TRL3707 Exam Prep Sem 2.

TRL3707 Exam Prep Sem 2. Logistics Activities. Discuss relative risks of inventory holding for the manufacturer, wholesaler & retailer. (6) Ref. Par. 2.2 Manufacturers - Inventory risk = Long Term - Commitment begins raw material & component parts purchase → work-in-progress → finished goods (ends). - Finished goods often positioned in warehouses in anticipation of customer demand - In some situations manufacturers are required to consign inventory to customer facilities (stock shelves in retail store) shifting inventory risk entirely to the manufacturer (has to wait for payment until consumer purchases product) . - Typically narrower product line than retailer/wholesaler but commitment is deep & of long duration. Wholesalers - Purchases large qty.'s from manufacturer → sells smaller qty.'s to retailers. - Economic justification = capability to provide customers an assortment of merchandise from different manufacturers in reduced quantities. - Seasonal products increase depth & duration of risk (inventory position far in advance of selling season) - Challenge = product line expansion to point where width of inventory risk approaches that of retailer while depth & duration remain characteristic of traditional wholesaling. Retailers - Inventory management is about velocity of buying & selling. - Purchase wide variety of products & assume substantial risk in marketing process. - Retail inventory risk = broad on wide variety but not deep on any one product (mass merchandisers) . - High cost of store location → place price emphasis on inventory turnover - Inventory turnover = a measure of inventory velocity; calc. as ratio of sales for time period ÷ avg. inventory. - ↓ risk by pressing invent. responsibility onto manufacturers & wholesalers [tendency to channel inventory holding upstream in distribution channel] → retailers demand for fast delivery ↑ - On the other hand, speciality retailers: less width with ↑ risk in depth & duration 15) Act 2.1 What can management do to reduce inventory levels thereby increasing productivity? Ref. Par. 2.2  Implementation of JIT (Just-in-time) & other inventory strategies  Exchange of info between different role players in the SC  Management's attempts to reduce uncertainty. 16) LO Why do enterprises carry inventory in spite of the risk involved? SAQ Explain the necessity & give examples of trade-off options. Ref. Par. 2.3 - Inventory = current asset that should provide return on the capital invested. - Return on investment = marginal profit on sales: could not occur without inventory Risks of Inventory Holding Inventory Shortage: • Production line Shut down / Adjust production schedule • = ↑ expenses / shortage of final product Surplus Inventory: • more warehouse space required, working capital (could invest with interest), obsolescence, insurance, etc. • = ↑ costs & ↓ profitability Take note of the time and variety kept by each T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 7 17) [PEx7 Variations] List and/or discuss 4 functions of inventory (3 or 4 or 8) Ref. Par. 2.3 Table 2.1 in SG / Table 7.1 Bowersox 2013 Geographic Specialisation - Allows geographical positioning across multiple manufacturing & distributive units of an enterprise. - Inventory maintained at different locations and stages of the value creation process allows specialization. - Inventory invested can only be modified by changes in network facility location & operational processes. Decoupling - Is the separations of a manufacturing process from the selling process - Allows economy of scale within a single facility - Permits each process to operate at maximum efficiency rather than having the speed of the entire process constrained by the slowest - Inventory invested can only be modified by changes in network facility location & operational processes. Balancing Supply & Demand - Inventory necessary when timing of product supply differs from demand pattern - Necessary to match supply & demand patterns - Accommodates elapsed time between inventory availability and consumption - Modifying invested inventory depends on ability to estimate seasonal requirements Buffer Stock (a.k.a. Safety Stock) - Inventory necessary when uncertainty occurs in both supply (Product availability) & demand (customer requires) - Accommodates uncertainty related to demand in excess of forecast or unexpected delays in delivery. - Commitments are operational in nature and can be adjusted rapidly in the event of error or policy change. 