Inventory Management

Transcription

1 Inventory Management

2 This book is a part of the course by Jaipur National University, Jaipur. This book contains the course content for Inventory Management. JNU, Jaipur First Edition 2013 The content in the book is copyright of JNU. All rights reserved. No part of the content may in any form or by any electronic, mechanical, photocopying, recording, or any other means be reproduced, stored in a retrieval system or be broadcast or transmitted without the prior permission of the publisher. JNU makes reasonable endeavours to ensure content is current and accurate. JNU reserves the right to alter the content whenever the need arises, and to vary it at any time without prior notice.

3 Index I. Content...II II. List of Figures... VIII III. IV. List of Tables...X Abbreviation... XI V. Case Study VI. Bibliography VII. Self Assessment Answers Book at a Glance I/JNU OLE

4 Contents Chapter I...1 Planning Foundations...1 Aim...1 Objectives...1 Learning outcome Defining Inventory Nature of Inventory Raw Materials Work-In-Process Finished Goods MRO Goods Inventory Types Of Inventory Transit Inventory Buffer Inventory Anticipation Inventory Cycle Inventory Top 5 Principles of Inventory Management Inventory Planning: Basic Concepts Need for Planning Reasons for Maintaining Raw Material Inventory Resource Inventory Management Production Planning Planning in Inventory Control Hierarchy of Planning Business Needs An effective Material Organisational Structure Methods of Valuation of Inventory Ratio Analysis in Business Inventory on the Income Statement Inventory on the Balance sheet...26 Summary...27 References...28 Recommended Reading...28 Self Assessment...29 II/JNU OLE

5 Chapter II...31 Long Range Planning and Forecasting...31 Aim...31 Objectives...31 Learning outcome Introduction Basics of Strategic Planning Creation of Strategic Plan Strategy of Team Development and Business Plans Concepts of Business Planning Forecasting Techniques Forecasting Planning and Goals Principles of Forecasting Demand Patterns Reasons for Forecasting Time for Forecasts Methods of Forecasting Qualitative Forecasting Methods Quantitative Forecasting Methods Time Series Forecasting Methods Measuring Forecast Errors Criteria for Selecting a Forecasting Method...50 Summary...51 References...51 Recommended Reading...52 Self Assessment...53 III/JNU OLE

6 IV/JNU OLE Chapter III...55 Sales and Operations Planning...55 Aim...55 Objectives...55 Learning outcome Basics of Sales and Operations Planning Approaches of Sales and Operation Planning Definitions Sales and Operation Planning Importance of S and OP Process Operations Planning for S and OP Process Theory of Constraints Affects Sales and Operations Planning Systems as Chains Throughput, Inventory, and Operating Expense The Five Focusing Steps Formal Work on the Case Study...68 Summary...70 References...70 Recommended Reading...71 Self Assessment...72

7 Chapter IV...75 Making Effective Presentations...75 Aim...75 Objectives...75 Learning outcome Basic Skills Required for Making Effective Presentations Tools for Effective Presentations Planning a Presentation Preparation for Sales and Operation Plan Develop a Proposed Sales and Operations Planning Policy and Meeting Agenda Implement Full Sales and Operations Planning...91 Summary...96 References...96 Recommended Reading...97 Self Assessment...98 V/JNU OLE

8 VI/JNU OLE Chapter V Master Scheduling Aim Objectives Learning outcome Introduction Master Production Scheduling Objectives of Master Production Scheduling Functions of Master Production Schedule Time Interval and Planning Horizon for MPS Time Fences in Master Production Schedules Guidelines for Master Scheduling Updating of MPS MPS in Produce-to-stock and Produce-to-order Firms Length of Planning Horizon of MPS Identify the Components Necessary to Develop a Master Production Schedule (MPS) Available-To-Promise (ATP) MPS time horizon The Four Fundamentals Describe and Develop the Master Schedule (MS) Inputs to MPS Outputs of MPS MPS Terminology Misconception about MPS The Logic of Master Schedule Twelve Principles of Master Scheduling Importance of Master Scheduling in Production Plan Summary References Recommended Reading Self Assessment...122

9 Chapter VI Future Planning Topics Aim Objectives Identify and discuss emerging topics in planning Emerging Trends in Inventory Management Inventory Optimization (IO) Inventory Optimization (IO) Technologies Just In Time (JIT) The Future of Inventory Management in the Era of E-Commerce Inventory Modelling Technology Modelling Demand Behaviour Summary References Recommended Reading Self Assessment VII/JNU OLE

10 List of Figures Fig. 1.1 Summary of purchasing plan...4 Fig. 1.2 Nature of inventory goods...5 Fig. 1.3 Types of inventory...7 Fig. 1.4 Five principles of inventory management...10 Fig. 1.5 The 5S...11 Fig. 1.6 Functions of raw material inventory management...12 Fig. 1.7 Models of inventory management approach...12 Fig. 1.8 EOQ model...13 Fig. 1.9 Reasons for planning...15 Fig Resource management as a process...18 Fig Hierarchy in interactive inventory management...20 Fig Hierarchy in organisational structure...20 Fig Elements of an effective material management organisation...21 Fig Methods of valuation of inventory methods...22 Fig Ratio assessment of Inventory in an organisation...23 Fig. 2.1 Step process of strategic plan...33 Fig. 2.2 Demand patterns of forecasting...40 Fig. 2.3 Time for forecasts...42 Fig. 2.4 Methods of forecasting techniques...43 Fig. 2.5 Types of qualitative methods...43 Fig. 2.6 Types of quantitative methods...45 Fig. 3.1 Plans included in sales and operations planning...56 Fig. 3.2 Two approaches to sales and operation planning...58 Fig. 3.3 Approaches to production plan...59 Fig. 3.4 The sales and operations planning framework...61 Fig. 3.5 Benefits of sales and operation planning...62 Fig. 3.6 The sales and operations planning implementation...63 Fig. 3.7 Theory of constraints...65 Fig. 3.8 Three Dimensions in theory of constraints...66 Fig. 3.9 Three options for system improvement...67 Fig. 4.1 Tools of effective presentation...77 Fig. 4.2 The P-I diagram...79 Fig. 4.3 Four factors required to analyse audience...80 Fig. 4.4 Organising one s thoughts...81 Fig. 4.5 Stating sub-points in the presentation...82 Fig. 4.6 Uses of handouts in presentation...83 Fig. 4.7 Functions of introduction...84 Fig. 4.8 Steps taken to plan a presentation...86 Fig. 4.9 Measurement Standard reviewed at each meeting...92 Fig Factors of Rough Cut Capacity Planning...93 Fig Key Operating objectives in Rough Cut Capacity Planning...94 Fig. 5.1 Four sections of time fence VIII/JNU OLE

11 Fig. 5.2 Planned BOM Fig. 5.3 Multiple MPS Levels Fig. 5.4 Available To Promise Fig. 5.5 Four Fundamentals Fig. 5.6 Matching demand through MPS IX/JNU OLE

12 List of Tables Table 2.1 Time for forecast...41 Table 2.2 Components of time series demand...46 Table 3.1 Throughput, Inventory and operating expense...66 Table 4.1 Educational steps in Sales and Operation Planning...89 Table 5.1 MPS Table Table 5.2 Format of MPS Table Table 5.3 MPS Table Table 5.4 Scheduling planned order release for Product 2400A base on Master Schedule Table 6.1 Different types of inventory management and control techniques X/JNU OLE

13 Abbreviations APICS - Advancing Productivity, Innovation and Competitive Success APS - Advanced Planning Software systems ATP - Available-To-Promise CEO - Chief Executive Officer CFE - Cumulative Sum of Forecast Errors CPG - Consumer Packages Goods CPU - Central Processing Unit CRT - Cathode Ray Tube EOQ - Economic Order Quantity ERP - Enterprise Resource Planning FIFO - First-In-First-Out GUI - Graphical User Interface HPCL - Hindustan Petroleum Corporation Limited IO - Inventory Optimisation JIT - Just in Time LA - Los Angeles LFL - Lot-Far-Lot LIFO - Last-In-First-Out MAD - Mean Absolute Deviation MAPE - Mean Absolute Percent Error MNCs - Multinational Companies MPS - Master Production Schedule MRO - Maintenance Repair and Operating Supplies MRP - Material Requirement Planning MSE - Mean Squared Error POS - Point-Of-Sale S&OP - Sales and Operation Planning SKU - Stock Keeping Unit SMART - Specific, measurable, possible, relevant, and time-framed SWOT - Strengths, Weaknesses, Opportunities, and Threats T, I and O E - Throughput, Inventory, and Operating Expense TOC - Theory of Constraints VMI - Vendor Managed Inventory WIP - Work In Progress XI/JNU OLE

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15 Chapter I Planning Foundations Aim The aim of this chapter is to: discuss the meaning of inventory state different types of inventory in business illustrate the nature of inventory in business Objectives The objectives of this chapter are to: highlight the principles of inventory management state different methods of inventory valuation clarify the different assessment ratios of inventory in business Learning outcome At the end of this chapter, you will be able to: understand the concepts and procedures in inventory management explain the crucial role of inventory in business profitability discuss the formulation and application of methods for inventory 1/JNU OLE

16 Inventory Management 1.1 Defining Inventory Inventory is one of the new, noticeable and concrete aspects for many small business owners. Raw materials, goods in process and finished goods all represent various forms of inventory. Each type represents money tied up until the inventory leaves the company as purchased products. Similarly, merchandise stocks in a retail store contribute to profits only when their sale puts money into the cash register. Inventory is an idle stock of physical goods that contain economic value, and are held in various forms by an organisation in its custody awaiting packing, processing, transformation, use or sale in future. Literally, inventory refers to stocks of anything necessary to do business. These stocks represent a large portion of the business investment and must be well managed in order to maximise profits. In fact, many small businesses cannot absorb the types of losses arising from poor inventory management. Unless inventories are controlled, they are unreliable, inefficient and costly. Inventory is a list of goods and materials or those goods and materials themselves, held available in stock by a business. Inventory are held in order to manage and hide from the customer the fact that, manufacture delay is longer than delivery delay, and also to ease the effect of imperfections in the manufacturing process that lower production efficiencies if production capacity stands idle for lack of materials. Any organisation which is into production, trading, sale and service of a product will necessarily hold stock of various physical resources to aid in future consumption and sale. While inventory is a necessary evil of any such business, it may be noted that the organisations hold inventories for various reasons, which include speculative purposes, functional purposes, physical necessities etc. From the above definition the following points stand out with reference to inventory: 2/JNU OLE

17 All organisations engaged in production or sale of products hold inventory in one form or other. Inventory can be in complete or incomplete state. Inventory is held to facilitate future consumption, sale or further processing/value addition. All inventoried resources have economic value and can be considered as assets of the organisation. One of the most significant aspects of inventory control is to have the items in stock at the moment they are required. This includes going into the market to buy the goods early enough to ensure delivery at the proper time. Thus, buying requires advance planning to determine inventory needs for each time period and then making the commitments without procrastination. For instance, a retail firm must formulate a plan to ensure the sale of the greatest number of units. Similarly, a manufacturing business must formulate a plan to ensure enough inventory is on hand for production of a finished product. In summary, the purchasing plan details will be as follows: 3/JNU OLE

18 Inventory Management When commitement should be placed When the first delivery should be received Purchase Plan Details When the inventory should be peaked When reorders should not be placed When the item should no longer be in stock Fig.1.1 Summary of purchasing plan Well planned purchases affect the price, delivery and availability of products for sale. 1.2 Nature of Inventory Inventory of materials occurs at various stages and departments of an organisation. A manufacturing organisation holds inventory of raw materials and consumables required for production. It also holds inventory of semi-finished goods at various stages in the plant with various departments. Finished goods inventory is held at plant, FG Stores, distribution centres etc. Further both raw materials and finished goods those which are in transit at various locations also form a part of inventory depending upon who owns the inventory at the particular juncture. Finished goods inventory is held by the organisation at various stocking points or with dealers and stockiest until it reaches the market and end customers. Besides raw materials and finished goods, organisations also hold inventories of spare parts to service the products. Defective products, defective parts and scrap also form a part of inventory as long as these items are inventoried in the books of the company and have economic value. Generally, inventory types can be grouped into four classifications: 4/JNU OLE

19 Raw Materials MRO Goods Nature of Inventory Goods Work in Progress Finished Goods Fig. 1.2 Nature of inventory goods Raw Materials Raw materials are inventory items which are used in the manufacturer s conversion process to produce components, subassemblies, or finished products. These inventory items may be objects or elements that the firm has purchased from outside the organisation. They also may be commodities or extracted materials that the firm or its subsidiary has produced or extracted. Even if the item is partially assembled or is considered a finished good to the supplier, the purchaser may classify it as a raw material if his or her firm had no input into its production. Usually, raw materials are commodities such as ore, grain, minerals, petroleum, chemicals, paper, wood, paint, steel, and food items. However, items such as nuts and bolts, ball bearings, key stock, casters, seats, wheels, and even engines may be considered as raw materials if they are purchased from outside the firm. The bill-of-materials file in a material requirements planning system (MRP) or a manufacturing resource planning (MRP II) system utilises a tool known as a product structure tree to clarify the relationship among its inventory items and provide a basis for filling out or exploding, the master production schedule. Consider an example of a rolling cart. This cart consists of a top that is pressed from a sheet of steel, a frame formed from four steel bars, and a leg assembly consisting of four legs, rolled from sheet steel, each with a caster attached. 5/JNU OLE

20 Inventory Management Commonly, raw materials are used in the manufacture of components. These components are then incorporated into the final product or become part of a subassembly. Then, the subassemblies are used to manufacture or assemble the final product. A part that goes into making another part is known as a component, while the part it goes into is known as its parent. Any item which does not have a component is regarded as a raw material or purchased item. From the product structure tree it is clear that the rolling cart s raw materials are steel, bars, wheels, ball bearings, axles, and caster frames Work-In-Process Work-in-process (WIP) is made up of all the materials, parts (components), assemblies, and subassemblies that are being processed or are waiting to be processed within the system. This generally includes all material from raw material that has been released for initial processing up to material that has been completely processed and is awaiting final inspection and acceptance before inclusion in finished goods. Any item that has a parent but is not a raw material is considered to be work-inprocess. A glance at the rolling cart product structure tree example reveals that work-in-process in this situation consists of tops, leg assemblies, frames, legs, and casters. Actually, the leg assembly and casters are labelled as subassemblies because the leg assembly consists of legs and casters and the casters are assembled from wheels, ball bearings, axles, and caster frames Finished Goods A finished good is a completed part that is ready for a customer order. Therefore, finished goods inventory is the stock of completed products. These goods have been inspected and have passed final inspection requirements so that they can be transferred out of work-in-process and into finished goods inventory. From this point, finished goods can be sold directly to their final user, sold to retailers, sold to wholesalers, sent to distribution centres or held in anticipation of a customer order. Any item that does not have a parent can be classified as a finished good. By looking at the rolling cart product structure tree example one can determine that the finished good in this case is a cart MRO Goods Inventory Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and maintain the production process and its infrastructure. These goods are usually consumed as a result of the production process but are not directly a part of the finished product. Examples of MRO goods include oils, lubricants, coolants, janitorial supplies, uniforms, gloves, packing material, tools, nuts, bolts, screws, shim stock, and key stock. Even office supplies such as staples, pens and pencils, copier paper, and toner are considered part of MRO goods inventory. 6/JNU OLE

21 1.3 Types Of Inventory Inventories can be further classified according to the purpose they serve. These types include transit inventory, buffer inventory, anticipation inventory, decoupling inventory, cycle inventory, and MRO goods inventory. Some of these also are know by other names, such as speculative inventory, safety inventory, and seasonal inventory. Transit Inventory MRO Goods Inventory Types of Inventory Buffer Inventory Cycle Inventory Anticipation Inventory Fig.1.3 Types of inventory Transit Inventory Transit inventories are the ones that need to transport items or material from one location to another, and from the fact that there is some transportation time involved in getting from one location to another. Sometimes this is referred to as pipeline inventory. Merchandise shipped by truck or rail can sometimes take days or even weeks to go from a regional warehouse to a retail facility. Big companies such as automobile manufacturers, employ freight consolidators to pool their transit inventories coming from various locations into one shipping source in order to take advantage of economies of scale. Of course, this can greatly increase the transit time for these inventories, hence an increase in the size of the inventory in transit. Take the case of HPCL, the transports are done from refinery to the customer through different modes of transport i.e., Pipeline, Roadways (Tankers), Shipping, etc. the time taken for goods to reach from refinery to the customer is called transit inventory. 7/JNU OLE

22 Inventory Management Buffer Inventory Some inventory used to protect against the uncertainties of supply and demand, as well as unpredictable events such as poor delivery reliability or poor quality of a supplier s products. These inventory cushions are often referred to as safety stock. Safety stock or buffer inventory is any amount held on hand that is over and above that currently needed to meet demand. Generally, the higher the level of buffer inventory, the better the firm s customer service. This occurs because the firm suffers fewer stock-outs (when a customer s order cannot be immediately filled from existing inventory) and has less need to backorder the item, make the customer wait until the next order cycle, or even worse, causes the customer to leave empty-handed to find another supplier. Obviously, the better the customer service the greater the likelihood of customer satisfaction Anticipation Inventory Some firms will purchase and hold inventory that is in excess of their current need in expectation of a possible future event. Such events may include a price increase, a seasonal increase in demand, or even an impending labour strike. This tactic is commonly used by retailers, who routinely build up inventory months before the demand for their products will be unusually high (i.e., at Halloween, Christmas, or the back-to-school season). For manufacturers, anticipation inventory allows them to build up inventory when demand is low (also keeping workers busy during slack times) so that when demand picks up the increased inventory will be slowly depleted and the firm does not have to react by increasing production time (along with the subsequent increase in hiring, training, and other associated labour costs). Therefore, the firm has avoided both excessive overtime due to increased demand and hiring costs due to increased demand. It also has avoided layoff costs associated with production cutbacks, or worse, the idling or shutting down of facilities. This process is sometimes called smoothing because it smoothes the peaks and valleys in demand, allowing the firm to maintain a constant level of output and a stable workforce. Case I: Let s take a case of Dulux paint, in paint industry there will be a seasonality of demand. Which means their production will be throughout the year and distribution will be on peak time i.e., market demand will be more in the month of March to May and June to November, this will be done for smooth distribution. Very rarely, if ever, will one see a production facility where every machine in the process produces at exactly the same rate. In fact, one machine may process parts several times faster than the machines in front of or behind it. Yet, if one walks through the plant it may be seen that all machines are running smoothly at the same time. It also could be possible that while passing through the plant, one notices that several machines are under repair or are undergoing some form of preventive maintenance. Even so, this does not seem to interrupt the flow of work-in-process through the system. The reason for this is the existence of an inventory of parts between machines, a decoupling inventory that serves as a shock absorber, cushioning the system against production irregularities. As such it decouples or disengages the plant s dependence upon the sequential 8/JNU OLE

