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INVENTORY
MANAGEMENT IN PRODUCTION COMPANIES
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
“Inventory
represents as important asset and is the largest single item of cost in almost
every business, accordingly, the success or failure of a concern may depend
largely upon efficient material purchasing, storage, utilization, and
accounting.”
C.I. Buyers and G.A. Homes
It
is possible to distinguish three different classes of inventory; they are:
1. Pre-production inventory (raw materials)
2. In-process inventory (work-in-process) and
3. Finished Goods inventory.
Pre-production
inventory provides a type of insurance for the company; if difficulties in the
future supply of raw materials are excepted, this inventory will enable
production to continue smoothly, if future costs of raw materials are expected
to rise, higher is might be held as a speculation against the rise in price.
Finished goods may also be thought of as insurance; if orders are received they
will be able to be supplied immediately from inventory, hence the customer will
not have to wait for delivery. Such insurance and speculative reasons for
holding inventory do have a cost and this cost must be recognized because it is
considered in times of high interest rates. Consequently, good management of
inventory is important to the profit minded enterprise.
Inventory
in represents a major asset of most industrial and commercial organization and
it is essential that s are managed efficiently so that such investment do not
become unnecessarily large. A firm should determine its optimum level of
investment in s, it must ensure that s are sufficient to meet the requirement
of production and sales, and secondly, it must avoid holding surplus which are
unnecessary and which increase the risk of obsolescence. The optimum level lies
somewhere between thee two extremes.
The
country is currently passing through a period of cash squeeze where profit is
hardly earned; hence stewardship of resource has become more and more vital.
Thus methods must be adopted to ensure that funds invested in inventory are not
wasted. For these reasons, more operations research has become directed towards
inventory control than toward any other problem in business and industry.
Resources invested in inventory are not earning a return for the company. They
are on the other hand costing the firm money, both in an opportunity cost
sense; in that other profitable uses of the funds are forgone, and in the sense
that they represent funds which have to be paid for.
Inventory
may be defined as being as ideal resource with economic value or as Lewis suggests,
“Inventory is money temporarily wearing the guise of a casting.” It is money on
which the company pays, rather than collects interest. Values lessen as
physical deterioration progresses, while insurance, storage and other cost
accumulate. Inventory is money always in danger of devaluation with forces such
as design and customers preference changing constantly in relation to time.
Management
has been defined as the establishment of the environment for group efforts in
such a way that individuals will contribute to group objectives with the least
amount of such inputs as money, time efforts, discomfort and materials (Baridam
C and O’donnel 1980)3. It can also be defined as the process of
planning, organizing, directing and controlling the efforts of organization
members and using all other organizational resources to achieve stated
organization goals. Control involves the development of precise
plans/standards/budgets and the monitoring of performance against them in order
to take any needed corrective action in time.
Inventory
management is the art and science of achieving the set objectives of procuring
the material at the lowest possible costs, ensuring adequate flow and making
the most economical use of such in order that the total cost of production is
minimized through the creation of such a environment that would enable the
individuals contribute to the achievement of the objectives with least amount
of such inputs as money, time, material etc. on the other hand, inventory
control is the science based art of ensuring that enough inventory is held by
an organization to meet economically both its internal and external demand
commitments. There can be disadvantages in holding either too much or too
little inventory, as such, inventory control is primarily concerned with
obtaining the correct balance or comprise between these two extremes. It is
therefore, the quantity that should be held that management is interested in.
An
economic lost size equation was developed which minimized the sum of inventory
carrying and set up cost where demand was known and constant. Accordingly,
industrial engineers, economists and to a large extent mathematics have
contributed to this work. A considerable literature exists on most of the
techniques and tools currently used by operations research in the inventory
control area, and these were developed in the last few years. The recent
development began with attempt to provide procedures which are applicable in
situations in which demands is not known with certainty but can only be
estimated. One problem that arises when uncertainty of demand is taken into
account is that of providing buffer to protect against shortages; through
recent findings have indicated that conditions under which optimum inventory
level can be found is possible.
Since
production is very important to an economy, adequate and proper utilization of
labour, materials and equipment’s will then have to be made in order to ensure
greater efficiency. In the case of Nigerian economy with its attendant
uncertainties, the manufacturing sector cannot afford wastages especially with
regards to materials. Hence, there is need for proper and effective utilization
of resources in order to prevent any shortfall in the level of production and
enhance profitability in an organization.
An
inventory problem exists when it is necessary to physical goods or commodities
for the purpose of satisfying demand over a specified period of time. Almost
every business organization must goods and raw materials to ensure smooth and
efficient running of its operation. Decisions regarding how much and when to
order are typical inventory problems. Inventory management and control systems
ensure that proper and adequate utilization of materials are made and that the
optimum levels of material investment are determined and maintained. Presently,
the Economic Order Quantity (EOQ) model is the most frequently used model for
controlling inventory in most production concern.