18) LO What does an inventory policy involve? Ref. Par. 2.4 Inventory policy drives inventory performance and consists of: - Guidelines of what to purchase/manufacture; when to take action; in what quantity - Decisions regarding geographical inventory positioning e.g. postponement or speculative strategy - Inventory management practice e.g. independently mange at each stocking location or central inventory management of all stocking locations - Target inventory levels for each facility 5 Inventory related concepts that play a role in inventory management & policy: - Average inventory: rolling mean across time Ref. Bowersox (201:159) o (2013:152) - Reorder point: defines when a replenishment order is initiated Ref. Bowersox (2010:161) or (2013:153) - Inventory turnover: = total sales ÷ average inventory - Order Cycle - Order Quantity: amount ordered for replenishment (difference between max & min stock levels) 19) LO SAQ What is the relationship between inventory and level of service? Ref. Par. 2.4 [CHECK] Two key indicators of inventory performance = service level & average inventory. One strategy to achieve high service level is to increase inventory. Alternative: faster/more reliable transport & collaboration with customers & service providers to ↓ uncertainty Service Level - Performance target specified by management - Defines inventory performance objectives - Measured in terms of performance cycle time, case fill rate , line fill rate, order fill rate / any combination - Performance cycle: elapsed time between release of a purchase order by a buyer to the receipt of shipment. - Case fill rate: % of cases/units ordered that are shipped as requested e.g. 95% = 95 out of 100 cases filled from available stock - Line fill rate: percent of order lines filled completely. - Order fill: percent of customer orders filled completely. T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 8 Average Inventory (Comprising of cyclic inventory, safety stock & Transit inventory) - Is a function of the reorder quantity: smaller quantities = ↓ avg. inventory - ↑ avg. inventory = ↑ carrying cost - Estimating Avg. Invent. N.B for calculating carrying cost - See also Question 20 Below 20) LO SAQ What is meant by average inventory, cycle inventory, safety stock inventory & transit inventory? Ref. Par. 2.4 Average Inventory see Bowersox (2010:156-162) & (2013:151-154) for examples, figures & formulas - Materials, components, work-in-progress & finished product typically stocked in logistical system is referred to as inventory - and the typical amount [rolling mean] across time is referred to as average inventory - See also Question 19 Above - Cycle Inventory or base stock: Portion of average inventory that results from replenishment A replenishment order is initiated so that inventory will arrive before an out of stock occurs. Average cycle inventory / base stock = ½ order quantity - Transit inventory: amount typically in transit between facilities or on order but not received - Obsolete Inventory: stock that is out-of-date or has not experienced recent demand Eventually donated, destroyed or sold at a loss - Speculative Inventory: bought prior to need to hedge a currency exchange, take advantage of a special discount or prepare for potential work force disruption. - Safety Stock: remainder of inventory in typical logistics system. Maintained to protect against demand & performance cycle uncertainty Used only near the end of replenishment cycles when uncertainty caused higher-than-expected demand or longer-than-expected performance cycle times 21) LO What are the basic principles of inventory replenishment? ? Usage / rate of sale, performance cycles, safety stock, reorder point, economic order quantity ? 22) LO What are the costs involved in holding stock? Inventory carrying cost is the expense associated with maintaining inventory. Financial accounts relevant to inventory carrying cost percent are:  Capital [Typically based on managerial policy]  Insurance  Obsolescence  Storage  Taxes [expense related] Carrying cost percentage can be calculated by adding the five components together Typical Average Inventory ½ Order Quantity [Max - Min stock] ÷ 2 Safety Stock & In-transit Stock T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 9 23) SAQ Using a suitable sketch, indicate the relationship between placing an order, the order cycle, order quantity & average inventory. Also show what the effect of a change in order quantity on the average inventory will be? TB Policy ordering 600 units every 60 days Policy ordering 100 units every 10 days Avg. base Inventory of 300 units Avg. Inventory on hand drops to 50 units Turnover of ±8 times per year Inventory turnover increase to 48 times per year 24) [PEx3 ] LO SAQ How can inventory carrying costs and carrying cost % be calculated? (11 or 17) Ref. Par. 2.5.1 Table 2.2 in SG Determining the inventory carrying cost PERCENTAGE is more difficult: [Table 2.2 & Table 7.2] Cost Element Quantification & Determinants Example % Ranges Capital Investment  Prime interest rate (cash to replace money invested in inventory to be purchased in