23 requirements of the system (i.e., one machine feeds parts to the next machine).the more inventory a firm carries as a decoupling inventory between the various stages in its manufacturing system (or even distribution system), the less coordination is needed to keep the system running smoothly. Naturally, logic would dictate that an infinite amount of decoupling inventory would not keep the system running in peak form. A balance can be reached that will allow the plant to run relatively smoothly without maintaining an absurd level of inventory. The cost of efficiency must be weighed against the cost of carrying excess inventory so that there is an optimum balance between inventory level and coordination within the system. Case II: Take a case of Book making industry. The manager knows that paper making machine will not be working after two days and production will stop because of that so, they will produce more quantity of papers in advance and when the machine is not working at that time binding will be done. As a result distribution will not be affected by stopping the production Cycle Inventory Those who are familiar with the concept of economic order quantity (EOQ) know that the EOQ is an attempt to balance inventory holding or carrying costs with the costs incurred from ordering or setting up machinery. When large quantities are ordered or produced, inventory holding costs are increased, but ordering/setup costs decrease. Conversely, when lot sizes decrease, inventory holding/carrying costs decrease, but the cost of ordering/setup increases since more orders/setups are required to meet demand. When the two costs are equal (holding/carrying costs and ordering/setup costs) the total cost (the sum of the two costs) is minimised. Cycle inventories, sometimes called lot-size inventories, result from this process. Usually, excess material is ordered and, consequently, held in inventory in an effort to reach this minimisation point. Hence, cycle inventory results from ordering in batches or lot sizes rather than ordering material strictly as needed. 1.4 Top 5 Principles of Inventory Management Inventory management is the most integral part of any business, small or large.the principles of inventory management can be listed as under : 9/JNU OLE

24 Inventory Management Demand Forecasting Process Auditing Principles of Inventory Management Warehouse Flow Cycle Counting Inventory Turns/Stock Rotation Fig. 1.4 Five principles of inventory management Demand forecasting Depending on the industry, inventory ranks in the top five business costs. Accurate demand forecasting has the highest potential savings for any of the principles of inventory management. Both over supply and under supply of inventory can have critical business costs. Whether it is end-item stocking or raw component sourcing, the more accurate the forecast can be. Establishing appropriate max-min management at the unique inventory line level, based on lead times and safety stock level help ensure that you have what when you need it. This also avoids costly overstocks. Idle inventory increases incremental costs due to handling and lost storage space for fast-movers. Warehouse flow The old concept of warehouses being dirty and unorganised is out dated and costly. Lean manufacturing concepts, including 5S have found a place in warehousing. Sorting, setting order, systemic cleaning, standardising, and sustaining the discipline ensure that no dollars are lost to poor processes. 10/JNU OLE

25 Sorting Setting Order Systemic Cleaning Sustaining the Discipline Standardising Fig. 1.5 The 5S The principles of inventory management are not any different from other industrial processes. Disorganisation costs money. Each process, from housekeeping to inventory transactions needs a formal, standardised process to ensure consistently outstanding results. Inventory turns/stock rotation In certain industries, such as pharmaceuticals, foodstuffs and even in chemical warehousing, managing inventory can be critical to minimising business costs. Inventory turns is one of the key metrics used in evaluating how effective your execution is of the principles of inventory management. Defining the success level for stock rotation is critical to analysing your demand forecasting and warehouse flow. Cycle counting One of the key methods of maintaining accurate inventory is cycle counting. It helps measure the success of your existing processes and maintains accountability of potential error sources. There are financial implications to cycle counting. Some industries require periodic 100% counts. These are done through perpetual inventory count maintenance or through full-building counts. Proactive One of the cornerstone principles of inventory management is to audit early and often. Error source identification starts with process audits. Process audits should occur at each transactional step, from receiving to shipping and all inventory transactions in between. 11/JNU OLE

26 Inventory Management 1.5 Inventory Planning: Basic Concepts Every organisation which is engaged in production, sales or trading of products, hold inventory in one or the other form. While production and manufacturing organisations hold raw material inventories, finished goods and spare parts inventories, trading companies might hold only finished goods inventories depending upon the business model. Raw material inventory management essentially deals with two major functions, which are: Functions of Raw Material Inventory Management Inventory Planning Inventory Tracking Fig. 1.6 Functions of raw material inventory management As inventory planners, their main job consists of analysing demand and deciding when to order and how much to order new inventories. Traditional inventory management approach consists of three models namely: Economic Order Quantity (EOQ) Continuous Order Model Periodic System Model Fig. 1.7 Models of inventory management approach 12/JNU OLE

27 EOQ (Economic Order Quantity): Economic Order Quantity method determines the optimal order quantity that will minimise the total inventory cost. EOQ is a basic model and further models developed based on this model include Production Quantity Model and Quantity Discount Model. Annual cost ($) Minimum Total Annual Total Annual Cost Annual carrying Cost Annual Ordering Cost Order Quantity Fig. 1.8 EOQ model (Source: EOQ for Production Lot: This model is also used to determine the order size and the production lot for an item to be produced at one stage of production and stored as work in progress inventory to be supplied to the next state of production or to the customer. Continuous Order Model: This model works on fixed order quantity basis where a trigger for fixed quantity replenishment is released whenever the inventory level reaches predetermined safety level and triggers re ordering. Periodic System Model: This model works on the basis of placing order after a fixed period of time. Example: Biotech. Co produces chemicals to sell to wholesalers. One of the raw materials it buys is sodium nitrate which is purchased at the rate of $22.50 per ton. Biotech s forecasts show a estimated requirement of 5, 75,000 tons of sodium nitrate for the coming year. The annual total carrying cost for this material is 40% of acquisition cost and the ordering cost is $595. What is the Most Economical Order Quantity? Solution: EOQ = D = Annual Demand C = Carrying Cost S = Ordering Cost D = 5, 75,000 tons C =0.40(22.50) = $9.00/Ton/Year S = $595/Order 13/JNU OLE

28 Inventory Management EOQ = = 27, tons per Order This model pre supposes certain assumptions as under: No safety stocks available in inventory. No shortages allowed in order delivery. Demand is at uniform rate and does not fluctuate. Lead time for order delivery is constant. One order = One delivery (no shortages allowed) This model does not take into account other costs of inventory such as stock out cost, acquisition cost etc to calculate EOQ. In this model, the demand increases for production the inventory gets depleted. When the inventory drops to a critical point the re order process gets triggered. New order is always placed for fixed quantities. On receipt of the delivery against the order the inventory level goes up. In addition, by using this model, further data extrapolation is possible to determine other factors like how many orders are to be placed in a year and what is the time lapse between orders etc. 1.6 Need for Planning Every organisation would have to maintain inventory for various purposes. Optimum inventory management is the goal of every inventory planner. Over inventory or under inventory both affect financial impact as well as effect business opportunities. Inventory holding is resorted to by organisations as hedge against various external and internal factors such as precaution, opportunity, a need and for speculative purposes. Planning is defining organisational goals, establishing a strategy for reaching those goals and developing a comprehensive hierarchy of plans to integrate and coordinate activities. It can be either formal or informal, depending on the time frame and amount of documentation. Planning should be done for four reasons. First planning coordinates effort by giving direction to managers and non-managers. When all members of organisation understand where the organisation is going and what they should do to contribute to the objectives, they will coordinate their activities and cooperate with each other. On the other hand, various organisational members or their units might work against one another. 14/JNU OLE

29 Second planning reduces uncertainty by forcing managers to look ahead, anticipate change and develop appropriate responses. If the environment never changes, there would be little need for planning. In that case everything can be spell out in some manual. Technological, social, political, economic, and legal changes are ever-present. The environment is too dynamic to left the organisation s survival to chance. Third planning reduces redundancy. Coordination beforehand can uncover the redundancy and when ends and means are clear, inefficiencies become obvious. Fourth planning sets standards or objectives that facilitate control over the process of achieving goals. Set Control Standards Minimise Waste or Redundancy Reasons for Planning Provide Direction Reduce the Impact of Change Fig. 1.9 Reasons for planning Planning is essential to: define an organisation s goals and requirements for organisational structure and employees establish an overall strategy and objectives for leading and directing develop a comprehensive hierarchy of plan and standards for controlling organisation s activities 15/JNU OLE

30 Inventory Management 1.7 Reasons for Maintaining Raw Material Inventory raw material inventory warehouses attached to the production facilitiesin many organisations. The raw materials, consumables, and packing materials are stored and issue for production on JIT (Just in Time)basis. The reasons for holding inventories can vary from case to case basis which can be reviewed as under:. Meet variation in production demand The sales, estimates, orders, and stocking patterns in an organisation keep changing.resulting in Production plan changes Accordingly the demand for raw material supply for production varies with the product plan in terms of specific SKU (Stock Keeping Unit) as well as batch quantities. Issuing the required quantity and item to production just in timemakes holding inventories at a nearby warehouse important. Cater to cyclical and seasonal demand Some demand in market and supplies are seasonal depending upon various factors like seasons; festivals etc and past sales data help companies to anticipate a huge surge of demand in the market well in advance. Accordingly they stock up raw materials and hold inventories to be able to increase production and rush supplies to the market to meet the increased demand. Economies of scale in procurement Many organisations buy raw materials in larger lot and holding inventory as it is found to be cheaper for the companies than buying frequent small lots. In such cases one buys in bulk and holds inventories at the plant warehouse. Take advantage of price increase and quantity discounts If there is a price increase anticipated by the managers few months down the line due to changes in demand and supply in the national or international market, impact of taxes and budgets etc. So the companies tend to buy raw materials in advance in order to hedge against increased costs holds stocks. Companies resort to buying in bulk and holding raw material inventories to take advantage of the quantity discounts offered by the supplier. The savings on account of the discount enjoyed would be substantially higher that of inventory carrying cost in such cases. Reduce transit cost and transit times One can save a lot in terms of transportation cost buy buying in bulk and transporting as a container load or a full truck load as raw materials being imported from a foreign country or from a far away vendor within the country, Part shipments can be costlier. In terms of transit time too, transit time for full container shipment or a full truck load is direct and faster unlike part shipment load where the freight forwarder waits for other loads to fill the container which can take several weeks. There could be a lot of factors resulting in shipping delays and transportation too, which can hamper the supply chain forcing companies to hold safety stock of raw material inventories. 16/JNU OLE

31 Long lead and high demand items need to be held in inventory Often raw material supplies from vendors have long lead running into several months. If the particular item is in high demand, and short supply one can expect disruption of supplies making it safer to hold inventories and have control. 1.8 Resource Inventory Management Resource inventory management manage the information pertaining to all the resources used to implement services and products. Various element management systems and resource inventory database systems are areas which typically linked to this application Resource Management applications also play a role in managing spare parts; dumb resources such as cable pairs, and external plant and customer premises equipment. These applications can also be used to discover and manage underutilised or stranded resources. Resources are the most integral part of Inventory management Emergency management and incident response activities which require carefully managed resources such as personnel, teams, facilities, equipment, and/or supplies to meet incident needs. Utilisation of the standardised resource management concepts such as typing, inventorying, organising, and tracking will facilitate the dispatch, deployment, and recovery of resources before, during, and after an incident. If resource management is flexible and can be scaled then it will support any incident and be adaptable to changes. Efficient and effective use of resources requires that resource management concepts and principles be used in all phases of emergency management and incident response. The resource management process would be divided for convenience as two separate process: resource management as an element of preparedness and resource management during an incident. The preparedness activities (resource typing, credentialing, and inventorying) are carried out on a regular basis which helps ensure that resources are ready to be mobilised when called to an incident. During an incident, Resource management would be considered as a finite process, as shown in the below figure, with a distinct beginning and ending specific to the needs of the particular incident. 17/JNU OLE

32 Inventory Management Identify requirements Preparedness activities for Resource management Resources typing Credentialing Incident Order and Aqcuire Inventory Mobilise Reimburse Recover/ demobilise Expendable/ Nonexpendable Track and Report Fig Resource management as a process Credentialing The credentialing process entails the objective evaluation and documentation of an individual s current certification, license, or degree; training and experience; and competence or proficiency to meet nationally accepted standards, provide particular services and/or functions, or perform specific tasks under specific conditions during an incident. 1.9 Production Planning Production planning is strongly related to the layout type of a considered production system. An experimental analysis of production systems to be found in industrial practice reveals many differences which have a significant impact on the type of planning models that may be applicable in a certain planning environment. There are numerous different layout types, e.g. fixed position layout, process layout (job shop production), product layout (flow lines), just-in-time production systems, and cellular layout, among others. In each type of production system specific planning problems emerge for which the literature provides an appropriate modelling and solution approach. A wide variety of planning approaches are partly implemented for the solution of the production planning problems. The operations management literature provides in so called Advanced Planning Software systems (APS) for this. It is a common 18/JNU OLE

33 property of most of these approaches, such as aggregate production planning, master planning as well as lot sizing, that planning is based on forecasts of future demands. This is treated as deterministic data in the planning process. This could be interpreted as the external demand quantities and the flow times (including waiting times caused by bottlenecks or machine breakdowns) as well as the scrap rates which in some industries are significant, are treated as deterministic factors. In reality random influences take effect, planning concepts are required which are able to take the unavoidable uncertainty on all levels of planning and control of the value-adding processes into account. From a theoretical point of view, this would mean to extend, say, a mixed-integer multi-level capacitated dynamic lot sizing model by including random variables in the model formulation. Such an approach are considered disappointing as for many production planning models including the deterministic version of the problem can be solved satisfactorily Planning in Inventory Control For retailers, planning ahead is one of the most important aspects of inventory control management. This includes prepping activities like going into the market to buy the goods early enough to ensure delivery on time. Therefore buying requires advance planning to determine inventory needs for each time period and then making the commitments without procrastination. New items are for sale months before the actual calendar date for the beginning of the new season,. It is vital to formulate buying plans early enough to allow for intelligent buying without any last minute panic purchases The early offering for sale of new items is that the retailer regards the calendar date for the beginning of the new season as the merchandise date for the end of the old season. For example, many retailers view March 21 as the end of the spring season, June 21 as the end of summer and December 21 as the end of winter. Exhaustion of the inventory Part of your purchasing plan must include accounting for the same Before a decision can be made as to the level of inventory to order, one must determine how long the inventory you have in stock will last. For instance, a retail firm must formulate a plan to ensure the sale of the greatest number of units. A manufacturing business must formulate a plan to ensure enough inventories is on hand for production of a finished product Hierarchy of Planning The inventory department is a very important department in any organisation The hierarchy of planning inventory can be explained with the help of the following figure: 19/JNU OLE

34 Inventory Management Manage Inventory Update Stock Genarate Report Manage Report Process Sale Process Return Process Shipment Respond to Query Display Status Report Modify Record Add Record Delete Record Fig Hierarchy in interactive inventory management (Source: html#heading6) 1.12 Business Needs The functions of business are to reduce purchasing and inventory costs. If a connection is brought about between inventory control, purchasing, and sales order processing with demand planning, it will further help in reducing costs, improve cash flow, and help ensure that you have the right stock available when you need it. Gaining visibility into inventory processes by effectively balancing availability with demand and track items and their possible expiration dates throughout the supply chain to help minimise on-hand inventory, optimise replenishment, and increase warehouse efficiency. To improve customer satisfaction, make more accurate order promises and intelligent last-minute exceptions with access to up-to-date inventory information. Respond quickly and knowledgably to customer queries for improved customer service. Reduce time to market. With integrated order, inventory, and distribution processes, as well as item tracking capabilities, your business can reduce manual data entry and get your goods to market fast. General Management Manucfacturing Materials Manager Marketing Finance Human Relation Purchasing Production Planning and Inventory Control Distribution and Traffic Fig.1.12 Hierarchy in organisational structure 20/JNU OLE

35 The output of an undertaking depends on successful implementation of activities which are followed in the process of building an effective organisational structure. These activities consist of assigning duties and responsibilities clearly. Various departments decide the requirements according to the qualifications of each position determining each task to be carried out An effective Material Organisational Structure Define Duties Acheive Co-ordination Functional Decentralisation Proper Delegation of Authority Proper Assignment of Responsilities Periodical Checks Fig Elements of an effective material management organisation An effective material organisational structure should also be economic. In an organisational structure, the materials manager exercises a high degree of coordination and control over all the material activities. A single line of command runs through the organisational structure where activities constitute different stages of a single function. An integrated form helps in rapid transfer of data through effective and informal communication channels ensuring cost savings and improvements in service levels. A central materials manager is on par with engineering and production and enjoys better support and coordination in the accomplishment of the materials function. This creates an atmosphere of trust and better relations between the user department and the materials management department Methods of Valuation of Inventory Increased automation and item tracking capabilities help you improve inventory accuracy and better match with the goods you have on hand with customer demand. In order to assign a cost value to inventory, you must make some assumptions about the inventory on hand. Under the federal income tax laws, a company can only make these assumptions once per fiscal year. Tax treatment is often an organisation s chief concern regarding inventory valuation. There are five common inventory valuation methods: 21/JNU OLE

36 Inventory Management First-in, First-out (FIFO) inventory valuation assumes that the first goods purchased are the first to be used or sold regardless of the actual timing of their use or sale. This method is most closely tied to actual physical flow of goods in inventory. Last-in, First-out (LIFO) inventory valuation assumes that the most recently purchased/acquired goods are the first to be used or sold regardless of the actual timing of their use or sale. Since items you have just bought often cost more than those purchased in the past, this method best matches current costs with current revenues. Average Cost Method of inventory valuation identifies the value of inventory and cost of goods sold by calculating an average unit cost for all goods available for sale during a given period of time. This valuation method assumes that ending inventory consists of all goods available for sale. Average Cost = Total Cost of Goods Total Quantity of Goods Available for Sale Available for Sale Specific Cost Method (also Actual Cost Method) of inventory valuation assumes that the organisation can track the actual cost of an item into, through, and out of the facility. That ability allows you to charge the actual cost of a given item to production or sales. Specific costing is generally used only by companies with sophisticated computer systems or reserved for high-value items such as artwork or custom-made items. Standard Cost Method of inventory valuation is often used by manufacturing companies to give all of their departments a uniform value for an item throughout a given year. This method is a best guess approach based on known costs and expenses such as historical costs and any predictable changes coming up in the foreseeable future. It is not used to calculate actual net profit or for income tax purposes. Rather, it is a working tool more than a formal accounting approach. First-in, First-out (FIFO) Last-in, First-out (LIFO) Average Cost Method Standard Cost Method Fig Methods of valuation of inventory methods 22/JNU OLE

