Inventory Management at Excellent Manufacturing Company - Research Paper Example

The Vice President of Operations – EMC A.N. Consultant Inventory Management at Excellent Manufacturing Company 12th September 2011 Report Introduction The management of inventory is very important to any company involved in the manufacturing and distribution of goods. Inventories in their various forms represent a material portion of the assets of these companies and so proper management is critical. According to Strategos, it is an important determinant of various measures of financial performance such as return on assets (ROA) and inventory turns. It is very important that the goods in stores are sufficient to meet demands while maintaining a minimum level of buffer stock. EMC requires a plan to improve the flow of its products, holding down inventories and making sure that inventory records are accurate. Inventory Analysis The graph labeled as Figure 1 below shows an analysis of the inventory held by EMC at the beginning and end of the year just completed. Figure 1 Figure 1 indicates that most of the goods are work-in-progress. At the beginning of the year work-in-progress (WIP) represented approximately 39% of the goods in stock, finished goods 25, raw materials 21% and purchased parts 15%. At the end of the period they represent 36%, 28%, 19% and 17% respectively. According to Wong (2006) the first step in determining an inventory situation can be facilitated through the use of ABC analysis. This analysis determines the importance of items and the level of controls placed on them. Using the relative proportions of cost of goods sold for the company’s product line the relative proportions of the different inventory types are shown in Table 1 below. Analysis of Closing Inventory Product Line Percentage Raw Materials($) Purchased Parts ($) Work-in-progress($) Finished Goods ($) Cost ($) Fasteners 9.42% 15.73 14.22 30.33 22.89 83.18 Cabinet Hardware 25.85% 43.17 39.03 83.24 62.82 228.26 Construction Hardware 27.25% 45.51 41.15 87.75 66.22 240.62 Decorative Hardware 37.48% 62.59 56.59 120.69 91.08 330.95 Total 100.00% 167 151 322 243 883.00 The actual raw material and purchased parts that are used to make the different products in each product line has not been identified but it shows that 37.48% are decorative hardware, 27.25% construction hardware, 25.85% Cabinet Hardware and 9.42% Fasteners. Plan to Improve the Inventory Situation In order to improve the inventory situation at EMC the company should first apply ABC analysis. ABC analysis places emphasis on the value of inventory (Wong n.d.). Focusing on inventory with the highest value can allow companies to assign the necessary resources to achieve the optimum inventory levels and in so doing reduce inventory cost while ensuring that customers needs are met (Wong n.d.). ABC analysis when applied to EMC’s inventory situation will help the company determine the importance of items and the level of controls that should be placed on them. The majority of EMC’s inventory relates to items used in the production of decorative and construction hardware. These could be described as the A items because they are of higher value while those used in the production of cabinet hardware would be the B items, and fasteners - C items. The A items (a combination of decorative and construction hardware inventory would be given the highest priority since they have the greatest level of impact on EMC’s overall performance while the C items (fasteners) would be given the lowest priority. Tight controls would therefore be placed on decorative and construction items and should be accompanied by less frequent reviews. Fasteners, on the other hand should be assigned the lowest level of control which would be accompanied by a higher level of safety stock. Since fasteners are of a lower value and should also be ordered in lower quantities. Figure 2 below provides a visual illustration of the relative contributions of the different product lines to EMC’s revenues, cost of sales and gross margin. Figure 2 The graph above shows that Decorative Hardware is the largest contributor both in terms of sales revenue and that the cost of goods sold and gross margin is more or less proportionate for this product. In the case of Construction Hardware the gross margin the proportionately higher when compared with the cost of goods sold while for Cabinet Hardware and Fasteners the proportion of cost of goods sold is proportionately higher than the gross margin proportion. This would indicate that EMC should seek to focus on making sure that it does not run out of the products in the construction hardware line of its business. The Economic Order Quantity (EOQ) model could also be applied to determine the inventory level at which both the order and carrying costs are at their lowest. This will provide critical information on the most cost