money market)  Return on investment (funds invested in inventory lose earning power & limit other more lucrative investments) Hurdle Rates 17% Aggressive cash use High value/short life cycle = high rates 4 – 40% Insurance  Direct levy based on estimated risk/exposure  Insurance cost percentage on avg. inventory value of past year  Product value High value / hazardous = high insurance cost  Risk & Exposure of product & storage facility  Preventive Measures 2% 0 – 2% Obsolescence Damage Shrinkage  Deterioration of product while stored (cost of each unit that must be disposed of at a loss because can no longer be sold at the usual price)  Damage: net amount after claims  Problematic to quantify  Percentage of average inventory declared obsolete yearly  Direct loss related to inventory storage 2% 0.5 – 2% Storage Space - Depends on types of warehouses used (own, public, contract) - Allocated to specific products (not directly related to inventory value) - Private: Find standard cost per day per square/cubic metre. Multiply daily standard by space occupied per year for the specific product. - Public/Contract: Storage charges (not handling). Normally based on maximum required storage space 5% 0 – 4% Taxes - Direct levy based on inventory value on specific day or avg. inventory value over period of time [exemption as free port status might be available] 2% 0.5 – 2% Total 28% Carrying Cost a.k.a. Inventory Expense Avg. Inventory [½ Order Qty. + S.Stock] Inventory Carrying Cost Percentage E.G. R200,000.00 = R1,000,000.00 x 20% T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 10 25) SAQ Discuss the impact of inventory carrying cost on enterprise's financial records & logistical decision-making & strategy Ref. Par. 2.5.2 & 2.5.3 Financial Records & Finance - Inventory is shown on balance sheet as Current Asset - Major element of inventory carrying costs results from capital invested. - To pay for inventory: o borrow funds as working capital – Enterprise pays interest on borrowed funds o reduce retained earnings – Enterprise cannot invest retained earnings in other projects Logistics Decisions & Strategies - Low Carrying Cost Percentage [e.g. 12%] - Reduces influence of inventory cost on total cost decisions - Makes transport costs relatively more important - RESULT IN: Logistics strategies aimed at minimising transport costs by using more distribution centres - Additional distribution centres → more sites → more safety stock → additional inventory - ↓ carrying cost carrying cost % = strategies that replace expensive transport with cheaper inventory - High Carrying Cost Percentages [e.g. 40%] - Opposite effect - Logistics strategies attempt to centralise inventory in small number of locations - Allow for longer & more expensive transport movements T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 11 STUDY UNIT 3, PAGE 24 [2015-S2-EXAM: SHORTER QUESTIONS- CALCULATIONS, PE & PROBLEM SET 2] 26) LO When and how often should inventory be ordered? SAQ Write down a formula for determining the reorder point for a specific item and explain how it works. Ref. Par. 3.2.1. Bowersox (2010:161) & (2013:153) When to order: under conditions of demand & performance cycle certainty - Determined by demand & Replenishment lead time average and uncertainty. - Reorder point: defines when a replenishment shipment should be initiated. Specified in terms of units or days' supply - Alternative form to e.g. below: define reorder point in terms of days of supply i.e. days of supply reorder point = 10 days When to order: when safety stock [SS] is necessary to accommodate uncertainty 27) LO How much inventory should be ordered at a time? Ref. Par. 3.2.1 How much to order is determined by order quantity. Identify ordering quantity that minimizes total inventory carrying & ordering cost. i.e. EOQ Lot sizing balances inventory carrying cost with the cost of ordering Remember: Avg. Inventory = ½ order qty. Meaning ↑ order qty. → ↑ avg. inventory → ↑ annual carrying cost However ↑ order qty.; ↓ orders required per planning period → ↓ total ordering cost. Lot qty. formulations identify precise qty.'s at which annual combined total inventory carrying & order cost is lowest for given sales volume. [see figure below in question 28] 28) [PEx3 ] Make use of a sketch to explain Economic Order Quantity [EOQ] (4) Ref. Par. 3.2.1 Figure: Economic Order Quantity Formula: Basic Reorder Point R = D x T R = Reorder point in units D = Average daily demand in units T = Average performance cycle length in days Example: R = 20 x 2 = 200 units D = avg. daily demand = 20 units/day T = avg. performance cycle = 10 days Formula: SS Reorder Point R = D x T + SS R = Reorder point in units D = Average daily demand in units T = Average performance cycle length in days SS = Safety stock in units Most economical