Inventory Planning and Control Systems - Research Paper Example

?[Type the company Operation Management Inventory Planning & Control abc TABLE OF CONTENTS …………………………………………………………………………………………………………………………… 1 Definition …………………………………………………………………………………………………………………………. 2 Reasons for holding inventory ………………………………………………………………………………………….. 2 Costs associated with holding inventory……………………………………………………………………………. 3 The need for inventory planning and control ……………………………………………………………………. 3 Problems related with inventory management ………………………………………………………………… 4 Solutions …………………………………………………………………………………………………………………………. 6 Conclusion ………………………………………………………………………………………………………………………. 8 References ……………………………………………………………………………………………………………………… 9 Abstract Increasing importance of inventory planning and control in recent years is discussed in this report. Different methods of inventory management are discussed emphasizing on the benefits of focusing on the particular system. How critical inventory planning and control is for a firm is defined in detail emphasizing on the issues that would arise if it is neglected. Supported with an example of the sugar industry, the report further emphasizes on the disadvantages of inventory mismanagement. Listing the problems related to inventory control encountered by the management the report further identifies the solutions required to solve them. The report contains valuable information regarding efficiencies that exist in a firm due to proper inventory planning and control. It also emphasizes on the impact inventory planning and control has on the competitiveness of a firm and how the competitiveness results into increased profitability. The report summarizes the critical importance of inventory planning and control for a firm to survive in an industry and the fierce competition. Definition An inventory can be defined as a list of goods which are either finished, in form of raw material, in process or just simply as stock in hand. Inventory is also usually referred to as the list which contains all the information regarding the operation management of an organization. In detail, an inventory includes the amount of raw material available and the amount required to be ordered, finished goods ready to be delivered to the customers, goods stocked in the warehouse and even the half finished goods that require space to be stored before they move on to the next phase of the production process. Besides exceptional cases such as of those firms in the services industries; inventories are considered to be a firm’s major revenue producer. Reasons for holding inventory Inventory is basically the most critical component of a production process and it exists in an organization just so that the firm is able to respond to requirements in relation with forecasted demand. The need for inventory can arise in situations where the product has uncertain demand and the producers are not particularly sure about the amount they should produce (Broyles, 2003, p.389). They therefore resort to inventory tactics such as producing in excess of the estimate forecasted. In some industries there is even a percentage of uncertainty regarding the availability of raw material. For example the sugar industry is plagued with the uncertainty attached to sugar cane because floods may sometimes ruin the crop. Furthermore, lack of rain and lack of fertility of a land leads to low levels of sucrose extracted from the sugar cane which is why the supply of sugar is not always consistent. With the help of the same example of the sugar industry we can further identify the importance of inventory management. The raw material (sugar cane) cannot be kept for too long after being harvested and needs to be attended to immediately. The more it spends time in the storage area the more quickly it loses the sucrose content. Therefore it is mandatory in the sugar industry that the availability and production processes related to the raw material be very well managed. An unstable economy is another reason why it is important for firms to hold inventory in forms of stock, raw material or goods in process. It is only then that the firm will be prepared to deal with all kinds of complicated situations that may possibly arise in an economy. Costs associated with holding inventory The costs associated with inventory are holding costs, re-order costs, and shortage costs. Holding cost is the cost that is incurred due to the storage area and other extra requirements associated with holding either the finished good, raw material or in process. The money spent on warehouse or storage places are all parts of the holding cost. The re-order cost consists of billing, phone calls, and order receipts and so on. A shortage cost is the part of cost that up till now has been claimed to be extremely difficult when being calculated in order to quantify. Shortage costs are incurred when the firm keeps stock of goods in excess to the amount required just in case of shortages that may take place at any point of time. It is to reduce these costs which always add up to the cost of production that firms have begun to adopt inventory planning and control. The need for inventory planning and control Inventory is a vital part of any organization. Previously ignored and taken up as the least important factor when analyzing a firm; inventory is now taken to be the most critical factor for an organizations ability to run itself properly. Therefore, inventory planning and control systems such as lean production are extremely important for any organization and especially under the department of operational management (Olsson & Johansson, 2007, p.179). Planning itself is a systematic process which needs to be thought through properly. In order to make a plan one needs to be organized, identify the agenda, gather the resources of information and then come up with plan. A plan is created in order to reach the objective decided upon previously. The plan is then implemented and after implementation it is necessary to look back and compare if the result or outcome is similar to what we had wanted it to be. Inventory planning has only one objective; to manage inventory as efficiently as possible. Each and every organization works on inventory planning and control systems for a simple reason of reducing costs incurred. Poor inventory management is one of the causes identified for increasing the cost of production because it is creates a lot of waste in the system (Pycraft, 1997, p.542). As the world evolved so did businesses and in the process of this evolution they learned the concept of utilizing capacity effectively. Without planning