37 1.15 Ratio Analysis in Business Ratio is an expression of number of items which is contained within another. The business world uses Ratios in selecting parts of an organisation s financial statements.it compares one set of financial conditions to another. A company s financial statements contain important aspects of the business. By reviewing these aspects, determination of an organisation s economic well-being can be achieved. Division of one by the other is one way of reviewing these financial conditions. For example, if you had $200 cash and $100 worth of debts, you could divide the cash (assets) by the debt (liabilities) getting a ratio of 2 to 1. In other words, you have twice as many assets as you have in liabilities. Ratios are useful tools to explain trends and also help in summarising business results. Often third parties, such as banks use ratios to determine a company s credit worthiness. A ratio holds little meaning but however when it is compared to other industry and/or company-specific figures or standards, ratios can be powerful in helping to analyse your company s current and historical results. Companies in the same industry often have similar liquidity ratios or benchmarks, as they often have similar cost structures. Your company s ratios can be compared to: Prior period(s) Company goals or budget projections Companies in your industry Companies in other industries Companies in different geographic regions The following can list three ratios that are useful when assessing inventory in an organisation. Current Ratio Quick ratio/ Acid test Inventory turnover ratio Fig Ratio assessment of Inventory in an organisation Current Ratio. The current ratio assesses the organisation s overall liquidity which indicates a company s ability to meet its short-term obligations. The current ratio indicates how much of assets we have against liabilities that the organisation owes. In other words, it measures whether or not a company will be able to pay its bills. The current ratio is calculated as follows: 23/JNU OLE

38 Inventory Management Current Ratio = Current Assets Current Liabilities Current Assets refers to those assets which are in form of cash or that are easily convertible to cash within one year, such as accounts receivable, securities, and inventory. Current Liabilities refers to liabilities that are due and payable within twelve months, such as accounts payable, notes payable and short-term portion of long-term debt. Standards for the current ratio vary from industry to industry. Companies that carry inventory also have higher current ratios. Manufacturing companies are included in this latter group where in they inventory in the form of finished goods have ready for sale and also they carry inventory of goods that are not yet ready for sale. The longer it takes a company to manufacture the inventory will have higher the current ratio and the more inventory it must keep on hand. A low current ratio may signal either that a company has liquidity problems or has trouble meeting its short and long-term obligations. In other words, the organisation might be suffering from a lack of cash flow to cover operating and other expenses. As a result, accounts payable may be building at a faster rate than receivables. This is sometimes used in conjunction with other factors to determine the overall financial health of an organisation as an indication. In fact, some companies will have good cash flow can sustain lower-than-average current ratios because they move their inventory quickly and/or are quick to collect from their customers. A high current ratio is not necessarily desirable. It might indicate that the company is holding high-risk inventory or just maybe doing a bad job of managing its assets. For example, fashion retailers may have costly inventory, but they might also have significant trouble getting rid of the inventory if at all the wrong clothing line were to be selected. The fact that makes it a high-risk company, forcing creditors to require a bigger financial cushion. Further, if a high current ratio is a result of a very large cash account can be used as an indicator that the company is not reinvesting its cash appropriately. The liquidity problems might still exist even if the current ratio looks fine as other factors must be taken into consideration. Since ratios look at quantity, not quality, it is important to look at what the current assets consist of to determine if they are made up of slow-moving inventory. Quick Ratio or Acid Test. The quick ratio compares the organisation s most liquid current assets to its current liabilities. The quick ratio is calculated as follows: Quick Ratio = (Current Assets Inventories) Current Liabilities In other words, the company has at less in liquid assets (likely in the form of accounts receivable) than liabilities. Industries that have significant cash sales (such as grocery stores) tend to be even lower. As with the current ratio, a low quick ratio could be an indicator of cash flow problems, while a high ratio may indicate poor asset management as cash may be properly reinvested or accounts receivable levels are out of control. An organisation s ability to promptly collect its accounts receivable has a significant impact on this ratio. It has more collection results in more liquidity. 24/JNU OLE

39 Inventory Turnover Ratio. The inventory turnover ratio measures how many times inventory is replaced over a period of time on an average. In simple terms, an inventory turn occurs every time an item is received, is used or sold, and then is replaced. If an SKU (Store Keeping Unit) came in twice during the year, was used/sold, and then replenished, that would be two turns per year. If this happened once per month, it would be twelve turns per year, and so forth. Since the ability to move inventory quickly Inventory turnover is considered quite an important measure since it directly impacts the company s liquidity. Inventory turnover is calculated as follows: Inventory Turnover Ratio = Cost of Goods Sold Average Inventory Essentially, when a product is sold, it is subtracted from inventory and transferred to cost of goods sold. Therefore, this ratio indicates how quickly inventory is moving for accounting purposes. It does not necessarily reflect how many times actual physical items were handled within the facility itself. This is true because the cost of goods sold number may include items you sold but never physically handled. For example, items that we purchase and then have drop-shipped directly at our customer s site aren t ever handled within our facility. A more accurate measure of how many times actual physical inventory turned within the site would be: Inventory Turnover Ratio = Cost of Goods Sold Average Inventory If the inventory has shown an increase or decrease significantly during the year, then the average inventory for the year may be distorted and not accurately reflect your turnover ratio going forward. Also, if the company uses the LIFO method of accounting, the ratio may be inflated because LIFO undervalues the inventory sometimes. Unlike the current ratio and quick ratio, the inventory turnover ratio does not abide to any standard range. Organisations with highly perishable products can have inventory turns of 30 times a year or more. Companies that retain large amounts of inventory or that require a long time to build their inventory might have turns of only two or three times a year. In general, the overall trend in business today is to reduce carrying costs by limiting the amount of inventory in stock at any given time. As a result, both individual inventory turnovers and industry averages in this area have increased in recent years. It is important to understand, however, that many factors can cause a low inventory turnover ratio. The company may be holding the wrong type of inventory, its quality may be suffering, or it may have sales/ marketing issues Inventory on the Income Statement The income statement is a report that identifies a company s revenues (sales), expenses, and resulting profits. While the balance sheet gives you a financial picture of a company on a specific date (June 30, for example), the income statement covers a given period of time (June 1 through June 30). The cost of goods sold is the item on the income statement that reflects the cost of inventory 25/JNU OLE

40 Inventory Management flowing out of a business. The business makes money by using or selling inventory. That inventory costs the businessman money while acquiring it Cost of goods sold (on the income statement) represents the value of goods (inventory) sold during the accounting period. The value of goods that are not sold is represented by the ending inventory amount on the balance sheet calculated as: Ending Inventory = Beginning Inventory +Purchases Inventory -Cost of Goods Sold This information is also useful because it can be used to show how a company officially accounts for inventory. The cost of purchases can be arrived without knowing the actual costs by turning around the equation as follows: Purchases = Ending inventory Beginning Inventory + Cost of goods sold The costs of goods are sold if you know what your purchases are by making the following calculation: Cost of goods sold = Beginning Inventory + Purchases- Ending Inventory Inventory on the Balance sheet The balance sheet shows the financial position of a company on a specific date. It provides details for the basic accounting equation: Assets = Liabilities + Equity. In other words, assets are a company s resources while liabilities and equity are how those resources are paid for Assets represent a company s resources. Assets can be in the form of cash or other items that have monetary value including inventory. Assets are made up of (a) current assets (assets that are in the form of cash or that are easily convertible to cash within one year such as accounts receivable, securities, and inventory), (b) longer-term assets such as investments and fixed assets (property/plant/equipment), or (c) intangible assets (patents, copyrights, and goodwill). Liabilities represent amounts owed to creditors (debt, accounts payable, and lease-term obligations). Equity represents ownership or rights to the assets of the company (common stock, additional paid-in capital, and retained earnings). Inventory is among a company s current assets as it can be sold within one year. This information is used to calculate financial ratios that help assess the financial health of the company The balance sheet is one important place that inventory plays a role in the financial analysis of the company. It also shows up on the income statement in the form of cost of goods sold. 26/JNU OLE

41 Summary Inventory refers to stocks of anything necessary to do business. These stocks represent a large portion of the business investment and must be well managed in order to maximise profits One of the most significant aspects of inventory control is to have the items in stock at the moment they are required. This includes going into the market to buy the goods early enough to ensure delivery at the proper time. Raw materials are inventory items that are used in the manufacturer s conversion process to produce components, subassemblies, or finished products. These inventory items may be commodities or extracted materials that the firm or its subsidiary has produced or extracted Work-in-process (WIP) is made up of all the materials, parts (components), assemblies, and subassemblies that are being processed or are waiting to be processed within the system. A finished good is a completed part that is ready for a customer order. Therefore, finished goods inventory is the stock of completed products. These goods have been inspected and have passed final inspection requirements so that they can be transferred out of work-in-process and into finished goods inventory. Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and maintain the production process and its infrastructure. These goods are usually consumed as a result of the production process but are not directly a part of the finished product Transit inventories are the ones that need to transport items or material from one location to another, and from the fact that there is some transportation time involved in getting from one location to another. Some inventory used to protect against the uncertainties of supply and demand, as well as unpredictable events such as poor delivery reliability or poor quality of a supplier s products Some firms will purchase and hold inventory that is in excess of their current need in expectation of a possible future event. Such events may include a price increase, a seasonal increase in demand, or even an impending labour strike. This tactic is commonly used by retailers, who routinely build up inventory months before the demand for their products will be unusually high Maintenance, repair, and operating supplies, or MRO goods, are items that are used to support and maintain the production process and its infrastructure First-in, First-out (FIFO) inventory valuation assumes that the first goods purchased are the first to be used or sold regardless of the actual timing of their use or sale Last-in, First-out (LIFO) inventory valuation assumes that the most recently purchased/acquired goods are the first to be used or sold regardless of the actual timing of their use or sale 27/JNU OLE

42 Inventory Management Average Cost Method of inventory valuation identifies the value of inventory and cost of goods sold by calculating an average unit cost for all goods available for sale during a given period of time. Standard Cost Method of inventory valuation is often used by manufacturing companies to give all of their departments a uniform value for an item throughout a given year. The current ratio assesses the organisation s overall liquidity and indicates a company s ability to meet its short-term obligations Quick Ratio or Acid Test. The quick ratio compares the organisation s most liquid current assets to its current liabilities. The inventory turnover ratio measures, on average, how many times inventory is replaced over a period of time. References Walker, M., Inventory Management-Introduction [Video online] Available at :< 01July 2011]. BeckySavage, 2008.LIFO Vs FIFO [Video online ] Available at :< youtube.com/watch?v=exnsfh0_39s>[ Accessed 04 July 2011]. Muller, M., Essentials of inventory management, AMACOM Div American Mgmt Assn. Bose, C.D., Inventory Management, PHI Learning Pvt. Ltd. FEMA, Resource Management [Online] Available at :< emergency/nims/resourcemngmnt.shtm>[accessed 04 July 2011]. Tmforum, Resource Inventory Management [Online] Available at:< tmforum.org/resourceinventorymanagement/2556/home.html>[accessed 04 July 2011]. Recommended Reading Piasecki, D.J.,2003. Inventory Accuracy: People, Processes, & Technology, Ops Pub Bragg, S.M.,2011. Inventory Best Practices,2nd,ed.,Wiley Mercado, E.C.,2007. Hands-On Inventory Management (Resource Management), Auerbach Publications 28/JNU OLE

43 Self Assessment 1. is a list of goods and materials or those goods and materials s held available in stock by a business a. Inventory b. Supplies c. Commodities d. Products Some inventory used to protect against the uncertainties of supply and demand are called a. MRO inventory b. Buffer inventory c. Anticipation inventory d. Transit Inventory are items that are used to support and maintain the production process and its infrastructure a. Finished Goods b. Raw Material c. Maintenance, repair, and operating supplies(mro goods) d. Work in Progress goods is that inventory valuation assumes that the first goods purchased are the first to be used or sold regardless of the actual timing of their use or sale a. Last-in, First-out (LIFO) b. Average Cost Method c. Standard Cost Method d. First-in, First-out (FIFO) of inventory valuation is often used by manufacturing companies to give all of their departments a uniform value for an item throughout a given year. a. Standard Cost Method b. First-in, First-out (FIFO) c. Last-in, First-out (LIFO) d. Average Cost Method 29/JNU OLE

44 Inventory Management compares the organisation s most liquid current assets to its current liabilities a. Last-in, First-out (LIFO) b. Average Cost Method c. Standard Cost Method d. The Quick ratio test inventory valuation assumes that the most recently Purchased/ acquired goods are the first to be used or sold regardless of the actual timing of their use or sale a. Average Cost Method b. Standard Cost Method c. First-in, First-out (FIFO) d. Last-in, First-out (LIFO) are the ones that need to transport items or material from one location to another, and from the fact that there is some transportation time involved in getting from one location to another. a. MRO inventory b. Buffer inventory c. Anticipation inventory d. Transit Inventory measures, on average, how many times inventory is replaced over a period of time. a. The inventory turnover ratio b. The Quick ratio c. The Current ratio d. Last-in, First-out (LIFO) 10. assesses the organisation s overall liquidity and indicates a company s ability to meet its short-term obligations a. The inventory turnover ratio b. The Current ratio c. Last-in, First-out (LIFO) d. The Quick ratio 30/JNU OLE

45 Chapter II Long Range Planning and Forecasting Aim The aim of this unit is to: introduce the concept of basic strategic planning explain the creation of strategic plan illustrate the strategy of team development and business plans Objectives The objectives of this unit are to: state the principles of forecasting enlist the various methods of demand patterns analyse the criteria for selecting a forecasting method Learning outcome At the end of this unit, you will be able to: discuss the concepts of business planning understand the crucial role of forecasting methods in business profitability describe measuring forecast errors 31/JNU OLE

46 Inventory Management 2.1 Introduction Managers of any department, warehouse, or supply chain want to be successful in any organisation. The manager has to employ an effective inventory management strategy to guarantee success in the organisation. The most successful retail, warehouse, and supply chain managers are those who are fully aware of the state of their stocked inventory at any time and have a system that helps keeping up which allows them to easily index and monitor the coming and going of product within that inventory. Implementing an inventory management plan begins with the specific items that one has and the type of storage location in which the product is kept. A strategy may involve careful planning for spatial needs, especially if you must maintain a number of items in a minimal amount of space. An appropriate plan at this point would be to create a diagram of your warehousing or storage environment and map out the locations of stocked items that will best organise the materials with no wasted space. The success of tracking and managing your inventory can be accomplished with electronic tools or simply by hand. The next order of business is where the managers are mapping out the strategy to maximise the profit. Many times, the items in the inventory may remain there without moving for long periods of time due to lack of demand. This is not only a wasted expense but also takes up valuable room in the warehouse or supply room that could be filled with a faster selling item which would draw more profit. The inventory management strategy should definitely include some form of tracking system to identify quick selling products, as well as those with the highest profit margin. Such systems will report what items should be maintain at high levels within the inventory to meet demand and maximise profit. Any business inventory management strategy would not be complete without a well equipped software system that allows the manager to keep track of every item that comes in and out of his warehouse. This means that, when inventory checks are completed, the manager will be able to identify errors, thefts, losses, and any other discrepancies much more readily. It will also assist in ordering process, since the electronic tracking will give information on exact quantities of inventory without having to run out and count everything by hand. When the manager sees that the stock of a particular item is low, he can prepare to reorder. The final implementation of an effective inventory management strategy is to make sure that all items are properly labelled. Wrong or incomplete labelling can lead to several problems, including wrong identification by the software, misplacement when restocking the inventory, loss of the item, or inability to find it for shipment or shelving later. 32/JNU OLE

47 2.2 Basics of Strategic Planning As a manager of a small or medium sized firm having a strategy plan is the most important and intimidating activity. Organisations of any size which effectively utilise a strategic plan enjoy a much greater chance of long-term success, whether measured in key financial performance indicators, longevity, or cultural stability. A concise working definition of Strategy can be provided as what a company does, or does not do to fulfil its vision in a competitive marketplace. The high-impact strategic plan can be presented effectively on one page. Its elements can be expressed in a few well-chosen words, clauses or sentences. The strategic plan and operations or business plan are not the same. The latter two are compliant to the strategic plan and are shorter in timeframe, and far more detailed. One great feature is that it is powerful enough to guide the daily activities of dozens, hundreds, and even thousands of employees. Within the strategic plan, senior management sets the dominant logic and the moral compass of the organisation. It is an opportunity to unambiguously document ethics for leadership continuity. It forces introspection and situational analysis. Primarily through articulation of core values, it provides a directional beacon especially in hard times. 2.3 Creation of Strategic Plan The creation of a strategic plan is a five-step process which could be listed as follows: Vision The Mission Strategic Plan Core Values SWOT Analysis Strategic Objectives Fig. 2.1 Step process of strategic plan 33/JNU OLE

48 Inventory Management Vision Having a vision is an inspirational call to action. In a few short words, the Chief executive officer or senior manager uses the Vision, to point at the way to the company s future. It should include emotions and should be designed to last for many years. We could take an illustration of Google s vision statement which is To develop a perfect search engine. Core Values The downfalls of countless corporations each year are due to ethical problems therefore, preparing a statement of core values becomes vitally important. Choosing five or six words or short phrases which define the values must be basic to the working culture. Examples of such words might include integrity, transparency, or honesty. Core values will guide the organisation in making hard choices in very difficult times which should not be compromised. Hiring people who define core values will help the organisation in strategic planning. The Mission An effective mission statement is one which tells about the company story and ideals in less than 30 seconds. Now a days, companies have mission statements comprised of three or four short sentences, it is more detailed than the Vision, and is often written in the present tense. It defines your company s customers, products, and how your company contributes unique value for its customers. Strategic Objectives Strategic objectives should be specific, measurable, possible, relevant, and time-framed (SMART). Three to five objectives should suffice, and they should be attainable within one to three years. For reasons of confidentiality, strategic objectives are rarely published outside the company, but they must be effectively communicated to all employees. SWOT Analysis This acronym stands for Strengths, Weaknesses, Opportunities, and Threats. An honest, fact-based discussion between senior management and key advisors needs to take place. Documenting strengths and weaknesses tends to involve serious introspection, while opportunity and threat analysis tend to require external environmental scanning. Since it establishes the firm s current position relative to its competitive environment, the SWOT can be very useful in establishing objectives and even the mission. It is therefore frequently performed early in the planning process. The strategic plan is a living document which must be must be communicated effectively and constantly with the employees of the firm. Successful businesses frequently fit in the plan into the annual employee performance review process, ensuring that individual and departmental goals and objectives are going hand in hand with the strategic plan. The strategic plan should be reviewed at least annually, noting any SWOT changes that might require modifying strategic objectives. A 34/JNU OLE