number of orders Total cost Ordering cost Maintenance cost Number of orders per year Total dollars 0 [2015-S2-Scope: Calculations] T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 12 29) SAQ Explain EOQ With aid of a sketch & formula. Also name the assumptions underlying the simple EOQ model. EOQ is the replenishment practice that minimizes the combined inventory carrying & ordering cost. Assumes: - All demand is satisfied - Rate of demand is continuous, constant & known - Replenishment performance cycle time is constant & known - A constant price of product that is independent of order quantity or time - Infinite planning horizon - No interaction between multiple items of inventory (individual product basis only) - No inventory is in transit - No limit is placed on capital availability 30) [PEx4 ] With the data & formula given, calculate the Economic Order Quantity (5 each) Ref. Par. 3.2.1 Annual Sales Volume 4500 bottles Unit Value of Cost R30 per bottle Inventory Carrying Cost 20% annually Ordering Cost R15 per order Annual Sales Volume 4500 bottles Unit Value of Cost R30 per bottle Inventory Carrying Cost 15% annually Ordering Cost R20 per order Annual Sales Volume 2500 bottles Unit Value of Cost R12.50 per bottle Inventory Carrying Cost 20% annually Ordering Cost R20 per order Annual Sales Volume 3800 bottles Unit Value of Cost R30.00 per bottle Inventory Carrying Cost 25% annually Ordering Cost R20 per order Formula: Economic Order Quantity Co = Cost per order Ci = Annual inventory carrying cost D = Annual sales volumes, units U = Cost per unit Example: EOQ = Co = Ordering Cost = R19.00 per order Ci = Inventory carrying cost % = 20% Annually D = Annual Demand Volumes = 2400 units U = Unit value at cost = R5.00 EOQ = 2CoD CiU 2 x 19 x 2 400 0.20 x 5.00 =302 (round to 300) = 91,200 2 x 15 x 4500 0.20 x 30.00 = 22 500 =150 units EOQ = 2CoD CiU EOQ = 2CoD CiU EOQ = 2CoD CiU 2 x 20 x 4500 0.15 x 30.00 = 40 000 = 200 units 2 x 20 x 2500 0.20 x 12.50 = 40 000 = 200 units 2 x 20 x 3800 0.25 x 30.00 = 20 266 = 142 units EOQ = 2CoD CiU [2015-S2-Scope: Calculations] [2015-S2-Scope: Calculations] T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 13 31) SAQ Explain all the factors that influence the EOQ for a particular item. Ref. Par. 3.2.1 [Unsure if I'm using right factors] Volume Transportation Rates - Any EOQ must be tested for transportation cost sensitivity across a range of weight breaks - Cost of transportation must be paid by supply chain participants. - Collaborative efforts to order in qty.'s minimise total cost are essential to sound logistical arrangements - ↑ order weight the ↓cost per pound of transportation from origin to destination - Freight-rate discount for larger shipments is common across all transportation modes - SC arrangements should utilise qty.'s that offer max transportation economies Qty.'s may be larger than EQO purchase quantity. ↑ order size has twofold impact on inventory cost: o Increases average base inventory = increase inventory carrying cost o Decrease in number of orders required to satisfy annual requirements = ↑ shipment size, facilitating lower per-unit transportation cost. Quantity Discounts - handled directly with basic EOQ formula: calculate total cost at any given volume-related purchase price - viable if discount at any associated qty. is sufficient to offset added inventory carrying cost less reduced cost of ordering - Qty. discounts & vol. transportation rates each drive larger purchase quantities. Other EOQ Adjustments - Production lot size: most economical quantities from a manufacturing perspective - Multiple-item purchase: when more than one product is bought concurrently, qty. & transportation discounts must consider impact of product combinations - Limited capital: budget limitations for total inventory investment across the product line - Dedicated trucking: can influence order qty. sine truck has fixed cost consideration consider full capacity use / back-hauls - Unitisation: storing & moving products in standard units e.g. cases/pallets to fit vehicles 32) LO How can inventory shortages be prevented? ? By keeping safety stock ? 