effective quantity of the different inventory items to purchase (Piasecki n.d.). The formula for calculating EOQ is as follows: EOQ = √[(2(Annual usage in units)(order cost))/(Annual carrying cost per unit)]. Piasecki (n.d) indicates that the formula that is used to calculate EOQ is relatively simple; however, determining inputs such as order cost and carrying cost requires quite a bit of work. Piasecki (n.d) further warns against using benchmark figures and published industry standards. The order costs are the fixed costs that are incurred each time an order is made and are not associated with the quantity of items ordered but with the activities involved in processing the order and the frequency of the orders (Piasecki n.d.). Order cost includes the cost of the process from initiating the order to the receipt of the goods into stores. Some items are purchased and some are manufactured and this has to be taken into account. Carrying cost on the other hand is the cost of holding inventory. The cost here includes storage costs and handling charges. More storage space means more storage costs and moving inventory around unnecessarily as a result of overstocking will lead to increased handling charges. Additionally, there are other charges such as interest if money is borrowed to finance inventory purchase and insurance which is related to the total value of inventory (Piasecki n.d.). The information provided indicates that the average inventory is $934. Lowering the level of inventory would reduce insurance cost. Piasecki (n.d.) indicates that there are two ways to implement EOQ. If the inventory items are in the thousands then the EOQ could be programmed into the existing inventory system or a simple spreadsheet system could be utilized where EOQ is manually calculated one at a time (Piasecki n.d). The method chosen should be tested to ensure that it is working properly; allow for projection of results to determine for both long and short term effects of EOQ calculation on storage space, cash flow and operations; and evaluating both order and carrying costs for changes in order to maintain EOQ (Piasecki n.d.). McCreary (2009) points out that lean time in a machining environment such as that in which EMC operates involves ‘reducing lead- time, improving on time delivery performance, eliminating waste and reducing costs. EMC could apply lean manufacturing which can be achieved through a reduction in set up time, the use of smaller scale equipment where applicable, and cellular layouts which if adopted would avoid excessive handling, WIP queues, disconnects and poor quality which results in high scrap and rework costs (Strategos (n.d.). Strategos (n.d.) also suggests that in order of EMC to achieve lean manufacturing an inventory turnover rate of between 200% and 1000% of the industry average would be in order. EMC is currently experiencing an inventory turnover rate of 7.38. This is much less than the industry average of 13.6 turns. However, Piasecki (n.d) warns against concentrating on inventory turnover rates alone. The use of ABC analysis and EOQ should help in improving inventory management at EMC. Singh (2010) points out that some companies have improved their financial performance and have designed better products for customers as a result of the efficient management of their inventory. However, it is also possible that shortages may occur if the model applied is not managed properly. While inventory reductions could impact positively on EMC’s profits, reducing production and tightening inventories may result in shortages which could lead to angry customers as was the case for John Deere (Singh 2010). Conclusion In order to accommodate these changes and improve the accuracy of the inventory records EMC needs to computerize its inventory system and ensure that information can be obtained on all inventory items in stock. This will allow for a proper analysis using ABC and will facilitate the use of an EOQ model that can be programed into the system to allow for regular determination of stock values and other information that may be required. References McCreary, P.J. (2009). The Need for Lean Flow. Retrieved on 9th Sept 2011 from: http://www.americanmachinist.com/304/Issue/Article/False/84882/Issue Piasecki, D. (n.d.). Optimizing Economic Order Quantity (EOQ). Retrieved on 7th Sept 2011 from: http://www.inventoryops.com/economic_order_quantity.htm Singh, S. (2010). Low Inventory Angers John Deere Customers. Retrieved on 9th Sept 2011 from: http://www.businessweek.com/magazine/content/10_18/b4176029906771.htm?chan=magazine+channel_news+-+companies+%2B+industries Strategos (n.d.). Inventory – Why All the Fuss? Retrieved on 7th Sept 2011 from: http://www.strategosinc.com/inventory.htm Wong, C. (n.d.). Using ABC Analysis for Inventory Control. Retrieved on 6th Sept 2011 from: http://www.apics-redwood.org/articles/art0302BCW.htm Read More