the systematic process of inventory and adopting tools that can control the process; firms would become uncompetitive. Indeed the issue of competitiveness pushes firms of different industries into adopting inventory planning and control. For if they don’t adopt the effective inventory management tools it will affect their competitiveness and make them less appealing to stakeholders. Therefore, it is necessary for a firm wishing to be an active participant in the modern world business practices to learn to utilize the different tools related to inventory planning and control. In case the firm does not realize the importance of adopting the tools and does not invigorate the entire framework of the organization according to that then it will automatically end up falling out of the competition. The consequences of a structure in which inventory management techniques are not available would be increase in costs, more and more bottle necks in the production process, decreasing profit, losing appeal for investors, uncompetitive, adverse affect on the reputation of the company and frustrated employees who won’t be able to be as productive as their potential. Firms fail if they are not able to adapt to the changing dynamics of an environment. Their success resides in being flexible and adapting to changes as quickly as possible incurring least cost possible. Those firms which are willing to accept that inventory control is around 90% of its overall operational expenses are the ones that eagerly search for different unique approaches to handle their inventory issues. (Broyles, 2003, 389) Problems related with inventory management As previously discussed the uncertainty of demand of the product, the raw materials and unstable economy are all reasons for a firm to involve itself in inventory management. To avoid oneself from ending up in a stock-out situation is the main reason why firms believe in holding inventory because the cost of losing a customer is one of the biggest losses ever incurred. Furthermore control of inventory is also important to ensure that the firm is safe from occasions of theft. Although a novel ideal for someone who isn’t aware of the operational issues attached to a production system, theft of inventory is an extremely common phenomenon. Proper accountability also depends on proper management of each and every element involved in the operational procedures of a firm. Therefore in order to be able to adopt a proper accounting system in the organization; inventory management is critical. Problems related to inventory management do not end there and there are many other issues which have made inventory planning and control tools as one of the most critical aspects of an organization. The fact that majority of the firms are involved in improper management techniques in which an excessive amount of capital is tied up in idle inventory speaks for itself. This is common in many different firm structures as they are unable to realize the potential of the capacity covered by inventory. The potential available of the capacity can only be highlighted if it is freed from excessive inventory which is of no use. To make it worse, the great potential hidden beneath the capacity overloaded with huge amounts of inventory could be extremely worthless because the inventory is not the right kind. It could have become obsolete, worn out, the fashion could have faded, or the batch could have been defected. All in all the possibility of investing capital and capacity in a stock that has no appeal for the customer is the worst possible case scenario. In this modern era, there is a solution to each and every problem and therefore there is a solution available for inventory control issues too. Inventory management techniques range from reserve stock systems to other technical systems that are computer based. Firms are increasingly adopting such computer based tools and have begun to invest time and money in finding out ways to manage inventory instead of just holding huge amounts of it. Inventory is usually valued at the lowest cost be it the original cost, the market value of the inventory being held or replacement costs. Firms look for the lowest cost possible in order to reduce the chances of overstating its assets. Valuation of inventory may not seem so important initially but it is an important part of inventory management and aids proper accountability. The concept of inventory too high or too low is based on inventory turnover, or an analysis of the firm’s quick ratio. It varies from company to company, market to market and industry to industry. Ideally, firms use the industry average to compare it with their own figures and ratios. This is a common practice because an industry average indicates a trend being followed through each firm in the company and guides whether the firm is following the trend or making a mistake at some point. If there is a situation where a firm is identified to be holding excessive inventory it can only be justified in a situation of uncertain demand. However, it also increases the opportunity cost of capital that could have been invested in a commodity that yields a greater return. Holding a small inventory is also not the answer because that could affect sales volume, profits of the firm as the customers head towards the competition and the reputation of the firm as a brand that is never available when needed. Thus, it can be concluded that with the problems associated with excessive and too small inventory calls for a system which is based on the optimum inventory quantity through proper inventory reordering time management. Holding costs, cost of purchasing raw material and costs of holding inventory are all expenses that a firm requires to reduce as much as it can. However, in the process of reducing these costs the firm should also keep in mind the disadvantages associated with stock-outs and unavailability of inventory when required. A repetition of these factors is necessary in order to instill the importance of a proper balanced inventory management structure in any firm. It is the availability of efficient and effective inventory management policies that help a firm become competitive and operate at its potential. (Broyles, 2003, p.388) Solutions There comes a time in the operations that resembles a bottleneck and the process sort of gets tangled up due to the narrow capacity of adjustment. A theory known as the Theory of Constraints has been developed in order to understand such situations and assisting the managers with identifying the points on constraints in a process. Optimized Production Technology is a