33) SAQ Discuss the difference between the performance cycle uncertainty and demand uncertainty. Identify the activities necessary to make provision for this uncertainty. Ref. Par. 3.2.2. see Bowersox (2010:168-178) & (2013:162-171) Performance Cycle Uncertainty - Involves inventory replenishment time variation. Meaning operations cannot assume consistent delivery - Performance cycle experience will cluster near expected value & be skewed toward delayed delivery - Use Poisson Distribution if actual experience has been skewed in excess of expected cycle duration In Poisson Freq. Distribution: σ = square root of the mean. The ↓ the mean the ↑ degree of skewness Demand Uncertainty - Involves variation in sales during inventory replenishment - Under conditions of demand uncertainty: avg. inventory = ½ order qty. + safety stock - Sales forecasting estimates unit demand during inventory replenishment cycle - To protect against stock-out when demand exceeds forecast: add safety stock to base inventory - Standard Deviation[σ]: Basis for predicting demand during performance cycle using normal distribution. Provides a method of estimating SS required to achieve specified degree of out-of-stock protection Combined Uncertainty - Planning for both demand & performance cycle uncertainty requires combining two variables. - Determine joint impact of probability of both demand & performance cycle variation. - With basic relationship in mind, SS req. can be determined by either numerical or convolution procedures - Use combined standard deviation: % reflects probability & not an indication of the relative magnitude T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 14 34) LO How much safety stock should be kept to make provision for variable demand and order cycle time to maintain a certain level of customer service? Ref. Par. 3.2.2 Calculating SS: no interest in cases where probability of demand mean. No problem meeting demand if SS ≤ mean. Therefore only interested in right-hand side of normal distr. curve: Standard Deviation(s) % Using Both Sides of Normal Distribution Curve % Using Right-Hand Side of Curve 1σ 68.27% 84% 2σ 95.45% 98% 3σ 99.73% 99.9% 35) [PEx1] Explain what is meant by the term "fill rate" (2) Bowersox (2010:176) & (2013:168) Fill rate: magnitude rather than the probability of a stock out. Indicates safety stock necessary to ensure that customer's order is properly met; desired cust. service objective. Case fill rate: the percentage of units that can be filled when requested from available inventory 36) [PEx3 ] Given the following information, answer the questions below: Ref. Activity 3.2; 2015-S1-Assign.01 (slight variation) Suppose an analysis of daily sales: 20 cases Standard deviation of performance sales: 1,634 days Average order cycle: 10 days Average daily sales: 100 cases EOQ 1 000 cases (a) Calculate the combined standard deviation. (5) (b) How many cases should be kept in stock to make provision for a 98% level of service? (3) 98% = Two standard deviation (2σ) = 2 x 175 = 350 cases (c) What is the fill rate with a safety stock of 280 cases? (7) Formula: Standard Deviation Fi = Frequency of observation i Di = Deviation of observation from mean for i n = Total observations available Formula: Combined σ σc = TSD 2 + D2St 2 σc = Standard deviation of combined probabilities T = Avg. Performance Cycle St = Standard deviation of performance cycle D = Avg. daily sales Sd = Standard deviation of daily sales σ = ΣFiDi 2 n T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 15 Thus for each 100 units of demand, there will be 99.59 on hand if the order quantity is 1 000 cases and the safety stock is 280 cases. (d) How much safety stock should be kept to maintain a fill rate of 95%? (6) K Factor (or Safety factor) is N.B for both Fill Rate & Safe Stock in combined uncertainty Table 7.14: Loss Integral for Standardized Normal Distribution Info was Given in Past Papers k f(k) k f(k) k f(k) k f(k) 0.0 0.3989 0.8 0.1202 1.6 0.0232 2.4 0.0027 0.1 0.3509 0.9 0.1004 1.7 0.0182 2.5 0.002 0.2 0.3068 1.0 0.0833 1.8 0.0143 2.6 0.0015 0.3 0.2667 1.1 0.0686 1.9 0.0111 2.7 0.0011 0.4 0.2304 1.2 0.0561 2.0 0.0085 2.8 0.0008 0.5 0.1977 1.3 0.0455 2.1 0.0065 2.9 0.0005 0.6 0.1686 1.4 0.0366 2.2 0.0049 3.0 0.0004 0.7 0.1428 1.5 0.0293 2.3 0.0037 3.1 0.0003 Formula: Fill Rate SL = 1 - f(k)σc Q SL = Stock-out magnitude (Product availability level f(k) = funciton of normal loss curve which provides (need corrosponding K factor) σc = combined standard deviation considering both uncertainties Q = Replenishment order quantity Calculate Safety Stock: First: f(k) = (1 - SL) x (Q ÷ σc ) Then calculated value of f(k) is compared to Table 7.14 = closest approximation to find K Finally: SS = k x σc SS = Safety Stock in units K = K factor that corresponds with f(k) σc = combined standard deviation K Factor = SS ÷ combined σ Bowersox Table 7.14 is Crucial! T R L 3 7 0 7 | Question Bank S t u d e n t In t e r p re t a t i o n s i .e . Do c a c c u r a c y i s n o t e n s u re d P a g e | 16 37) SAQ Discuss the assumptions underlying safety stock planning in the case of the demand for components in the motor manufacturing industry. Explain also possible approaches that can be adopted in planning safety stock. 2 Assumptions for not carrying safety stocks under conditions of dependent demand: - Procurement replenishment to support planning is predictable & constant - Vendors & suppliers maintain adequate inventories to satisfy 100%.