Materials & Inventory Management

Dr Prashant Gupta
 Inventory / Materials
• Inventory can be broadly defined as the stock of
goods, commodities or other economic resources
that are stored or reserved at any given period for
future production or for meeting future demand.

• Inventory may also be defined as “usable but idle

resource having economic value”.

• If resource is some physical and tangible object

such as materials, then it is generally termed as
stock.
 Types of Inventory
• Raw Materials
• Purchased Parts and Supplies
• Spares And Other Indirect Materials
• Component Parts
• In-process (Partially Completed) Products
• Finished Goods
• Tools, Machinery, and Equipment
• Labor
• Working Capital
 Reasons To Hold Inventory
• Meet unexpected demand
• Smoothen seasonal or cyclical demand
• Meet variations in customer demand
• Take advantage of price discounts
• Hedge against price increases
• Quantity discounts
• Maintain independence of operations
• Allow flexibility in production scheduling
• Safeguard for variation in raw material delivery time
 Value Chain
FIRM INFRASTRUCTURE

HUMAN RESOURCE MANAGEMENT

MARGIN
SUPPORT
ACTIVITIES
TECHNOLOGY DEVELOPMENT

PROCUREMENT

INBOUND OPERATIONS OUTBOUND MARKETING SERVICE AND

SALES
LOGISTICS LOGISTICS

MARGIN

PRIMARY ACTIVITIES
 Purchasing Cost as a Percent of Sales
Industry Percent of Sales

All industry 52%

Automobile 61%
Food 60%
Furniture 61%
Paper 55%
Petroleum 74%
Transportation 63%
 Importance of Materials
• The amount spent on materials is higher than other inputs.
• Materials offer considerable scope for reducing cost and improving
profit
• Improving return on investment depends on effective utilization of
materials
• Materials add value to products
• Quality of end product depends on materials.
• Need for preservation of scarce resources for posterity
• Increasing demand for ensuring environmental safety
• Efficiency of any organization depends upon availability of right
materials, in right quantity , at right price.
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5-R Principle of MATERIALS MANAGEMENT

1. Right Quality
2. Right Quantity
3. At Right Time
4. At Right Place
5. At Right Cost
Definition of Materials Management
• Materials Management is planning, organizing
and controlling flow of materials from their initial
purchase through internal operations to the
service point through distribution.
• Materials management is concerned with three
basic activities
* Buying
* Storage of materials
* Movement of materials
 Conflicts in Traditional Systems
Function Objectives
Marketing High Revenues
High Product Availability

Production Low Production Cost

High-Level Production
Long Production Runs

Finance Low Investment and Cost

Low Fixed Costs
Low Inventories
Integrated Systems Approach to Materials
Management
• Materials Planning
• Make or buy Decisions
• Purchase of the required materials
• Receipt and Inspection
• Storage
• Distribution of materials
• Transportation
Integrated Systems Approach to Materials
Management (Cont.)
• Inventory Control
• Disposal of overstocks, Surplus and scrap
• Developing new sources of supply
• Developing ancillary industries
• Developing indigenous sources of supply
• Materials cost control
• Coordination with various departments
• Research and development with respect to materials
Why Integrated Form of Materials Management
• Right balance between conflicting interests of
different functional areas
• Clarity in accountability because of centralization of
authority
• Better coordination between different departments
due to identity of purpose
• Judicious and faster decision making
• Easy access to data for improved decision making
• Better development and growth of employees
 Delivery Lead Time for Different Manufacturing
Strategy
Manufacturing Delivery Lead Time
Strategy
Engineer-to Order

Make-to-Order
Configure-to-Order

Assemble-to-Order

Make-to-Stock
 Delivery Lead Time for Different Manufacturing
Strategy
Manufacturing Delivery Lead Time
Strategy
Engineer-to Order Design Purchase Manufacture Assemble Ship

Make-to-Order Inventory Manufacture Assemble Ship

Configure-to-Order Inventory Manufacture Assemble Ship

Assemble-to-Order Manufacture Inventory Assemble Ship

Make-to-Stock Manufacture Assemble Inventory Ship

 Impact of Materials Management on Profitability
Budget Head Amount in Rs Percentage of Sales
Revenue 1,000,000 100%
(Sales)
Cost of Goods
Sold
Direct Material 500,000 50%

Direct Labour 200,000 20%

Factory Overhead 200,000 20%

Total Cost of 900,000 90%

Goods Sold
Gross Profit 100,000 10%
Assumption: Direct Material and Direct Labour costs vary proportional to sales, but
Overhead Costs remain constant.
 Impact of Materials Management on Profitability-
(Cost of Direct Materials is reduced by 12%)
Budget Head Amount in Rs Percentage of Sales
Revenue 1,000,000 100%
(Sales)
Cost of Goods
Sold
Direct Material 440,000
Direct Labour 200,000
Factory Overhead 200,000
Total Cost of 840,000 84%
Goods Sold
Gross Profit 160,000 16%
Assumption: Direct Material and Direct Labour Costs vary proportional to sales, but
Overhead Costs remain constant.
Impact of Materials Management on Profitability-
(Sales Required for increase in Profit by Rs 60,000)
• Say the sales are ‘X’, then
• Profit= Sales –(Direct Material Cost+ Direct
Labour Cost+ Overheads)
• 160,000= X – (0.5X +0.2X+200,000)
• 160,000 = X-0.7X-200,000
• 360,000=0.3X
• X=120,000
Therefore, Sales have to be increased by 20%
 Impact of Materials Management on Profitability-
(Profit to be increased by 60%)
Budget Head Amount in Rs Percentage of Sales
Revenue 120,000 100%
(Sales)
Cost of Goods
Sold
Direct Material 600,000

Direct Labour 240,000

Factory Overhead 200,000

Total Cost of 1,040,000 86.7%

Goods Sold
Gross Profit 160,000 13.3%
Assumption: Direct Material and Direct Labour Costs vary proportional to sales, but
Overhead Costs remain constant.
 Example Problem
a. If the cost of direct material is 60%, direct labour is
10%, and overhead is 25% of sales, what will be the
improvement in profit if cost of direct material is
reduced to 55%
b. How much will sales have to increase to give the
same increase in profit? ( Assume Overhead Cost to
be constant.)
 Work-in-Process (WIP)
• On average, a company has a 12-week production
Lead Time (LT) and annual cost of goods sold of Rs
360,000. Assuming the company works 50 weeks per
year:
a. What is the Rupee Value of the WIP?
b. If the lead time could be reduced to 5 weeks, and
the annual cost of carrying inventory was 20% of
the inventory value, what would be the annual
savings?
 Work-in-Process (WIP)
a. What is the Rupee Value of the WIP?
•Weekly cost of goods sold = 360,000 /50
•Weekly cost of goods sold = 7,200/ week
•WIP value at 12 weeks LT = 7,200 X 12 = 86,400
b. Annual Savings?
•WIP value at 5 weeks LT = 7,200 X 5 = 36,000
•Reduction in WIP= 86,400 – 36,000 = 50,400
•Annual Savings @20% = 50,400 X 0.20 = 10,080