computer based technique that has been developed as a solution to issues regarding capacity constraints caused by bottle necks. The technology identifies the processing speed at points where the bottle neck emerges in order to determine the optimum pace required for the process to neither be under-utilized nor be over utilized and produce goods not required yet (Pycraft, 1997, p.520). How well a firm does utilize its capacity, manages the inventory and controls the entire process depends heavily on the forecasters. It is based on the knowledge and expertise of the forecasters how well do they forecast and identify the prospects of an increase or decrease in demand and other factors that affect inventory. The MRP (Materials Requirement Planning) and MPS (Master Production Schedule) are the tools used by forecasters in order to identify point when materials will be required, when products will be made and which ones. Material requirement planning is incomplete without the information regarding lead time and inventory. It is an extremely helpful tool that aids the entire organization because in the end the organization is able to utilize capacity effectively and time the production process for least waste. Overall, the entire process is expedited by the help of the tools. Inventory planning and control is not only done through the above mentioned techniques known as Optimized production technology, materials requirement planning and master production schedule. There are many other theories, systems and technologies developed in order to assist modern day firms in performing efficiently and effectively. One such system is known as the JIT (just in time) approach. Just in time is a perfect example of the growing acceptance regarding the importance of timing the inventory properly to reduce cost of production. When compared with the traditional approach towards manufacturing it can be easily identified that just in time reduces the number of buffer stages that occur in the traditional approach. However it is often argued that a traditional approach protects each stage from problems that could arise in stages other than the stage itself. For example the availability of buffers in between each stage does not hinder the process of a stage in case another goes haywire. To elaborate on the example, an assumption is made that the production process of a firm is divided into two stages; A and B. According to the traditional approach there is a buffer zone available just in between stage A and B where the goods that have passed stage A are stored. Now at times of emergencies or on occasions when a machine in stage A breaks down leaving it incapable of completing any further product, there will be no affect on stage B for a while because the buffer zone will have enough half finished goods to be processed further in the next stage. Just in time according to the critics is a tool that exposes the issues of each stage on all the other stages and is not able to protect other stages from the weaknesses consisting in any one stage. Besides Just-in-time there are other inventory planning and control tools such as Kanban. Kanban is a Japanese term and the method is usually divided into three types; the conveyance, the production and the vendor Kanban. The conveyance kanban is used in order to signal which stage requires what amount of material from the inventory, the production kanban simply indicates the production process to begin producing a specific component to be added to the inventory and the vendor kanban is a system that alerts the supplier when and where to send the materials. Synchronization is also an effective inventory planning and control tool which identifies the pace of each production stage in order to keep the same pace at all stages so that the production process is a smooth flow. Economic order quantity is a method which comes under the financial category because it is a quantifiable process of ordering just the optimum amount. The method uses holding cost, reorder cost and the demand of the product as the variables that are required in order to calculate the economic order quantity. Adding to that, tools such as lean production, FIFO(first in first out), LIFO(last in first out), weighted average cost and moving average costs are also techniques utilized by firms for inventory planning and control. With the help of these methods, a firm can effectively utilize its capacity without having to fear the risk of not meeting uncertain demand or the risk of a stock-out situation. (Pycraft, 1997, p.558) Figure 1: an example of an Inventory Management System Conclusion To conclude, inventory planning and control achieves the following objectives. The quantity of perishable items is maintained, speed of the entire production process is increased, each stage is less dependent on the stage before and after it, the production process is flexible enough to absorb changes of the economy and lastly the total cost of managing inventory and the underutilized potential of the capacity covered with it is reduced considerably! (Slack, Chambers & Johnsons, 2004)Companies are now adopting different types of inventory planning systems because they have begun to understand the importance of proper production management for improving production performance. Managing inventory decides the firm’s efficiency, effectiveness and profitability. It is of utmost importance for investors or shareholders who depend on a firms efficiency ratios in order to decide whether the firm is worth investing into or not. Efficiency ratios are calculated through information which has been collected with the help of inventories. References Broyles, J.E. (2003). Financial management and real options. Retrieved from: http://books.google.com.pk/books?id=DJGsyx1bCa4C&pg=PA388&dq=inventory+planning+and+control+systems&hl=en&sa=X&ei=pB3-Tq_NH8SYOo_l7a0B&ved=0CC8Q6AEwAA#v=onepage&q=inventory%20planning%20and%20control%20systems&f=false Olsson, P. & Johansson, M. I. (2007). Changes in the planning and control system during the implementation of lean production. Retrieved from: http://www.plan.se/files/Olsson_Johansson_07.pdf Pycraft, M. (1997). Operations Management. Retrieved from: http://books.google.com.pk/books?id=v6tVJ43nuD0C&pg=PA542&dq=inventory+planning+and+control+systems+for+operation+management&hl=en&sa=X&ei=zB3-TqT1GIGg-wa0ppzVAQ&ved=0CEMQ6AEwAg#v=onepage&q=inventory%20planning%20and%20control%20systems%20for%20operation%20management&f=false Slack, N., Chambers, S. & Johnton, R. (2004) Study guide: Chapter 12 Inventory planning and control. 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