49 complete renewal of the strategic plan should be undertaken every three years. A good plan will also discourage spending on projects that are not associated with strategic goals and helping to prevent deliberate conflicts between operational departments. There are several ways in which a manager can simplify your system of product inventory management. Choosing the methods and procedures that suits the firm is very important so that the manager can follow the guidelines set up initially. If the manager thinks of a procedure that is felt not important or vital to the system, then it will be difficult for them to follow it. This is equally difficult to keep sticking to the policy as the same is expected by the staff. Following are few suggestions to get proper product inventory management strategies for the departments in any organisation. Organisation Organising the stock within the space provided has to be determined by the managers. Several methods could assist the managers in making this decision simpler. The most popular products to be the most easily accessible as their use are frequent. Mapping out the space which is available and a look at the size of items that has to be stocked. How much quantity to keep is also an idea any manager should get. Chalking it out on paper and scratching out where each item would best be located to maintain organisation while still making efficient use of the room is a great product inventory management strategy. Analysis All items that, a firm has in stock when any manager takes over the product inventory management process is necessary. A look at sales records and stock that hasn t moved for several months so, the only option left is to get rid of that product entirely. It is better to determine the course of action when the kind of product arrives, product quantity in stock, and the number of other items for which more storage space will be needed, is to simply write it off. They are offered at reduced prices for quick sale to help cut the firms losses, but it is best to remove it and make way for items that bring in revenue. Budget The concept here would be that the firm has space for more stock, so that there is no need to just fill it. Sometimes these spaces help in future in case there is a need for the stock to be kept. For example, you have a product that goes on sale and the demand soars. This space can be used to store temporary additional stock of that item. It is better to have open space than to overextend the budget by ordering too many items. Also, having too much inventory on hand detracts from the value of the company. 35/JNU OLE

50 Inventory Management Tools Make use of software and other tools that the firm has for product inventory management. Most of the software packages available will give the manager an analysis reports that can help him make better decisions in the future and help him track the goods in the warehouse, taking a lot of stress and strain off his shoulders.motivating their team to maintain a free flowing inventory process with the help of the software tools. 2.4 Strategy of Team Development and Business Plans Creating a business plan for a small business is like laying a path to success, building it brick by brick. The toughest part is starting from scratch and having a well laid plan. But once started, each brick, strategically placed, takes you one step further with great thought and determination. This is the most important tool for a small business owner. It is a manager s guide, or roadmap, to success because it should scrutinise every aspect of the business. The main areas this document should contain are Management and Operations Plans, Market Analysis, Services and Pricing, Sales Strategy and Financial Analysis. The biggest mistake entrepreneurs make is placing the business plan on a shelf and never reviewing it again. The business plan provides guidelines, projections and suppositions. It does not provide certainty or absolutes. Therefore, it must continue to be continuously revised. This document is a living, breathing document that helps the owner see what works, what doesn t, what has changed and what needs to change. Three key components that should be analysed closely are the Sales and Service, Market Analysis and Pricing. When starting a business, research on the projected market can only provide a best guess. As the business grows, the entrepreneur will find variations that should be included into the business plan without fail. When reviewing the business s client base, the manager might discover a need to adjust his assumptions. After scrutinising his findings and make changes to his business plan accordingly. The Sales strategy might also change for example, the plan might have called for print advertising and direct mail, but suddenly discovered that networking and referrals turned out to be the best way to secure sales. The advertising budget will adjust positively with this scenario, but there may be a need of an additional part-time employee to cover the time where manager is attending networking meetings. Let s consider a cleaning service, established to do weekly cleaning to the Boomer market. The advertising was directed at the Boomers, and it is noticed that it reached the consumers it targeted exactly. The ones calling to hire a cleaning service for their parents who are old. The aging seniors would most likely need less frequency (monthly or quarterly), which could create a cash flow issue. Therefore, there might be a need for a different pricing structure. More refining to the plan will make it a better path to success. A business plan will help to see where the business is and where it can go. It will help to determine if the business is staying 36/JNU OLE

51 on track or there is a need to focus again. Just like a brick path that needs constant care, the same is true for a business plan. The manager must secure loose ones, replace broken ones, pull weeds, and often widen and lengthen the entire path to handle additional traffic (customers, products, services).this vital document will make the journey more enjoyable and more successful, but only if it is visited and revised often rather than sitting on a shelf collecting dust. 2.5 Concepts of Business Planning Businesses often have a considerable part of their investment tied up in inventory. At the end of the year, only the cost of those goods that are sold can be deducted as a business expense on the taxes paid, the unsold portion is considered part of the company s assets. In order to make a reasonable profit, the inventory must be managed in most effective way to provide enough products for good customer service, but not so much as to cause financial difficulties. There are different ways of accomplishing this balance. All require good management skills and decision making. First of all, precise recordkeeping is vital. Inventory records can be kept manually or by using more sophisticated computer programs. While the type of system and kinds of records may vary from business to business, all require accuracy and timeliness to be effective. At the end of the year you will need to physically take inventory. Successful inventory management requires a balance between the costs and benefits of inventory. Costs include not only the money tied up in the inventory, but also storage, insurance, taxes, etc. The benefits of inventory include having adequate stock on hand, a wide assortment, low cost volume purchases, etc. It is difficult to maintain the correct balance but the following considerations should be kept in mind: High inventories increase financial risk. Maintain a wide assortment but keep an adequate supply of those items with quick turnover. Increase turnover but don t sacrifice service level. Make volume purchases for lower prices, but don t end up with slow moving inventory. Have plenty of inventories on hand, but don t get stuck with obsolete items. Many industries rely on a ratio which measures inventory turnover rate. Inventory Turnover Rate can be calculated in various ways, providing a rough guideline by which managers can set goals and measure performance. 2.6 Forecasting Techniques There are various forecasting techniques in inventory management that helps in the organisations profitability. We will first understand the meaning of forecasting, planning and goals. 37/JNU OLE

52 Inventory Management Forecasting Planning and Goals Forecasting is a term used to describe the prediction of future events. Demand planning is the process of recognising economic demands for products in the marketplace. Forecasting enables the future to be visualised, it creates a baseline against which actual data can be measured. The key in demand planning is to monitor the gaps between the anticipated (forecast) and the achieved (actual) and then, using forecasting skills and tools to reduce the gap in the next cycle. Forecast is an estimate of future demand. A forecast can be determined by mathematical means using historical data; it can be created subjectively by using estimates from informal sources; or it can represent a combination of both techniques. Forecasting is a common statistical task in business, where it helps inform decisions about scheduling of production, transportation and personnel, and provides a guide to long-term strategic planning. However, business forecasting is often done poorly and is frequently confused with planning and goals. They are three different things. Forecasting is about predicting the future as accurately as possible, given all the information available including historical data and knowledge of any future events that might impact the forecasts. Goals should be linked to forecasts and plans, but this does not always occur. Too often, goals are set without any plan for how to achieve them, and no forecasts for whether they are realistic. Planning is a response to forecasts and goals. Planning involves determining the appropriate actions that are required to make your forecasts match your goals. Forecasting should be an integral part of the decision-making activities of management, as it can play an important role in many areas of a company. Modern organisations require short-medium- and long-term forecasts, depending on the specific application. Short-term forecasts are needed for scheduling of personnel, production and transportation. As part of the scheduling process, forecasts of demand are often also required. Medium-term forecasts are needed to determine future resource requirements in order to purchase raw materials, hire personnel, or buy machinery and equipment. Long-term forecasts are used in strategic planning. Such decisions must take account of market opportunities, environmental factors and internal resources. An organisation needs to develop a forecasting system involving several approaches to predicting uncertain events. Such forecasting systems require the development of expertise in identifying forecasting problems, 38/JNU OLE

53 applying a range of forecasting methods, selecting appropriate methods for each problem, and evaluating and refining forecasting methods over time. It is also important to have strong organisational support for the use of formal forecasting methods if they are to be used successfully Principles of Forecasting While planning a forecast, certain points should be considered The forecast will be more accurate for groups: Total units sold are easier to forecast than specific products. The forecast that, a company will sell a total of 2500 lakhs next year might be useful for cash flow information, but there must be more details of 12 modules (subassemblies), forecasting the 12 modules will be more accurate than forecasting 100 lakhs and will meet the needs of a manufacturing planning systems. The Forecasts will be more accurate for the short term: The further out you go, the less accurate you are. Every effort should be made to reduce the cumulative lead time required for the planned item. The cumulative lead time is the total planned length of time to produce and distribute an item. It is the longest combination of events and critical path, necessary for product availability. The forecast will be wrong: Although there will be a forecast error, it is most important to have an estimate of that error. Through mathematical techniques, it is possible to estimate the probability of error. For example, the forecast of weekly demand may be 100, but based on past deviations from average, the actual demand may be expected to vary from plus or minus 6.98% of the time. The forecast should be tested before using: There are many models to use for forecasting and it is recommended to test the various techniques based on the same past history. The technique or model that worked best in the past will most likely work best in the future. The forecast is no substitute for actual demand: As there will be a degree of error in any forecast, reducing lead time as much as possible, so as to allow actual demand history to have a greater impact on the forecast is most desirable Demand Patterns In tracking demand history, the data will indicate one of five patterns or combinations that may apply. The five time series patterns are: 39/JNU OLE

54 Inventory Management Linear Pattern Trend Pattern Cyclical Pattern Seasonal Pattern Random Happenings Fig. 2.2 Demand patterns of forecasting Linear pattern: The activity will follow a straight line (linear) pattern, such as growth of vada pav sales. Trend pattern: A pattern which indicates a trend over and beyond the linear pattern, such as a product demand that is growing due to not only population growth, but also to superior quality. Cyclical pattern: An example is a product with a life cycle of 3 years and therefore a replacement cycle of 3 years. The business cycle may also be considered using random happenings. Seasonal pattern: Examples are lawn mower sales in the spring and snow blower sales in the fall. Random happenings: This is irregular and difficult to understand. A broken windshield is an example of factors causing random happenings Reasons for Forecasting The type of Forecast solution that is needed will vary depending on the reasons selected but the key drivers which probably will be: To reduce uncertainty: Every manager feels the need to predict future demand which will in turn reduce uncertainty. It is however not so easy to do so. Prediction leads to reduced costs as the management becomes more responsive to the needs in the market. This eventually leads to improved customer service. To anticipate change: Business conditions keep changing every day. There are new competitors in market which pose a threat to the sale margins. Planning for future change, in order to adjust with changes in the environment, competitors, new entrants, etc. supports the company strategy. 40/JNU OLE

55 To improve communication: Forecasting helps communication between all departments and affiliates. Effective communication drives continuous improvement and migrates to intelligent models. Provide elements of realism to reduce inventories driven by fanciful sales targets To increase knowledge: Project production capacity, project future costs and revenues, compare forecast and actuals to budget, evaluate marketing initiatives and decipher correlations between casuals and actuals Time for Forecasts Time Process High level process just before budget cycle. Aimed at 0-12 Months setting base for Budget discussion and high level capacity check (long horizon) Months Process to set sales targets. Set once or twice a year. Process which is aimed at providing accurate predictions 0-6 Months of market potential. Data used to drive supply planning, allocation and production operations. 1 Month Process (weekly/daily) used to obtain latest sales data from Sales (orders + expected orders). Applies to current month only. Table 2.1 Time for forecast 41/JNU OLE

56 Inventory Management Budget review Budget Process Sales forecasts Sales progress Budget Process Fig. 2.3 Time for forecasts 2.7 Methods of Forecasting Many businesses have a very practical approach when they use forecasting techniques. A number of important business decisions could possibly be affected by the forecasted sales of a given product. Production schedules, raw material purchasing plans, policies regarding inventories, and sales quotas will be affected by such forecasts. It is vitally important for the business to make use of accurate forecasting methodologies after taking into considerations all risks in the market. All forecasting methods can be divided into two broad categories: Qualitative and Quantitative. Many forecasting techniques use past or historical data in the form of time series. A time series is simply a set of observations measured at successive points in time or over successive periods of time. Forecasts essentially provide future values of the time series on a specific variable such as sales volume. Division of forecasting methods into qualitative and quantitative categories is based on the availability of historical time series data. 42/JNU OLE

57 Forecasting Methods Qualitative methods Quantitative methods Fig. 2.4 Methods of forecasting techniques Qualitative Forecasting Methods Methods generally employ the judgment of experts to generate forecasts. A key advantage of these procedures is that they can be applied in situations where historical data are simply not available. Moreover, even when historical data are available, significant changes in environmental conditions affecting the relevant time series may make the use of past data irrelevant and questionable in forecasting future values of the time series. For example, historical data on gasoline prices would likely be of questionable value in determining future gasoline prices if other factors (oil boycotts, gasoline rationing programs, scientific breakthroughs in alternative energy use, etc.) suddenly assumed increased importance. Qualitative forecasting methods offer a way to generate forecasts in such cases. Three important qualitative forecasting methods are: the Delphi technique, scenario writing, and the subject approach. Qualitative forecasting methods are based on educated opinions of appropriate persons. Qualitative Methods Delphi Method Market Research Product Life Cycle Analogy Expert Judgement Fig. 2.5 Types of qualitative methods 43/JNU OLE

58 Inventory Management Delphi method: This forecasting is also a non-quantitative technique for forecasting. It draws its name from the Oracles of Delphi, which in Greek ancient times advised people based on intuition and common sense. These are those methods that use so-called objective predictions involving quantitative analysis. This particular method is based on purely expert opinions. It has been demonstrated that predictions obtained this way can be at least as accurate as other procedures. The core of the procedure is to use the estimation of opinions and predictions by a number of experts over a number of rounds in carefully managed sequences. One of the most important factors in Delphi forecasting is the selection of experts. The persons invited to participate must be knowledgeable about the issue and they should belong to different backgrounds. The number must not be too small to make the assessment too narrowly based, nor too large making it cumbersome to coordinate. It is widely considered that 10 to 15 experts can provide a good base for the forecast. In short, this forecasting method is developed by a panel of experts who anonymously answer a series of questions; responses are fed back to panel members who then may change their original responses Market research: The objective of conjoint analysis is to determine what combination of a limited number of attributes is most influential on respondent choice or decision making. A controlled set of potential products or services is shown to respondents and by analysing how they make preferences between these products, the implicit valuation of the individual elements making up the product or service can be determined. These implicit valuations (utilities or part-worth) can be used to create market models that estimate market share, revenue and even profitability of new designs. Examples could be panels, questionnaires, test markets, surveys. Product life-cycle analogy: These forecasts are based on life-cycles of similar products, services, or processes. Products go through a life cycle of introduction, growth, maturity and decline. It is based on experiences of similar products in the past, one can make decision. Expert judgement: The forecast made by experts are based on experience and understanding of the situation by management, sales force, or other knowledgeable person Quantitative Forecasting Methods These methods are used when historical data on variables of interest are available. These methods are based on an analysis of historical data concerning the time series of the specific unfixed nature of interest. There are three major categories of quantitative forecasting methods. The first type uses the past trend of a particular variable in order to make a future forecast of the variable. In recognition of this method s reliance on time series of past data of the variable that is being forecasted, it is commonly called the time series method. The second category of quantitative forecasting techniques also uses historical data. But in forecasting future values of a variable, the forecaster examines the cause-and-effect relationships of the variable with other relevant variables such as the level of consumer confidence, 44/JNU OLE

59 changes in consumers disposable incomes, the interest rate at which consumers can finance their spending through borrowing, and the state of the economy represented by such variables as the unemployment rate. Thus, this category of forecasting techniques uses, past time series on many relevant variables to produce the forecast for the variable of interest. Forecasting techniques falling under this category are called causal methods, since such forecasting is predicated on the cause-and-effect relationship between the variable forecasted and the other selected elements. Quantitative Methods Time Series Method Causal Method Focus Forecasting Moving Averages Exponential Smoothing Mathematical Models Box-Jenkins Method Fig.2.6 Types of quantitative methods Time Series Forecasting Methods Time series forecasting methods are based on analysis of historical data (time series: a set of observations measured at successive times or over successive periods). They make the assumption that past patterns in data can be used to forecast future data points. Moving averages (simple moving average, weighted moving average): Forecast is based on arithmetic average of a given number of past data points. Exponential smoothing (single exponential smoothing, double exponential smoothing): A type of weighted moving average that allows inclusion of trends, etc. Mathematical models (trend lines, log-linear models, Fourier series, etc.): Linear or non-linear models fitted to time-series data, usually by regression methods. Box-Jenkins methods: Autocorrelation methods used to identify underlying time series and to fit the best model. 45/JNU OLE

60 Inventory Management Components of time series demand The components of the time series demand are given in the table below: Component Average Trend Seasonal influence Cyclical movement Random error Explanation The mean of the observations over time. A gradual increase or decrease in the average over time. Predictable short-term cycling behaviour due to time of day, week, month, season, year, etc. Unpredictable long-term cycling behaviour due to business cycle or product/service life cycle. Remaining variation that cannot be explained by the other four components. Table 2.2 Components of time series demand Simple Moving Average Moving average techniques forecast demand by calculating an average of actual demands from a specified number of prior periods. Each new forecast drops the demand in the oldest period and replaces it with the demand in the most recent period; thus, the data in the calculation moves over time. Simple moving average: A t = D Where N = total number of periods in the average Forecast for period t+1: F t+1 = A t Key decision: N - How many periods should be considered in the forecast Tradeoff: Higher value of N - greater smoothing, lower responsiveness Lower value of N - less smoothing, more responsiveness The more periods (N) over which the moving average is calculated, the less susceptible the forecast is to random variations, but the less responsive it is to changes. A large value of N is appropriate if the underlying pattern of demand is stable. A smaller value of N is appropriate if the underlying pattern is changing or if it is important to identify short-term fluctuations. Weighted Moving Average Weighted moving average is a moving average where each historical demand may be weighted differently. Average: A t = W 1 D t + W 2 D t-1 + W 3 D t W N D t-n+1 where: 46/JNU OLE

