to the purchase price Specific results are not available yet. The verification of this step is still in progress in cooperation with the company. CONCLUSIONS Our goal was to create a methodology for inventory management which will be easily applicable in the practice. Therefore, the methodology focuses on storage lagers and analyzes inventory levels in the warehouse. By comparing the calculated values with recent values it is possible to identify those items for which this value differs. Then these materials are individually reviewed and corrective measures are applied. We must realize that we cannot look only at calculation results. We have to look from bigger perspective. There might be good reasons for holding high inventory levels of some items. An important output of the proposed methodology is calculation of fixed costs of pallet space in the warehouse. This knowledge is crucial especially for company management. It can be also used for further analysis. Another output is a percentage surcharge to the purchase price. This allows the company to put-away materials priced with real value. In other words, it allows company to add to the purchase price the costs associated with storing. Calculation of this percentage is inefficient to make separately for all materials located in the warehouse. This would be extremely time consuming job. The best option seems to be allocation of materials into several groups. All materials in the same group are solved together. ACKNOWLEDGMENTS This paper was supported by the Internal Grant Agency of the University of West Bohemia, project No. SGS Integrated design of manufacturing system as metaproduct with a multidisciplinary approach and with using elements of virtual reality. REFERENCES [1] LAMBERT, D. M., STOCK, R. J., ELLRAM, L. M. Logistika. 2. vydání. Brno : CP Books, str ISBN [2] SIXTA, J., MAČÁT, V. Logistika teorie a praxe. 1. vyd. Brno : Computer Press, a.s., str ISBN [3] Internal documents of the company XYZ.