61 N = total number of periods in the average W t = weight applied to period t s demand Sum of all the weights = 1 Forecast: F t+1 = A t = forecast for period t+1 Exponential Smoothing Exponential smoothing gives greater weight to demand in more recent periods, and less weight to demand in earlier periods. Average: A t = a D t + (1 - a) A t-1 = a D t + (1 - a) F t Forecast for period t+1: F t+1 = A t Where: A t-1 = series average calculated by the exponential smoothing model to period t-1 a = smoothing parameter between 0 and 1 the larger the smoothing parameter, the greater the weight given to the most recent demand Double Exponential Smoothing (Trend-Adjusted Exponential Smoothing) When a trend exists, the forecasting technique must consider the trend as well as the series average. Ignoring the trend will cause the forecast to always be below (with an increasing trend) or above (with a decreasing trend) actual demand. Double exponential smoothing smooths (averages) both the series average and the trend Forecast for period t+1: F t+1 = A t + T t Average: A t = ad t + (1 - a) (A t-1 + T t-1 ) = ad t + (1 - a) F t Average trend: T t = B CT t + (1 - B) T t-1 Current trend: CT t = A t - A t-1 Forecast for p periods into the future: F t+p = A t + p T t where: A t = exponentially smoothed average of the series in period t T t = exponentially smoothed average of the trend in period t CT t = current estimate of the trend in period t a = smoothing parameter between 0 and 1 for smoothing the averages B = smoothing parameter between 0 and 1 for smoothing the trend Multiplicative Seasonal Method What happens when the patterns you are trying to predict display seasonal effects? What is seasonality? - It can range from true variation between seasons, to variation between months, weeks, days in the week and even variation during a single day or hour. To deal with seasonal effects in forecasting two tasks must be completed: A forecast for the entire period (i.e., year) must be made using whatever forecasting technique is appropriate. This forecast will be developed using whatever. 47/JNU OLE

62 Inventory Management The forecast must be adjust to reflect the seasonal effects in each period (i.e. month or quarter). The multiplicative seasonal method adjusts a given forecast by multiplying the forecast by a seasonal factor. Step 1: Calculate the average demand y per period for each year (y) of past data by dividing total demand for the year by the number of periods in the year. Step 2: Divide the actual demand D y,t for each period (t) by the average demand y per period (calculated in Step 1) to get a seasonal factor f y,t for each period; repeat for each year of data. Step 3: Calculate the average seasonal factor t for each period by summing all the seasonal factors f y,t for that period and dividing by the number of seasonal factors. Step 4: Determine the forecast for a given period in a future year by multiplying the average seasonal factor t by the forecasted demand in that future year. Seasonal Forecasting (multiplicative method) Actual Demand Year Q1 Q2 Q3 Q4 Total Avg Seasonal Factor Year Q1 Q2 Q3 Q Avg. Seasonal Factor Seasonal Factor - the percentage of average quarterly demand that occurs in each quarter. Annual Forecast for year 4 is predicted to be 400 units. Average forecast per quarter is 400/4 = 100 units. Quarterly Forecast = avg. forecast seasonal factor. Q1: 1.303(100) = 130 Q2:.85(100) = 85 Q3:.74(100) = 74 Q4: 1.083(100) = /JNU OLE

63 Causal Forecasting Methods Causal forecasting methods are based on a known or perceived relationship between the factor to be forecast and other external or internal factors. Regression: Mathematical equation relates a dependent variable to one or more independent variables that are believed to influence the dependent variable. Econometric models: System of interdependent regression equations that describe some sector of economic activity. Input-output models: Describes the flows from one sector of the economy to another, and so predicts the inputs required to produce outputs in another sector. Simulation modelling- Different equations are used in production ordering activities under this method Focus Forecasting Focus forecasting refers to an approach to forecasting that develops forecasts by various techniques, then picks the forecast that was produced by the best of these techniques, where best is determined by some measure of forecast error. Example: For the first six months of the year, the demand for a retail item has been 15, 14, 15, 17, 19, and 18 units. A retailer uses a focus forecasting system based on two forecasting techniques: a two-period moving average, and a trend-adjusted exponential smoothing model with = 0.1 and = 0.1. With the exponential model, the forecast for January was 15 and the trend average at the end of December was 1. The retailer uses the mean absolute deviation (MAD) for the last three months as the criterion for choosing which model will be used to forecast for the next month. a. What will be the forecast for July and which model will be used? b. Would you answer to Part a. be different if the demand for May had been 14 instead of 19? 2.8 Measuring Forecast Errors There are two aspects of forecasting errors to be concerned about - Bias and Accuracy. Bias: A forecast is biased if it errs more in one direction than in the other. The method tends to under-forecasts or over-forecasts. Accuracy: Forecast accuracy refers to the distance of the forecasts from actual demand ignore the direction of that error. 49/JNU OLE

64 Inventory Management Example: For six periods forecasts and actual demand have been tracked The following table gives actual demand D t and forecast demand F t for six periods: t D t F t E t (E t ) 2 E t E t / D t % % % % % % Total % Forecast Measure 1. Cumulative sum of forecast errors (CFE) = Mean absolute deviation (MAD) = 170 / 6 = Mean squared error (MSE) = 5150 / 6 = Standard deviation of forecast errors = 5150 / 6 = Mean absolute percent error (MAPE) = 83.4% / 6 = 13.9% Forecast has a tendency to over-estimate demand. Average error per forecast was units, or 13.9% of actual demand. Sampling distribution of forecast errors has standard deviation of 29.3 units. 2.9 Criteria for Selecting a Forecasting Method Objectives: 1. Maximise Accuracy and 2. Minimise Bias Potential Rules for selecting a time series forecasting method. Select the method that gives the smallest bias, as measured by cumulative forecast error (CFE); or gives the smallest mean absolute deviation (MAD); or gives the smallest tracking signal; or supports management s beliefs about the underlying pattern of demand 50/JNU OLE

65 Summary Implementing an inventory management plan begins with the specific items that one has and the type of storage location in which the product is kept. As a manager of a small or medium sized firm, having a strategy plan is the most important and intimidating activity. The creation of a strategic plan is a five-step process Strategic objectives, SWOT analysis, core values, the mission, vision. The biggest mistake entrepreneurs make is placing the business plan and never reviewing it often. The business plan provides guidelines, projections and suppositions of how the business works. It must continue to be continuously revised In order to make a reasonable profit, any business s inventory must be managed in the most effective way to provide enough products for good customer service, and should also avoid financial difficulties. Forecasting is a common statistical task in business, where it helps inform decisions about scheduling of production, transportation and personnel, and provides a guide to long-term strategic planning. All forecasting methods can be divided into two broad categories: Qualitative and Quantitative methods. Qualitative Forecasting methods generally employ the judgment of experts to generate forecasts. A key advantage of these procedures is that they can be applied in situations where historical data are simply not available. The methods under qualitative forecasting techniques are Delphi method, Market research, Product life-cycle analogy and Expert judgement. Quantitative methods are used when historical data on variables of interest are available. These methods are based on an analysis of historical data concerning the time series of the specific unfixed nature of interest. The methods under quantitative forecasting techniques are Time series method, Usual method and focus forecasting The methods under time series are Moving averages, Exponential smoothing, Mathematical models, Box Jenkins methods References University of Guelph, Forecasting [Online] Available at: < uoguelph.ca/~dsparlin/forecast.htm#simple%20moving%20average [Accessed at 05 July 2011]. Microsoft Office, Forecast inventory levels with Moving Average analysis, [Online]Available at: < [Accessed at 05.July.2011]. Aiello J. L., Rightsizing Inventory (Resource Management), Auerbach Publications. 51/JNU OLE

66 Inventory Management Zipkin, P.H., Foundations of Inventory Management, McGraw-Hill/ Irwin. Pomscm,2009,Forecasting [Video online] Available at: < com/watch?v=yyspdbricf8>[accessed 5 July 2011]. Thetravhischool,2010,Delphi Method 1, [Video online] Available at: < [Accessed 5 July 2011]. Recommended Reading Silver, E. A., Pyke, D.F., and Peterson, R., Inventory Management and Production Planning and Scheduling, 3 rd ed.,wiley. Tersine, R.J., Principles of Inventory and Materials Management, 4 ed., Prentice Hall. Wild,T., Best Practice in Inventory Management, 2 nd ed.,butterworth- Heinemann. 52/JNU OLE

67 Self Assessment 1. What does SWOT analysis in inventory world of business mean? a. Strengths, Weaknesses, Opportunities, and Threats b. Strategy, Weaknesses, Opportunities, and Threats c. Strengths, Work, Opportunities, and Threats d. Strengths, Weaknesses, Operation, and Threats Which of the following are the two broad categories of forecasting methods? a. Usual method and Focus method b. Qualitative method and Quantitative method. c. Time series method and Quantitative method d. Weighted moving average and Exponential smoothing methods are based on a known or perceived relationship between the factor to be forecast and other external or internal factors. a. Weighted moving average forecasting b. Multiplicative seasonal forecasting c. Causal forecasting d. Usual forecasting Which of the following statements are true? a. Simple moving average is a moving average where each historical demand may be weighted differently. b. Time series forecasting methods are based on a known or perceived relationship between the factor to be forecast and other external or internal factors. c. Mathematical mode methods used to identify underlying time series and to fit the best model. d. Exponential smoothing gives greater weight to demand in more recent periods, and less weight to demand in earlier periods. is a moving average where each historical demand may be weighted differently. a. Simple moving b. Exponential smoothing c. Focus forecasting d. Weighted moving average 53/JNU OLE

68 Inventory Management method adjusts a given forecast by multiplying the forecast by a seasonal factor. a. The Multiplicative seasonal b. The simple moving method c. Exponential smoothing d. Times series includes both the series average and the trend methods of forecasting. a. Double exponential smoothing b. Exponential smoothing c. Time Series d. Simple moving Which of the statements are true? a. Quantitative Forecasting Methods are based on an analysis of historical data concerning the time series of the specific unfixed nature of interest. b. Product life-cycle analogy of forecasting is also a quantitative technique for forecasting. c. Delphi method forecasts based on life-cycles of similar products, services, or processes. d. Time series forecast made by experts are based on experience and understanding of the situation by management, sales force, or other knowledgeable person. Which of the statements are true?: a. Focus methods are based on a known or perceived relationship between the factor to be forecast. b. Exponential smoothing techniques forecast demand by calculating an average of actual demands from a specified number of prior periods and other external or internal factors. c. Expert research forecasts based on life-cycles of similar products, services, or processes. d. Market research valuations can be used to create market models that estimate market share, revenue and even profitability of new designs. 10. of forecasting is also a non-quantitative technique for forecasting which in Greek ancient times advised people based on intuition and common sense. a. Delphi method b. Market research c. Expert judgement d. Product cycle analogy 54/JNU OLE

69 Chapter III Sales and Operations Planning Aim The aim of this unit is to: discuss the meaning of sales and operation planning enlist different types of approaches in sales and operation planning illustrate the importance of sales and operation planning Objectives The objectives of this unit are to: state the theory of constraints discuss the 5 focusing steps of theory of constraints explain the importance of sale and operation process in an organisation Learning outcome At the end of this unit, you will be able to: understand the concepts of Sales and Operation Planning explain the Theory of Constraints discuss the system level measurements 55/JNU OLE

70 Inventory Management 3.1 Basics of Sales and Operations Planning Every business man wants to add value to his firm or organisation. For this a tested and proven technique is required which can bring significant new value to your firm s supply chain effort. A planning tool can improve forecast accuracy, better match supply with demand, and greatly reduce dependence on inventory. Sales and operations planning has become a major tool for supply chain leaders tired of accepting the natural problems with poor sales forecast accuracy, complications with planning and scheduling due to changing customer demand. There is a need to build safety stocks into inventory for the predictable problems introduced by certainties in the marketplace. This paper addresses the ideas behind sales and operation planning and discusses techniques that have been successfully applied. Sales and operation planning is all about gathering information that s generally available which may be not provided or used. The need is to balancing supply and demand in a way that overcomes the deficiencies of weak forecasting and results in more optimum performance coming from the initial suppliers to the satisfied customers. The techniques will be used to demonstrate how to apply the tool to cope with the problems and meet business objectives through the solutions it provides. Sales and operations planning(s and OP) is an integrated business management process through which the executive/leadership teams try to continually focus alignment and bring out synchronisation among all functions of the organisation. The Sales and operations planning include the following plans: Updated Sales Plan Production Plan Inventory Plan Customer Lead Time (Backlog) Plan New Product Development Plan Strategic Initiative Plan Resulting Financial Plan Fig. 3.1 Plans included in sales and operations planning 56/JNU OLE

71 Plan frequency and planning horizon depend on the specifics of that particular industry. Short product life cycles and high demand instability require a tighter planning.the S AND OPprocess also enables effective supply chain management. A properly implemented S and OP process routinely reviews customer demand and supply resources. If required it again plans quantitatively across an agreed rolling horizon. The re-planning process focuses on changes from the previously agreed sales and operations plan. It not only helps the management team to understand how the current level of performance is by company but also focuses on future actions and anticipated results. The S and OP process enables companies who have an integrated business management process to monitor the execution of the company s strategies. After applying sales and operation planning some firms can attain profits doing the following: increasing revenues due to decrease in stocks determining accurate demand from customers reducing inventories as per needs shortening cycle times from order to cash improving planning and scheduling eliminating mistakes in the processing better satisfying customers while reducing supplier frustrations Approaches of Sales and Operation Planning There are two different approaches which are used in sales and operations planning, namely, top-down planning and bottom-up planning. 57/JNU OLE

72 Inventory Management Sales and Operations Planning Top Down Planning Bottom Up Planning Fig. 3.2 Two approaches to sales and operation planning Top-down planning Top-down planning is the simplest approach to sales and operations planning. In this approach, there is a single sales forecast that drives the planning process. The forecast is derived from a combination of products and services that require similar resources, for example, a number of manufactured finished products. Using topdown planning, the management can create strategic plans based on the overall forecast and divide the resources across the finished goods in the plan. Bottom-up planning This approach is used by companies which do not have a stable manufacturing schedule and the number and type of finished goods can change from month to month. In this scenario the sales forecast is not helpful for resource planning. The management needs to calculate the resources for each of the products and then merge the resources to get an overall picture of resource requirements. Production plans After a company has worked through their sales forecasts and calculated the resource requirements, the various alternate production plans should be generated. There are three approaches that are used for the production plan, which are as follows: 58/JNU OLE

73 Level Production Plan Chase Production Plan Mixed Production Plan Fig. 3.3 Approaches to production plan The level production plan is used where the cost of making a change in the production level is extremely expensive, while the cost of holding inventory is very low, for example in the oil industry. Using the level production plan, the production remains constant and inventory is used to absorb the differences between the sales forecast and the production. The chase production plan is the opposite of the level production plan. In this production plan the production is changed for each time interval of the plan to match the sales forecast for that interval. With this approach the production is always chasing the demand, hence the name, chase production plan. This approach is best used for companies who either cannot hold inventory or to do so is extremely expensive, while changes in production costs very little. The mixed production plan takes elements from both the chase and level plans, where there will be variances in production and inventory levels which will produce the best production plan. 3.2 Definitions Sales and Operation Planning APICS defines Sales and Operation Planning as The function of setting the overall level of manufacturing output (production plan) and other activities to best satisfy the current planned levels of sales (sales plan and/or forecasts), while meeting general business objectives of profitability, productivity, competitive customer lead times, etc., as expressed in the overall business plan. One of its primary purposes is to establish production rates that will achieve management s objective of maintaining, raising, or lowering inventories or backlogs, while usually attempting to keep the workforce relatively stable. It must extend through a planning horizon sufficient to plan the labour, equipment, facilities, material, and finances required to accomplish the production plan. As this plan affects many company functions, it is normally prepared with information from marketing, manufacturing, engineering, finance, materials, etc. 59/JNU OLE

74 Inventory Management Sales and operations planning has also been described as a set of decisionmaking processes to balance demand and supply, to integrate financial planning and operational planning, and to link high level strategic plans with day-to-day operations S and OP is a process where executive level management meet regularly and reviews projections for demand, supply and the resulting financial impact. S and OP is a decision making process that keeps the overall view of the company s business plan in mind and plans every business area in line with it. The overall result of the S and OP process is that a single operating plan is created that identifies the allocation of company resources, including time, money and employees. S and OP is not a new technique to the management world but is a management tool for decades. There is a wide variation in the degree to which it is used and the results of the effort over an extended time frame. It also shows that most companies failed to pursue it to best case conditions and as a result their interest faded and therefore dropped it from the high priority activity list. Current studies indicate leading that firms have re-discovered the tool and are generally well pleased with the renewed effort. With the help of willing suppliers and customers, they have introduced combined techniques that dramatically and favourably impact sales forecast accuracy and the matching of supply with demand so cycle times and inventories can be significantly reduced, while improving responsiveness. Some of the points to be noted about sales and operations planning are that it does not comply with a Best Practice approach of structured processes. Data supported, consensus decision making and understanding of the business direction and potential risks for moving forward are not often included. Some firms resort to developing a formal and robust sales and operations planning process. Such efforts will become a vehicle for the communication and integration of the demand and supply planning activities with the financial plans of the company. This move will introduce clear and better understanding and communication of the business direction and potentials risks ahead throughout the organisation. A pilot approach can also be discussed that allows for a proof of concept for a piece of the business therefore minimising risk before rolling out S and OP across the entire organisation. Below is an illustration of the approach that can be taken, as the firm moves from an initial assessment to design and prototype of the system to be applied. It includes a recommended pilot phase and concludes with a successful roll-out. 60/JNU OLE

75 Assess Design and Prototype Pilot Roll - out Completed High Impact Supply Chain Assessment Proposing Next Phase Fig. 3.4 The sales and operations planning framework 3.3 Importance of S and OP Process Every company does some kind of production planning whether as a formal process or something informal like talking in a hall. There are many benefits after adopting Sales and Planning operations which could be listed: It makes customer service objectives happen through better management of finished goods inventory or backlog. One of the most important tools in a customer driven organisation is Sales and operation planning.the market trends keeps fluctuating constantly so there can not be a right level of finished goods inventory therefore sales and operation planning techniques comes to the rescue of the managers. Response to the marketplace is most importance as compared to managing inventories in right number. It connects strategy and operations- Sales and operations planning ties up the company s high level business and strategic plans to the operations of each department, guaranteeing harmony among them. Many organisations face a loss due to loss of control and lack of effective communication within the organisation as they have financial plans which are not directly tied up with the operating system. It yields a workable plan Some of the factors that lead to the failure of a workable plan are competitive pressures, unreasonable customers and increasing expectations from top management. In order to make this plan workable, Sales and operation process is adopted where a series of reality checks are done so that the plan is attainable.a rough cut test is passed through the plan just to verify the detail material and capacity plans. Each department participates in the process where all the key functions of the plans are accounted for eliminating surprises. It makes it possible to manage change managing change in business have two aspects one is making a change at the right level and second that change happens. Sales and operation planning is the appropriate place to make significant changes because it ensures that all department are in agreement. It links the low level and high level plans. Detail plans are translated well once the changes are made at the sales and operation planning level. 61/JNU OLE

76 Inventory Management It provides a basis for measuring performance. This process is related to the development of a common workable plan which is agreed by all. Such plan becomes a basis for measurement. Then the emphasis is laid on if the plan is attainable.. Many questions arise from if the plan is overstated and if someone needs to accept some part of the blame and there is little accountability. Therefore Sales and operation planning is critical to maintaining accountability and managing company effectively. Improves Customer services levels Improves Inventory levels Improves control of the business improves overall communication Fig. 3.5 Benefits of sales and operation planning 3.4 Operations Planning for S and OP Process Manufacturers in the Consumer Packages Goods (CPG) Sector were the early adopters of supply chain forecasting method in their organisation. CPG manufacturers focused on minimising the forecast error to drive fill rates and lower inventory carrying costs by catering to the firm demands of the Retail Partners. CPG companies started adopting S and OP process to develop forecast agreement and holistic planning. Most CPG supply chains have active sales and operations planning process, which is cross-functional with participation from sales, marketing, logistics, supply planning, finance, sales planning and demand planning functions. A tolerance between forecasts with different objectives is one of the important philosophy of sales and operation planning. This process thrives on group effort and honest communication between key organisational players. This is a unique process embodying several information sharing sessions and decision forums, with the final intent to generate an organisational plan. Some times the S and OP implementation with an on-site workshop are organised by lots of companies. These type of workshops will be a key input and bring to limelight many company-specific drivers. Such workshop addresses the key steps 62/JNU OLE

77 in developing and implementing an effective Sales and OP process. By having your key stakeholders attend this workshop, a huge competitive advantage is attained in moving forward the idea of integrated business planning. The technique starts with gathering the projected demand information and compiling it in a usable form by multiple constituents across the supply chain. From that information, a consensus demand forecast is generated. Bigger inputs from key customers are amended by knowledge of current operating and market conditions beginning with the sales forecast originally used for planning purposes. In the next step, an evaluation is made to match the consensus demand against any known or anticipated manufacturing and logistics constraints. When problems are encountered, the system is used to notify important constituents on either side of the manufacturing firm. Specific conflicts are considered for resolution through a gate that determines whether they can be resolved or need further attention. Where they can be resolved, there is a step in which alternative actions are considered and decisions are made to resolve the conflict. When the conflicts cannot be immediately resolved, the next step is to establish a consensus execution forecast or new supply plan that is again communicated to all important constituents. Finally, there is a step to monitor progress versus the altered demand and supply plans. The overall objectives, of course, are the optimal utilisation of corporate and enterprise resources and better satisfaction of the customer No Gather information and compile Establish a Demand Plan Evaluate against constraints Conflicts Establish a supply plan Monitor progress vs. Demand and supply plans Yes Optimal utilisation of Corporate resources Fig. 3.6 The sales and operations planning implementation S and OP have served companies well for many years as a way to balance supply and demand. But traditional S and OP processes were designed before globalisation and these days due to the internet, business world has gone through lots of changes. 63/JNU OLE

78 Inventory Management Companies want to achieve their goals to maximise business opportunities and lessen risks. Uncertainty of demand, volatility of supply, and increasing customer expectations are challenging factors in the business world and also the need of S and OP. 3.5 Theory of Constraints Affects Sales and Operations Planning The Theory of Constraints (TOC) is a philosophy of management and improvement which was originally developed by Eliyahu M. Goldratt and introduced in his book -The Goal. It is based on the fact that, like a chain with its weakest link, in any complex system at any point in time, often only one aspect of that system that is limiting its ability to achieve more of its goal. The particular constraint must be identified so that the system attains significant improvement and the in the mind whole system must be managed. Problems are looked at from a system level in TOC unlike to some quality methods that are focused on specific processes. When improving a system, one must look at the goal of the system, and then what constrains it from achieving the goal. The goal of a business is to make profits now and in future. The constraint can be viewed as its weakest link, and a system can have only one weakest link at any given time. TOC helps us find and manage that weakest link. In organisations improvement activity does little to improve the overall strength of the system. It is understood that strengthening a non-weak link could further strain the weakest link to the point of breaking the system. The body of knowledge and analytical tools (the TOC Thinking Processes) that give power to TOC come from experience in the accurate sciences and are based on rigorous which are also easily understood, cause-and-effect logic. These tools also provide the ability to support the development of breakthrough solutions through the premise. Fundamentally in the real world, all systemic conflicts that restrain action are the result of unexamined assumptions that can be identified and corrected for true win-win solutions. As a whole, the TOC thinking processes provide an integrated problem-solving methodology that addresses not only the construction of solutions but it also takes care of the need for communication and collaboration that successful implementation requires in an organisation. These constraints determine the output of a system whether they are approved or not. So manager s best interest would lie in identifying and reduce the system constraints within the organisation. The theory of constraints is both descriptive and prescriptive in nature. It describes the cause of system constraints and also provides guidance on their resolution Systems as Chains A system is a collection of interrelated, independent processes that work together to turn inputs into outputs in the pursuit of some goal. A chain always has one weakest link and any force applied to the chain at an increasing rate would lead to breakage at the weakest link. Therefore, the weakest link would be the 64/JNU OLE

79 constraint that prevents the system (chain) from doing any better at achieving its goal (accepting force). Goldratt states that at any given time there is only one constraint in a system that limits the output of the entire system. The remaining links are known as non constraints. After strengthening one constraint, the system is stronger. It should not be forgotten that the system does not become infinitely stronger. The constraint simply migrates to a different component of the system. Inputs Process A Process B Process C Output 10 units/ day 6 units/ day 8 units/ day Market demand 15 Source : Adapted from Goldratt s Theory of Constraints by H. William Dettmer Fig. 3.7 Theory of constraints An Example To get a better understanding lets take a look at the theory of constraints and non constraints. Consider a production system that runs raw materials through three component processes and then turns them into a finished product. Let s assume that each process is equivalent to a link in the production chain. Here constraints of the chain would be -Process B is the weakest link. Process B produces the least at only six units per day. Process A and C are the non constraints. Imagine that the manufacturer improves process B until it can produce 18 units per day. Now, process C becomes the system constraint while the non constraints are everywhere else. If process improvements continue until all processes are producing 18 units per day or higher, the system constraint becomes the marketplace, which can accept only 15 units per day. Internal constraints have been replaced by an external constraint at this point. Overall, the theory of constraints emphasises fixing the weakest link in the chain the system constraint and temporarily ignoring the non constraints. In this way, the theory has a greater impact on process improvement. Rather than spreading limited time, energy, and resources across an entire system (which may or may not result in tangible results), teams focus on that part of the system with the potential to produce immediate system improvement 65/JNU OLE

80 Inventory Management Throughput, Inventory, and Operating Expense In order to determine the effect that any local action has on progress toward a system goal, Goldratt created a simple relationship chart between three systemlevel measurements: throughput (T), inventory (I), and operating expense (OE). Dimensions Throughput :Rate at which an entire system generates money through sales of a product or services. Inventory: All of the money a system invests in the products or services it intends to sell. Operating expense: All of the money a system spends in turning inventory into throughput. Examples Money(for profit organisation) Delivery of a product or service to the customer ( non profit organisation) Raw Materials Unfinished goods Purchased parts Investment in equipment/ facilities Direct Labour Utilities Consumable supplies Depreciation of assets Table 3.1 Throughput, Inventory and operating expense Systems $ $ $ Throughout Money coming in Inventory money tied up inside Operating expense Money going out Source : Adapted from Goldratt s Theory of Constraints by H. William Dettmer Fig 3.8 Three Dimensions in theory of constraints Given Goldratt s three dimensions, organisations have three different options for system improvement: increasing T, reducing I, or reducing OE. 66/JNU OLE

81 The practical limits of reducing inventory and operating expenses are relatively low, as a system can t produce many outputs without them. Theoretically, there s no upper limit to how much an organisation can increase its throughput, but market sizes are limited. The potential for increasing T tend to be much higher than the potential for decreasing I and OE. Therefore, a basic model for system improvements focuses on increasing T and making reduction of I and OE a secondary priority, as shown below T I OE Maximise T Minimise I and OE without degrading T Source : Adapted from Goldratt s Theory of Constraints by H. William Dettmer Fig. 3.9 Three options for system improvement The Five Focusing Steps There are five focusing steps in theory of constraints, which are discussed below: Step 1: Identify the system constraint in an organisation identifies the part of the system that constitutes the weakest link in this step. Then it is important to understand if it is a physical constraint or a policy-related issue. Step 2: Decide the ways to exploit the constraint. Here the organisations exploit the constraint by utilising every bit of the constraining component without committing to potentially expensive changes and/or upgrades. Step 3: Subordinate everything else. To do that a plan in place is needed for exploiting the constraint; the organisation adjusts the rest of the system to enable the constraint to operate at maximum effectiveness. Evaluate the results to see if the constraint still holds back system performance. If it is, the organisation proceeds to Step 4. It not, the constraint has been eliminated and the organisation skips ahead to Step 5. Step 4: Elevate the constraint. If an organisation reaches Step 4, it means that Steps 2 and 3 were not sufficient in eliminating the constraint. At this point, the organisation elevates the constraint by taking whatever action needed to eliminate it. 67/JNU OLE

82 Inventory Management This may involve major changes to the existing system, such as reorganisation, or capital improvements. Since these typically require a substantial up-front investment, the organisation should be certain that the constraint cannot be improved from Steps 1 through 3. Step 5: Go back to Step 1. After a constraint is broken, the organisation repeats the steps all over again, looking for the next thing constraining link. At the same time, the organisation needs to monitor how the changes related to subsequent constraints impact the already improved constraints. 3.6 Formal Work on the Case Study Sales and Operations Planning Process for a leading Indian Cement Manufacturer Business scenario Operations involved selling multiple brands which were transported through a multimode logistics network (rail, road, sea), either directly to customers or to 200+depots which served the customers. A very loosely defined non-uniform sales and operations planning process with limited involvement of all stakeholders. Planning is done at a very aggregate level. Limited visibility and buy-in of the current process outputs. Somehow it did not drive the supply chain. Incorrect Sourcing decisions (source, mode) to meet demand. Increased logistics costs Reduced ability to react to changes in supply chain (e.g., reallocation of material due to changes in demand over a month). Capacity Constrained Situation. Affected service levels Threat from regional players providing superior service levels and entry of MNC s. Our solution An integrated and well defined sales and operations planning process was defined and implemented. It involved all the key stakeholders including the territory sales managers, regional heads, zonal heads and the central planning team. It was designed to work at more granular level than before. The process outputs were visible to all the stakeholders and a single plan was driving the supply chain. Metrics were put in place to measure the process compliance and output of each stakeholder. A best source-mode combination was suggested to meet demands depending on minimum and maximum level of demand to be met, the revenue realisation from meeting the demand and the logistics costs incurred in meeting the demand. 68/JNU OLE

83 Granular level of planning (month to days) meant more granular demand picture over a month and a better ability to reallocate material based on demand profiles. Benefits Existence of single plan and visibility of that plan to key stakeholders ensured better coordination between them. It also ensured better coordination with external stakeholders plant logistics teams were able to give better visibility to transporters and railways on the requirements, sales team was able to give more realistic commitments to their customers. The sum total of the above meant better customer service levels. Logistics cost reduction on account of better way to decide on source-mode and more granularities in planning Accountability on account of more visibility and metrics framework. 69/JNU OLE

84 Inventory Management Summary Sales and operations planning(s and OP) is an integrated business management process through which the executive/leadership teams try to continually focus, alignment and bring out synchronisation among all functions of the organisation. Top-down planning is the simplest approach to sales and operations planning. In this approach, there is a single sales forecast that drives the planning process. This approach is used by companies that do not have a stable manufacturing schedule and the number and type of finished goods can change from month to month. Sales and operations planning has also been described as a set of decisionmaking processes to balance demand and supply, to integrate financial planning and operational planning, and to link high level strategic plans with day-today operations. The Theory of Constraints (TOC) is a philosophy of management and improvement originally developed by Eliyahu M. Goldratt and introduced in his book -The Goal. In order to determine the effect that any local action has on progress toward a system goal, Goldratt created a simple relationship chart between three system-level measurements: throughput (T), inventory (I), and operating expense (OE). References Murray, M., Sales and Operations Planning, [Online] Available at:< logistics.about.com/od/tacticalsupplychain/a/sandop.htm> [Accessed on 07 July 2011]. IE Group, 2011,Sales & Operations Planning Summit,[Online] Available at: < on 07 July 2011]. Demand Solutions, 2008, How to Execute a Successful Sales & Operations Planning Process, [Video online] Available at : < watch?v=bimju4yjet4>[accessed 7 July 2011]. Martensson, H., The Chain Theory,[Video online] Available at: < [Accessed 7 July 2011]. Wallace, T. F. and Stahl, R. A., Sales and Operations Planning: The How-to Handbook, 3rd ed., T. F. Wallace & Co. Goldratt, E. M., Theory of Constraints, North River Press. 70/JNU OLE

85 Recommended Reading Dougherty, J. and Gray, C., Sales & Operations Planning - Best Practices: Lessons Learned, Trafford Publishing. Singh H., A Practical Guide for Improving Sales and Operations Planning, Supply Chain Consultants. Inc. Oliver Wight International, The Oliver Wight Class A Checklist for Business Excellence (The Oliver Wight Companies), 6th ed., Wiley. 71/JNU OLE

86 Inventory Management Self Assessment 1. The Theory of Constraints (TOC) is a philosophy of management and improvement originally developed by. a. Eliyahu M. Goldratt b. Eliott Goldratt c. Ellis Goldratt d. Ellien Godratt Rate at which an entire system generates money through sales of a product or services is. a. throughput b. inventory c. operating expenses d. investment All of the money a system invests in the products or services it intends to sell is. a. throughput b. inventory c. operating expenses d. investment All of the money a system spends in turning inventory into throughput is. a. Throughput b. Inventory c. Operating Expenses d. Investment is the simplest approach to sales and operations planning. a. Top-down planning b. Bottom-Up Planning c. Top-bottom planning d. Top- end planning 72/JNU OLE

87 is used by companies that do not have a stable manufacturing schedule and the number and type of finished goods can change from month to month. a. Top-down planning b. Bottom-Up Planning c. Top-bottom planning d. Top- end planning State if the following statement is false? a. It connects strategy and operations is one of the objectives of S and OP. b. It yields a workable plan is one of the objectives of S and OP. c. It makes it possible to manage change is one of the objectives of S and OP. d. Decide the ways to exploit the constraint is one of the objectives of S and OP. State if the following statement is false? a. Identify the system constraint in an organisation identifies the part of the system that constitutes the weakest link in this step is the one of the focus steps. b. Elevate the constraint is the one of the focus steps. c. To do that a plan in place is needed for exploiting the constraint is the one of the focus steps. d. An integrated and well defined Sales and Operations Planning process was defined and implemented is the one of the focus steps. State if the following statement is false? a. Sales and operations planning(s and OP) is an integrated business management process through which the executive/leadership teams try to continually focus, alignment and bring out synchronisation among all functions of the organisation. b. The Theory of Constraints (TOC) is a philosophy of management and improvement originally developed by Eliyahu M. Goldratt and introduced in his book -The Goal. c. A simple relationship chart between three system-level measurements: Throughput (T), Investment (I), and Operating expense (OE). d. Table of Constraints is based on the fact that, like a chain with its weakest link, in any complex system at any point in time, there is most often only one aspect of that system that is limiting its ability to achieve more of its goal. 73/JNU OLE

88 Inventory Management 10. State if the following statement is false? a. Inventory is the money a system invests in the products or services it intends to sell. b. Throughput is the rate at which an entire system generates money through sales of a product or services. c. Organising expense is all of the money a system spends in turning inventory into throughput. d. Sales and Operation management is a process where executive level management meet regularly and reviews projections for demand, supply and the resulting financial impact. 74/JNU OLE

89 Chapter IV Making Effective Presentations Aim The aim of this unit is to: introduce basic skills required for making presentations elaborate presentation plan elucidate sales and operations plan Objectives The objectives of this unit are to: describe tools of effective presentation explain steps required for planning a presentation detail outline of sales and operations plan Learning outcome At the end of this unit, you will be able to: deliver presentation like a professional prepare an effective presentation based on research implement sales and operation plan 75/JNU OLE

90 Inventory Management 4.1 Basic Skills Required for Making Effective Presentations A presentation is needed during business meetings, product launches, job interviews, trainings, as well as in selling products and services. Working professionals will generally be asked to give presentation in the presence of one or more people. Individuals whose presentation skills are lacking must work doubly hard to improve their skills. These days giving a presentation is an opportunity to shine. For professionals who are always nervous or have difficulty expressing their thoughts and ideas, it becomes a barrier to career growth. Some presentation skills training focuses on the key aspects that make an effective presentation. It is important to take note of necessary things you need to know in order to deliver an impressive presentation for both big and small audiences. Presentation skills are often overlooked by many professionals in the greater scheme of career development. Effective speech is not just one of the only presentation skills. In the modern world messages are conveyed with the help of visuals. Usage of computer technology such as PowerPoint or WebEx widely used to communicate has become a boon for the managers. Networking is highly valued by emergency managers. It not only helps agencies to work together in disasters and builds relationships. It is an important career development tool. Presentations can give anyone a fright but with the use of breathing techniques, visualisation techniques and many other aids, this fear can be taken care of. One of the best ways is to start with the contents of the material in order to ensure effective presentation. What one presents is as important as to how it is being presented. Further, it also helps corporate and organisation in its aim of uniting the entire workforce for a common mission. Therefore, identifying the varied contents for the presentation is a vital step. Then one must focus on understanding the attitude of target audience and adopting an approach suitable to address them. A better presentation skill helps in promoting co-operation between sections of the company as it displays high standards of professionalism. With this customers needsare taken into consideration. If the purpose and audience are taken in to consideration while making a presentation then it doesn t matter if it is presented in an informal manner. 76/JNU OLE

91 4.1.1 Tools for Effective Presentations Here are four simple tools for effective presentations. Determination of a Style Usage of Humour Tools of Effective Presentation Determine Core Information Know the Surroundings Well Fig. 4.1 Tools of effective presentation Determination of a style While delivering a presentation, the style of one s presentation helps in grabbing the attention of the audience. Hence, the style of presentation should match one s personality and be suitable for the topic chosen. The style of one s presentation comes across in the speaking manner, in the tone of voice, body language, expressions and gestures. Care should be taken that the styles are changed depending upon the choice of topic. For instance: A different style would be used to convey salient scientific data compared to the style adopted to inform the audience the benefits of a new type of cosmetic. The presenter s personality should match the topic chosen, the audience and the knowledge. Implementing the correct style is vital to effective presentations. It is important to know the audience, topic and know strengths and weaknesses. 77/JNU OLE

92 Inventory Management Determine core information There should always be substance to the presentation. The vital information about product or service constitutes this substance. This is what the audience is interested in and all else is secondary to it. Before any professional tries to inject some humour in their presentation, they should also have the substance in place. In verbal presentation emphasis is laid as to what is to be said and how it should be said in what way it would affect the audience. They probably would be surprised at the unique details presented. They have to be moved by the potential involved eventually helping them to take action. All of these things must be planned and structured beforehand. Creation of core of the information is not only important but ensuring it follows a logical manner. It should flow well which will help in creating effective presentations Know the surroundings well It s essential that the presenter has an understanding of the space where he will be doing a presentation or giving a speech. Whether he will be using props, a PowerPoint presentation or simply standing behind a lectern, it is important that he should get a grasp of the situation where he will be in. Visiting the venue ahead of time and finding out how to use their equipment, where one can plug the laptop and how loud he needed to speak to ensure that everyone will be able to hear him comfortably. Usage of humour Humour is one of the most powerful tools at one has at his disposal. It is one of the underlying emotions common to everyone, from presidents to the common layman. Humour can be used for many things it helps to connect with the audience on a deep, subconscious level. Initially, it helps to break the ice with the audience. It can also help the presenter feel less stressed and fearful when he takes the stage. A little humour makes the whole session better for the audience as well as the presenter.. A few well-placed anecdotes or an occasional joke about the state of the industry or even poking a bit of fun at oneself at key points during the presentation would be acceptable. The important thing is that the humour should feel natural rather than forced. Delivering an effective presentation is within reach provided the utilisation of the principles is outlined. Confident public speaking would be easy once the presenter uses these strategies. The delivering an engaging and captivating speech would be a cakewalk. 4.2 Planning a Presentation In the beginning one should determine the objectives of the presentation. A presenter must answer this question. What does he want to achieve by giving a presentation to a particular audience. The answer to this question should help one plan his presentation. For example: If one has been asked to give presentation to a group of managers in his company on next year s departmental budget. The important part is that what is to be accomplished with the presentation. Would it ask for a budget increase, or presenting a plan that shows how one can operate on less money? Think about the specific objectives keeping audience in mind before preparing your presentation. 78/JNU OLE

93 Step 1: Develop Objectives Persuasive Informative Fig. 4.2 The P-I diagram This diagram describes the relationship between persuasive and informative presentations. They are not of separate types but in a way they exist on a scale. An example of an informative presentation: At the far end of the diagram would be a status report or a project update. All persuasive presentations contain elements of information given and all informative presentations contain elements of persuasion. Heading in the direction of the arrow, presentations become more and more persuasive. When the vertical line in the centre is crossed, in the direction of the arrow, the presenter tells the audience what change is requested; this in part, is the definition of a persuasive presentation. Presentations on the informative side of the line imply that some action should be taken, in a stronger and stronger manner, as the centre line is approached. Use of the P-I Diagram helps to determine the objective. Marking the place on the diagram helps in finding out whether the presentation falls in persuasive or informative. 79/JNU OLE

94 Inventory Management Step 2: Analysing the Audience When analysing the audience four items have to be considered. Audience Value 0Needs 0Constraints 0Demographic Information Fig. 4.3 Four factors required to analyse audience Values: Values are very important to any group. Different organisations have different value systems. Giving a presentation outside your organisation is probably very different from delivering a presentation in-house. Again different departments within an organisation can have different values. Needs: It is important to find out in advance of the presentation what are the needs of the. This probably would be quite different from what one has thought they would need. The speaker then must find a way to resolve the discrepancy. Constraints: They are some of the things that might hold the audience back from doing what one wants them to do or from knowing what one wants them to know. Internal politics can be a constraint. If one must get support from competing factions one must take that into consideration when organising the presentation. In addition, personality clashes and other forms of conflict may interfere with the success. Resistance is encountered where there is an expenditure of money. This should be taken into consideration in the presentation. All of professionals have their own area of specialisation. Use of technical language, abbreviations, acronyms, buzz words, etc which people in the audience might not understand. Ask the audience if they are familiar with the terminology and define it if necessary. Demographic Information: Things like the size of the audience, location of the presentation, etc., may also influence the organisation. 80/JNU OLE

95 Step 3: Organising One s Thoughts It is always a good idea to start organising the body of the speech and not worry about the introduction until later. Introductions are often generated by what goes into the body. Effective speakers have learned to build from the centre of their speech outward. Brainstorming some possible main ideas for the presentation would be of some help. Penning down ideas would come handy. The strategy is to generate as many ideas as possible. Start eliminating once large number of ideas is written down. Two and five main ideas should be perfect as a typical number for a presentation. If more than five ideas are present then it should be reduced or you can put some of them as sub points. For example: Suppose while giving a presentation to upper management to defend the need for department s request for a 20% budget increase next year. You develop a persuasive presentation where in audience analysis sheet, 10 to 15 original ideas have been created to focus on. However, it could be narrowed down to the following three: We need to update our computer system More programmers are needed to develop our computers We must have finance department Fig. 4.4 Organising one s thoughts These three ideas are the general assertions you plan to make to your audience. Specific explanations, evidence and benefits should become one s sub points. Step 4: State the sub points Once you have the main points of your presentation, it is time to develop supporting ideas. These may consist of explanations, data or other evidence to support your main ideas as shown in our example. 81/JNU OLE

96 Inventory Management We need to update our computer system More programmers are needed to develop our computers We must finance department Old system is antiquated Will save money immediately by creating proprietary programs Need new data communication system Can t use latest software Will be less independent on outside vendors New Technology allows for better quality at same cost Old system costs are increasing because of inefficiency Can reassign most from within company New Personnel will contribute fresh ideas Many breakdowns recently Will help keep us competitive Need new programs Hard to replace parts Can develop new products New high speed printers will help develop new products Fig. 4.5 Stating sub-points in the presentation You may have more or less sub points in your presentation. Once this procedure is completed, rearranging the cards that suits the need best. After trying different arrangements to see what will work best. Always keep the objectives and audience in mind. STEP 5: State the benefits In persuasive presentations, it is necessary to tell the audience specifically what benefits they will receive if they do what you ask. Benefits are usually placed in the body of the presentation. An alternate method of organising a persuasive presentation might be to simply use the benefits as the main points. From the previous example (Why our department needs a 20% larger budget next year) we might summarise the following benefits to our audience: More money in our department will allow for a new computer system that will keep us competitive in our industry. It, along with the necessary programmers, will increase profits because of greater efficiency. 82/JNU OLE

97 A new system will allow us to upgrade our existing products, as well as develop new ones. STEP 6: Develop handouts If decided about handouts (if any) are to be added to the presentation. Following are three major uses of handouts in a presentation. presentation. To reinforce important information To summarise action items for the audience to follow up on To supply supporting data apart from visual aids Fig. 4.6 Uses of handouts in presentation After deciding what handouts would be beneficial then the time as to when they will handed them out. There are three alternatives: Before the Presentation: The main problem with this is that the audience may wish to satisfy their curiosity about the contents of the handout as the speaker is speaking. When people are reading, they are not listening. One way to deal with this problem is to have the handout in place when the audience enters the room. This will allow them to read it before the speaker begins speaking. In addition, you can explain the handout, satisfying their curiosity about its contents. During the Presentation: This must be used carefully. Handouts during a presentation must be disbursed quickly and be relevant to the point the speaker is making at the presentation. Otherwise, they will be a distracted n instead of being attentive. At the end of the Presentation: During the presentation, the audience should be informed that they will receive a handout covering so and so relevant points at the end of the presentation. This will allow them to avoid having to take necessary notes. However using this technique would depend on the audience analysis. If the audience is accustomed to receiving handouts with presentations, or if it would be useful for them to follow the presentation with the data before them. The speaker may not want to withhold them. But it should be considered whether it is going to distract them from the verbal presentation (such as glossy photos, marketing brochures, etc.) and not add substantially to the presentation then it should be held back. 83/JNU OLE

98 Inventory Management STEP 7: Develop Visual Aids Once the organisational pattern has been established, there is a need to decide if and where the visual aids are going to used. For now it is important to determine how they will fit into the plan. For example, the third sub-point under the first major idea in the sample presentation developed states that the old computer system is costing the company money. This point could be illustrated with a graph or similar visual showing the cost of the computer over the past three years versus the savings of a new system during the same time span. STEP 8: Main Idea Preview/Review Sentence There is a famous saying: Tell them what you re going to tell them Tell them Then tell them what you told them! In other words, previewing and reviewing the main points is a must in the presentation. This can be accomplished very easily by using a main idea preview sentence and a main idea review sentence. These sentences are separate from the introduction and conclusion. STEP 9: Develop the Introduction Introductions consist of two major functions: Introduction Providing necessary information Gathering attention Fig. 4.7 Functions of introduction Providing necessary information: This might include background material, establishing the significance of the topic, introducing oneself and establishing one s credibility by telling the audience why one is qualified to speak on the topic. Additional types of information could be appropriate to deliver at this point too. 84/JNU OLE

99 Getting attention: Right before the presentation the audience may be chatting with one another, daydreaming or reading the handout material that the speaker have cleverly placed on the table in advance of the presentation! Each presentation situation will call for its own necessary information depending on the audience analysis. However, almost all presentations require some type of attention getter. The smaller the group the smaller the attention getting device. Here are some of the more common types: Technical Background: Often speakers have to introduce their topic by giving some background information or data; they need to set the stage for what is to come in the body of the presentation. Anecdote: An anecdote is a short story used to help illustrate a point. It is sometimes humorous but not always. An example might be something like this. In the same way, if we raise salaries for our production workers 10%, we should expect to increase productivity. Humour: Humour is a great way to break the ice. Humour must be linked to the speaker, topic, audience or the occasion. Making jokes of racism or makes fun of national origin, religion or any personal topic should be avoided. There is nothing worse than a joke used in an introduction that has no connection to the speech. Questions: There are two ways of involving questions in the presentation. First where open-ended question could be asked.the second way, and the safer of the two, is to ask for a show of hands. This device is an excellent way to get the audience s attention. STEP 10: Develop the Conclusion Good conclusions always return to material in the introduction of the presentation. They normally should refer the background material, rhetorical question, anecdote or data that one has used in the introduction. In persuasive presentations sometimes there is a need of call-to-action statement in the conclusion. The conclusion should tell them what specific action they need to take, how to take it, and when it must be taken. Introductions and conclusions put the head and tail on the body of the presentation. Without a developed conclusion, the presentation is considered incomplete. Fig. 4. shows the steps taken to build a powerful and effective presentation. 85/JNU OLE

100 Inventory Management Define Objectives Analyse Audience Organise one s thoughts State sub-points State benefits Develop handouts Develop Visual Aids Main Idea Preview/ Review Sentence Introduction Develop the conclusion Fig. 4.8 Steps taken to plan a presentation 4.3 Preparation for Sales and Operation Plan Many companies implementing or operating integrated manufacturing planning and control systems have discovered benefits to be gained by formalising and integrating this planning process. This involves a monthly review process by top management and all functional areas of the company. Its ultimate goal is to always keep the detailed sales, manufacturing, purchasing and capacity planning systems in synchronisation with the latest high level plans of management (the business plan). This presentation understands the basic philosophies, concepts and mechanics of Sales and Operations Planning, Master Production Scheduling and Material Retailing Planning. The purpose of this presentation is to provide a simple, stepby-step implementation plan to get started quickly and effectively. APICS Dictionary defines and highlights the key points for developing the Sales and Operations Planning process and involvement of the right people in the process. 86/JNU OLE

101 Business Plan: A statement of long-range strategy and income, cost and profit objectives usually accompanied by budgets, projected balance sheet and a cash flow (source and application of funds) statement. It is usually stated in terms of money and grouped by product family. The business plan and the sales and operations plan should be in agreement with each other even if it is frequently stated in different terms. Top management usually plans in sales, profit, funds, etc. to run the factory. A production plan should be stated in units and is always equal to the business plan in money terms which is a requisite. Sales &Operations Planning: The function of setting the overall level of manufacturing output(production plan) and other activities is to best satisfy the current planned levels of sales (sales plan and/or forecasts). It is important to meet general business objectives of profitability, productivity, competitive customer lead times, etc., as expressed in the overall business plan. One of its primary purposes is to establish production rates that will achieve management s objective of maintaining, raising, or lowering inventories or backlogs. It also attempts to keep the work force relatively stable. It must extend through a planning horizon sufficient to plan the labour, equipment, facilities, material, and finances required to accomplish the production plan. The Sales and Operation plan affects many company functions therefore it should be normally prepared with information from marketing, manufacturing, engineering, finance and materials. If top management wishes to truly control inventories, backlogs and employment levels, it must ensure that the level of manufacturing output scheduled recognises current sales plans and backlogs. Concurrence from all company functions that can affect or be affected by the plans is vital to ensure realism and commitment. The production plan must be stated in a unit of measure, by product family that can be converted and reconciled to detailed end item schedules. Master Production Schedule (MPS): A schedule is maintained to record a set of planning numbers which puts material requirements planning in motion. It represents what the company plans to produce expressed in specific configurations, quantities and dates. The master production schedule is not a sales forecast which represents a statement of demand. The master production schedule must take into account the forecast, the production plan and other important considerations such as backlog, availability of material, availability of capacity, management policy and goals, etc. For the master production schedule to achieve management s objectives, it must exactly match the production plan (and reflect goals, constraints, etc.) in order to satisfy the sales plan. 87/JNU OLE

102 Inventory Management Rough Cut Capacity Planning: The process of converting the production plan and/or the master production schedule into capacity needs for key resources: manpower, machinery, warehouse space, and vendor s capabilities and in some cases- money. Product load profiles are often used to accomplish this. The production plan and master production schedule must match each other and should be achieved for management s goals to be met. But, to be achieved, they require recognising the physical constraints of the factory and vendors, and the financial constraints of budgets and cash flow plans. Rough Cut Capacity Planning allows production plans and master production schedules to be checked and adjusted for reality. Time Fence: A policy or guideline is established to note where various restrictions or changes in operating procedures take place. For example, changes to the master production schedule can be accomplished easily beyond the cumulative lead time whereas a change inside the cumulative lead time becomes increasingly more difficult to a point then these changes should be resisted. Time fences can be used to define these points. When Rough Cut Capacity Planning forecast changes, customer orders or the constraints of demonstrated capacity identify the need for rescheduling decisions, the procurement lead times of the various product families have to be considered. Top management and all affected functions must formulate policy that initiates the proper decision making guidelines, participants and management approval levels. These definitions outline the mechanics necessary to effectively integrate a good sales and operating plan with the other functions. There is a need for active leadership and participation by top management and all functional areas which is necessary during the design, implementation and ongoing operation of formal sales and operations planning.it is based on the company-wide impact of this process described above. It should be clear that the general manager, President or Chief Executive Officer (CEO) needs to oversee this function. This process drives the planning and execution systems, which dictate customer service and profitability. The executive is therefore responsible for the profitability and growth of the company needs to control Sales and Operations Planning. The functional heads (vice presidents or directors) of marketing, manufacturing, design, finance and materials must also participate for the same reason. The master production scheduler, production and inventory control manager and marketing manager should also be present to propose needed plan changes and note in order to implement management decisions. Educate the Participants. Gaining interest and involvement could be a laborious and slow process until there is a clear understanding of the goals. The impact and the process involved in Sales and Operations Planning has educational steps. They are not interchangeable but should be followed completely in sequence: 88/JNU OLE

103 Types Of Class Participants Purpose MRP II for Top Management (outside class) MRP II - Full Detail (outside class) Sales & Operations Planning and Master Scheduling (outside class) 2-Hour In-House Educational Sessions (approximately 20) 2-Hour In-House Educational Sessions (approximately 40) Top Management Middle Management All Top Management Middle Management Understand whole MRP II process, the role Sales and Operations Planning plays, Top Management s role, the payback. Same as above, but with more mechanical detail Understand how to implement and operate the system Determine how the concepts will be applied at this company, set operating policies, assign implementation responsibilities Same as above, but in more procedural detail for Sales and Operations Planning, Master Scheduling and all other functions of MRP II. Table. 4.1 Educational steps in Sales and Operation Planning Define Planning Families. Most companies group their products into families or lines, but often based on the customer s perspective (i.e., products bought together such as a particular computer CPU with its matching printers, CRT s, etc.). It is vital to additionally or alternatively define families from a manufacturing viewpoint. The basic rule to follow is that all products in a family must have a consistently proportional impact on costs, revenues and factory and supplier capacities. For example, a family could include knives, forks and spoons from a series of different patterns of silverware. Though knives, forks and spoons require widely varying manufacturing resources, a weighted average can be applied to the total number of pieces produced. Since knives, forks and spoons are sold in a consistent mix (place settings), if the production plan for the total pieces is changed, the impact on the critical manufacturing resources can be determined by multiplying the new plan times the weighted averages (load profiles) for each resource. All products must be 89/JNU OLE

104 Inventory Management grouped in 10 to 12 families (a number capable of review in a 2 hour meeting). The units of measure in which the family production plans are expressed must also relate to the manufacturing process - pieces, sets, pounds, gallons, cases, etc. This allows the proper expression of rough cut capacity planning factors and demonstrated capacities. These physical units of measure can then be converted back to rupees for financial analysis. Define the Format. A standard format to display forecasts (sales plans), customer orders, production plans, backlogs and inventories needs to be determined up front. This format should be extended for the full planning horizon (12 to 24 months). Individual companies often expand this format to also include investment as the key unit data. Prepare Pilot Data. A few families should be selected which will best demonstrate the benefit of the Sales and Operations Planning process. These may include families subject to seasonal demand, marketing promotions, volatile swings in actual demand versus forecast and/or limited capability to adjust manufacturing output rates. Forecasts, actual customer demands, production and inventory plans.actuals should be posted for the prior three months. Plans, forecasts and customer orders for at least the next three months (to start) should also be posted. The starting production plans can be derived from the current planning process or annual budgets or current master schedules, depending on what s available. Any plans or forecasts that appear to require review or alteration should be highlighted. Marketing and planning personnel should jointly prepare suggested changes for top management review and approval Develop a Proposed Sales and Operations Planning Policy and Meeting Agenda. The policy of Sales & Operation policy should include: Objective of the process. Schedule of future meetings. Attendees and their individual. Responsibilities (such as VP Marketing - review of actuals versus forecasts/ sales plans and changes to the future ). A description of the mechanics of the planning process (how forecasts/sales plans, backlogs, inventory goals, production plans, etc. are to be considered, by product family). A description of how demonstrated capacities by product family will be maintained and utilised. A description of the Rough Cut Capacity Planning techniques to be used. A guideline for determining which families will be reviewed in the meeting, based on actual variances from forecasts and plans. 90/JNU OLE

105 A guideline for developing and approving various changes to the plans depending on the timing and impact of the changes (e.g., different approvals required for overtime, subcontract, new hires, etc.). A statement defining how the plans will be used to establish financial plans, budgets and detailed Master Production Schedules and line item forecasts. A timed agenda for a monthly review meeting, to last no longer than 2 hours. The first few meetings often run longer as everyone is still becoming familiar with the process, formats, etc. It may take a few monthly meetings to fine tune the process and finalise the procedures and formats. It may be advisable to just review the initial pilot families, or to only gradually add new families until everything is final Implement Full Sales and Operations Planning The following key issues need to be resolved to ensure that the full benefits of Sales and Operations Planning can be achieved: Horizon: Establish how far out you need to plan based on the cumulative product replenishment cycle (manufacturing and purchase lead times) and the visibility required for planning changes in capacity (internal manufacturing, new plants and suppliers). Near the end of the horizon, data may be grouped quarterly. Rolling forecasts/sales plans: The shipment forecast/plan needs to be maintained continually through the full horizon, not just determined annually. Bookings versus shipments: The forecast/ sales plan must be expressed by customer requested ship dates, not by when the orders are received. In maketo-order companies this may involve developing standard lead time offset averages by product family, to convert planned booking dates into shipment dates. Some companies find it useful to track shipments and bookings versus the customer backlog, to provide early analysis by marketing of potential forecast changes. Production plans: If the initial numbers used are annual budget figures or a total of current master production schedules, the process of maintaining a rolling, monthly-updated production plan, separate from the master production schedules, must be developed. Ongoing measurement of how closely the summary of the master production schedules matches the production plans, by month, within tolerances established by family, should be initiated. Appropriate adjustments to the plan, based on changing customer demands, forecasts/sales plans and inventory levels should then be implemented. Measurements: A set of standard measurements, by family, should be published and reviewed at each meeting. These should include: 91/JNU OLE

106 Inventory Management Customer service Sales v/s Forecast/plan Shipment costs Master Production schedule v/s Production plan Actual production v/s MPS v/s Plan Level and frequency changes of schedule Fig. 4.9 Measurement Standard reviewed at each meeting Establish demonstrated capacity: For each family, the number of units possible to be manufactured each month should be determined from recent past history. The historical averages should not be exceeded unless known increases in capacity are implemented. The plan should reflect the inevitable learning curve of introducing new people, suppliers or equipment. Full family planning: Once the pilot families are being effectively managed through the full horizon, all other families should be added to the process, for the full horizon, representing virtually all manufacturing activity. The use of average product planning items for design-to-order business is often required, in both Sales and Operations Planning and Master Production Scheduling. The use of planning bills of material will be needed at the master production schedule level. Rough cut capacity planning: Key manufacturing and supplier capacity (and short term schedule change) constraints should be identified by family and expressed as load factors that can be multiplied by the planned quantities to produce expected resource requirements. These may include: 92/JNU OLE

107 Total people People by department or skill Key work centres/ lines bottlenecks fully loaded Proprietary ( no alternatives) Prone to break down Space Key Suppliers Inspection and Q.C. Design/Engineering Levels of Inventories Fig Factors of Rough Cut Capacity Planning Key operating objectives should be similarly expressed and analysed. These may include: 93/JNU OLE

108 Inventory Management Shipment Costs Production Costs Inventory Costs Profit Work force utilisation Inventory Level Fig Key Operating objectives in Rough Cut Capacity Planning Time zones (Fences): Depending on the lead times to procure and manufacture products within a given family, changing a schedule at different points in the future represents varying degrees of difficulty and cost. Exactly where these zones are for each family must be defined. Appropriate levels of analysis and approval should then be prescribed for proposed changes in each zone. Factors to consider include the amount of potential disruption in the factory and at suppliers, the potential extra cost (air freight, overtime, etc.), the impact on other commitments and the amount of increased inventory investment by delaying parts of the schedule already partially completed. Management objectives and policies: A well functioning Sales and Operations Planning system will improve the ability to achieve objectives and follow policies. But it often also highlights the potential for changing policies to better meet the objectives. Such opportunities include: - Make-to-stock versus make-to-order versus finish-to-order, by product line or individual product - Target inventory levels - Amount - Level in the structure - Desired backlogs, lead times and customer service levels - Level labour loads - Seasonal build-ups - New product introductions. Style of the meeting: Several key approaches should be encouraged to maximize the benefits of this process. First the various functions should avoid blame placing and competitiveness. This causes defensiveness and less than optimal cooperation. The focus should be on how to change or better achieve future plans or forecasts, not on penalizing poor prior predictions. 94/JNU OLE

109 Second, the focus should be on future months plans (generally 3 or more months into the future). Short term plans are very difficult and costly to alter. It is management s job to deal with the uncertainty of the future, and change forecasts and plans far enough in advance to better avoid short term emergencies. Third, a firm rule should be enforced forbidding time to be spent on postmortems as to why a particular customer order was missed. The meeting should deal only with overall rates of shipment and production. Individual issues should be discussed outside this meeting. Specifics should be discussed only if there is potential impact on meeting future plans. Finally, this process and the meeting should evolve to the point where middle management identifies problems and formulates suggested solutions before the meeting, so that top management s time can be preserved for only evaluating and approving the proposals. A pre-meeting meeting of middle management (manufacturing, materials, marketing, design, finance, etc.) often proves fruitful. Final result A good sales and operations planning process can start to produce benefits even before full MRP is operational. It provides a single set of company numbers, maintained monthly and expressed at a summary level appropriate for top management review. Good sales and operations plans provide ready answers to: - Why have inventory levels changed? - Why have customer service levels changed? - Why has profitability changed? All of these questions can be tied back to performance versus the plans and forecasts, and the changes made to them. Price, cost and volume variances, from both a sales and a manufacturing viewpoint, are easily visible. This process fosters an approach of Executive Consensus in running the business as opposed to one of functional selfishness and competitiveness between manufacturing, materials, marketing, design, finance and so on. 95/JNU OLE

110 Inventory Management Summary There are four simple tools for effective presentations, viz., Determination of style, determination of core information, knowledge of surrounding area and usage of humour. Planning of a presentation is a vital step to achieve the objectives of any presentation. Steps to be considered while planning a presentation are as follows: define objectives, analyse the audience, organise one s thoughts, state sub-points, state the benefits, deliver handouts, develop visual aids, main idea preview/ review sentence, develop introduction, develop conclusion. Formal sales and operations planning provides a single set of numbers and a routine process to ensure that top management s objectives and plans are realistic and accurately reconciled to the detailed scheduling done in a company. The top executives and heads of all functional areas in the company must participate in this process, along with scheduling and marketing personnel. Getting started first requires education. The next steps include defining families and formats, preparing pilot data, developing a policy and meeting agenda and finally, beginning the monthly meetings. There are several keys to effectively implementing this process including: defining the horizon, maintaining a rolling forecast/sales plan, converting bookings to shipment forecasts/plans etc while maintaining several key rules of style in making the meetings and the whole process effective. The final result is plans, and a process to maintain them, that all functions commit to and can be held accountable for. References Freedman, E., Making Effective Presentations [Online] Available at: < PRESENTATIONS.pdf> [Accessed 12 July 2011]. Dougherty, J. D., Getting Started with Sales & Operations Planning [Online] Available at: < [Accessed 12 July 2011]. About.com. How to Create a Powerful Sales Presentation [Online] Available at: < [Accessed 12 July 2011]. Mandel, S., Gerould, P., & Mapson, R., Technical Presentation Skills: A Practical Guide for Better Speaking [Online] Available at: < ebrary.com/lib/utspune/search.action?p00=technical+presentation+skills+ %3A+A+Practical+Guide+for+Better+Speaking&search=Search+ebrary>. [Accessed 12 July 2011]. 96/JNU OLE

111 Recommended Reading Rizvi, A. M., Effective Technical Communication, Tata McGraw-Hill Education. Lauer, D. L., Communication Power: Energizing Your Nonprofit Organization, Jones & Bartlett Learning, p Palmatier, G. E., Crum, C., Enterprise Sales and Operations Planning: Synchronizing Demand, Supply and Resources for Peak Performance, J. Ross Publishing, p /JNU OLE

112 Inventory Management Self Assessment 1. The of one s presentation comes across in the speaking manner, in the tone of voice and body language. a. style b. core information c. advance d. conclusion is one of the most powerful tools at one has at his disposal. a. Humour b. Style c. Confidence d. Knowledge The P-I diagram describes the relationship between persuasive and presentations. a. objective b. effective c. informative d. competitive are usually placed in the body of the presentation. a. Benefits b. Values c. Needs d. Sub-points Good always return to material in the introduction of the presentation. a. plans b. conclusions c. sales d. operations A plan should be stated in units. a. production b. business c. operations d. sales 98/JNU OLE

113 Which of the statements is false? a. Effective speakers have learned to build from the centre of their speech outward. b. Introductions are often generated by what goes into the body. c. Things like the size of the audience, location of the presentation, etc., do not influence the organisation. d. All of professionals have their own area of specialisation. Which of the statements is false? a. The important thing is that the humour should feel forced rather than natural. b. A little humour makes the whole session better for the audience as well as the presenter not too much of it. c. Humour can be used for many things it helps to connect with the audience on a deep, subconscious level. d. Humour is one of the underlying emotions common to everyone, from presidents to the common layman. Which of the statements is false? a. Presentation skills are often overlooked by many professionals in the greater scheme of career development. b. Effective speech is the only presentation skill. c. Usage of computer technology such as PowerPoint or WebEx widely used to communicate has become a boon for the managers. d. Promoting cooperation between sections of the company, displaying high standards of professionalism helps to respond to customers needs. 10. Using the P-I diagram helps to determine the. a. objective b. information c. report d. status 99/JNU OLE

114 Inventory Management Chapter V Master Scheduling Aim The aim of this unit is to: define master production scheduling (MPS) explain the time interval and planning horizon for MPS identify the aim of master production scheduling Objectives The objectives of this unit are to: enlist the guidelines for master scheduling introduce the concept of MPS time horizon discuss the role of master production schedule Learning outcome At the end of this unit, you will be able to: explain the functions of master production schedule enlist the objectives of master production schedule enumerate the principles of master scheduling 100/JNU OLE

115 5.1 Introduction The Master Schedule maintains an important position as a gateway in the flow of information between Master Planning activities such as business, demand and production planning. It also involves the detail planning and execution of daily business operations. The Master Schedule s primary purpose is to translate the strategic initiatives of top management into workable day-to-day actions. This results in making and shipping the products to customers, providing service in order to earn their satisfaction. The operations management chart describes the relationships between three important processes which are master planning, Detailed planning and planning execution. It supports these three processes in the information system represented by the bills of material,inventory, process/ routings and other important data bases. It holds all the processes together like linkages and its feedback loops show the flow of information between each functional area. The measure for finding out the effec tiveness of the total process is performance measurement. Most companies would recognise the importance of the Master Schedule in the total scheme of an effective Operations Management system. The Master Schedule is likely to be least understood and used. Somehow the data shows that most companies have not fully understood the importance of Master Scheduling. They do not realise the critical impact it has on the total effectiveness of their planning and scheduling and ultimately their performance in servicing the customer Master Production Scheduling The master production scheduler (MPS) maintains a schedule which eventually becomes a set of planning numbers that drives Material Requirements Planning. It represents what the company plans to produce expressed in specific configurations, quantities, and dates. A statement of demand represented by the Master Production Schedule is not a sales forecast. The master production schedule must take into account the forecast, the production plan, and other important considerations such as backlog, availability of material, availability of capacity, and management policies and goals. In other words Master Schedule is a presentation of demand, forecast, backlog, the MPS, the projected hand inventory, the available-to-promise quantity. The Master Production Schedule (MPS) sets the short range planning horizon in which the quantity of each end item (finished product) is to be completed in each time period (week or month or quarter). Reviewing market forecasts, orders, inventory levels, facility loading and capacity information are the information used to develop master production schedules. The MPS is a plan for future production of end items over a short-range planning horizon that usually spans from a few weeks to several months. It is considered as an important link between marketing and production. 101/JNU OLE

116 Inventory Management The MPS define precisely the required quantity per period for each finished product. The time bucket is usually the week and the time horizon up to 3-6 months or a least twice the longest product lead time. The MPS is used as a reference for the customer service. The effective MPS will give information to plan and control manufacturing. The MPS is established from firm s customer orders, sales forecasts and finished good stock levels. It aims at the following: Anticipate the customer demand per product (forecast) Distribute Sales & Operations Planning (S&OP) families into parts for each period Input quantity to produce and set deadlines for each product Follow current sales versus forecasts Insure the required customer service level while maintaining a low stock level Inform the customer service department on the available-to-promise (ATP) quantity for a given product The production plan is broken into product families for the master production schedule. Then production is planned based on demand forecasts provided by marketing department. Order promises can also be made against planned production. This job falls to marketing cell and is referred to as consuming the Inventory. When more product has been promised than that will be produced, marketing and operations must work together to develop a strategy to meet customer requirements. This can take the form of many options including; subcontract, allow overtime, increase capacity through equipment acquisition, expand facilities, increasing staffing levels, improve processes, etc Objectives of Master Production Scheduling An effective MPS helps in keeping the customer delivery promises. In today s competitive world, delivery in time is a very important factor, which contributes towards the formation of the image of the company, and its working on the customer s minds. An effective MPS acts as a basis for the utilisation of the capacity of the plant to a good level and also helps in resolving the trade- offs that usually occur in between production and marketing. With the help of the master production schedule, one can establish production schedule for the models of the products and one can also get the schedule input for the materials requirements planning process, along with the schedule that is used by order processing. The objectives of MPS can be listed as under: Maintaining the inventories at the desired level by making optimum use of the resources that are available with the company. 102/JNU OLE

117 Setting up due dates for the availability of the end items. This requires provision of the required information regarding resources and also the materials which act as the supporting pillars of the aggregate planning. Achieving the desired level of customer service. Setting particular schedules for the production of the parts and the components that are used as the inputs to materials requirements planning in the end items Functions of Master Production Schedule The MPS formalises the production plan and converts it into specific material and capacity requirements. Then in each job, viz., labour, material and equipment is assessed. Then, the MPS derives the entire production and inventory system by setting production targets and responding to feedback from all downstream operations. It is the beginning of all short-range production planning. From the MPS, Material Requirement Planning (MRP) develops short-range schedules for producing parts. These go into the end items in every work centre of the production system. The MRP develops short-range plans for purchasing the raw materials and components that are required to produce the products. Translating aggregate plans: The aggregate plan sets the level of operations that roughly balances market demands with the material, labour and equipment capabilities of the firm. The aggregate is translated into specific number of end products to be produced in specific time periods. Products are grouped into economical lot sizes that can realistically load the firm s facilities. The MPS represents a manufacturing plan of what the firm intends to produce. However, it is not the forecast of what the firm hopes to sell. Evaluating alternative master schedules: Master scheduling is done on a trial and error basis. Usage of computer helps in trial-fitting of alternative MP scan. Detailed material and capacity can be derived from the firm MPS, which is required. Generating material requirements: The MPS is the prime input to the MRP-1 system. The MRP-1 system provides for purchasing or manufacturing the necessary items in sufficient time to meet the final assembly dates specified based on the MPS for end products. Generating capacity requirements: Capacity needs arise for manufacturing the components in the required time schedule to meet the requirements of end products as per MPS. Capacity requirement planning is based on the MPS which should reflect an economic usage of labour and equipment capacities. Capacity requirements if found inadequate will require master schedules to be revised. Facilitating information processing: By controlling the work load of work centres, the MPS determines the delivery schedules for end products both for make-to-stock and make-to order items. 103/JNU OLE

118 Inventory Management It co-ordinates capabilities, financial resources, supplying labour, other management information (for carrying inventory), personnel and marketing policies for maintaining valid priorities: The absolute or relative priorities for various jobs to be completed should reflect the true needs. This means that the due date and the ranking of jobs should correspond with the time and the order is actually needed. When customers change their orders or materials get scrapped sometimes, either the components are not actually needed or end items cannot be produced because of shortage of some materials, it is necessary that the MPS should be modified to reflect this change. Effectively utilizing the capacity: By specifying the end item requirements over a time period, the MPS establishes the load and utilization parameters for labour and equipment (i.e., shifts worked or overtime or idle time) Time Interval and Planning Horizon for MPS The time interval used (for example, weekly, monthly, or quarterly) type, volume and component lead times of the products being produced depends upon the time horizon covered by the MPS. It also depends upon product characteristics and lead times. The time horizon may vary from a few weeks to a year or more and should encompass the lead times for all purchased and assembled components Time Fences in Master Production Schedules MPS can be divided into four sections, each section separated by a point of time called a time fence. The first section includes the first few weeks of the schedule and is referred to as frozen, the second section of a few weeks is referred to as firm, the third section is referred to as full and the last section of a few weeks is referred to as open. Frozen Open Time Fence Firm Full Fig. 5.1 Four sections of time fence 104/JNU OLE