1.2 STATEMENT OF PROBLEMS
The
primary objectives of most business organizations include survival and growth,
and the maximization or shareholders wealth. To attain these objectives, a
level of profit must be earned to allow a company takes advantages of business
opportunities, undertake research and innovations which will enable growth. The
achievement of these objectives make it imperative that positive steps will be
taken to minimize the total cost of the business and at the same time maximize
revenue generating potentials. One major component of the operation cost of any
manufacturing concern that deserves the attention of top management is the
investment in inventories. The inventory figure for many firms is the largest
single item in the current asset group.
The
biggest question before management is: How
big should inventory? The answer to this question is obvious it should be
just big enough. But what is big enough? This question is made more difficult
by the mere fact that generally each individual within a management group tends
to answer the question from his own point of view. He fails to recognize costs
outside his usual framework. He tends to think of inventories in isolation from
other operations. The Sales Manager commonly says that the company must never
make a customer wait; the Production Manager says that there must be long
manufacturing runs for lower costs and steady employment; the Treasurer says
that large inventories are draining of each which could be used to make profit.
Such a situation occurs all the time. The task of all production planning,
scheduling, or control functions, is typically to balance conflicting
objectives such as those of minimum purchase or production cost, minimum
inventory investment, minimum storage and distribution cost, and maximum
services to customers.
An
excess inventory consumes a proportion of the company’s finance which otherwise
could have been profitability employed in other areas; while a situation in
which a firm runs out of materials and finished products could be costly in
terms of the loss of sales and customers goodwill. The ability of management to
effectively manage this issue helps to strike a balance between the cost of
holding and ordering its inventory.
Any
manufacturing organization needs to effectively manage its inventories. The
management of inventory involves determining the basic of inventory to hold on
hand at any particular point in time; decisions as to whether to buy raw
materials in large quantity; the number of times to place orders for materials
and the optimum time to place requisition. Why
are we always out of? So goes the complaint of great number of businessmen
faced with the dilemmas and frustrations of attempting simultaneously to
maintain stable production operations, providing customers with adequate
services and keeping investment in s and equipment’s at reasonable levels.
But
this is only one of the characteristic problems business managers face in
dealing with production planning, scheduling and keeping inventories in hand to
meet customers need. Other question just as perplexing and baffling when
managers approach them on the basis of intuition and pencil work done are: How
often should we reorder?; What capacity levels should we set for job-shop
operations?; How do we plan production and procurement for seasonal sales?,
And so on, and so forth. Inventory management further involves how to schedule
the departments and machines in order to avoid the risk of having excess in
process inventory. A profit oriented company that can maintain these features
of inventory management will accentuate the company’s chances of optimizing
profitability and will have to be doing a good job of controlling its
inventories and production levels.
Even
though a recent invention, the Economic Order Quantity (EOQ) model, designed by
engineers, accountants and mathematicians has been in existence for some time
now. The model has an objective of determining the inventory quantity a firm
should order and carry in order to minimize the cost of carrying and holding.
But despite this laudable objective of the Economic Order Quantity (EOQ) model,
it is still noticeable that most companies in Nigeria are operating annually at
losses as a result of the high costs due from poor management of inventories.
Consequently, this project will also aim at finding out if actually production
concerns apply the inventory management model-EOQ. If they do, why do most of them
still run high operating costs especially in the area of inventory management?
How realistic are the assumptions of the economic order quantity? Is it
possible to use the EOQ mode without any modification is a
Nigeria settings? These and other related questions will be
answered in the course of this research work.
Oftentimes,
it takes between nine months to one year in the Nigeria Cement Company Nkalagu;
from the time customers place order to the time, the orders are filled. A
critical analysis of their reveals that production is usually far below
customers requirement; hence the need to ration the available output on a
pro-rata basis. Is there actually a relationship between production
stop-pages/insufficient output and inventory? Synder (1964) identified
some questions necessary for solving the inventory problem:
Ø Why
are we out of too often?”
Ø Why
do we have too much capital tied up in inventories?
Ø Why
is our storage costs high?”
Ø Are
we losing business because we don’t have enough inventories?
Ø Why
do competitors operate with lower inventory sales ratio?”
Ø Why
do we have too much ‘dead’ inventory?”
The
fact that the statement are voiced so frequently pints out the many conflicts
of interest which appear in most inventory situations. To resolve these
conflicts, we need to resolve uncertainties such as:
v Should
we even have inventories?
v What
should the inventories be?”
v What
is the correct inventory level for a product?”
v How
can we control inventories?”
v How
can we evaluate performance?”
1.3 OBJECTIVES OF THE STUDY
The
objectives of this study are as follows:
1. To
examine the basic inventory models (such as the EOQ), safety as operated by the
Nigerian Cement Company, Nkalagu; otherwise to find out how much the company is
losing for not buying gypsum in the Economic Order Quantity (EOQ) lost sizes.
2. To
determine whether there is any relationship between the level of gypsum and the
level of production/customers services.
3. To
determine whether there is any relationship between the level of gypsum and the
level of profitability of the Nigerian Cement Company, Nkalagu.
4. To
identify the weakness if any involved in implementing inventory management and
control systems in production concern with special reference to Nigerian Cement
Company, Nkalagu.
5. Finally,
to make recommendations for improvement.
1.4 HYPOTHESIS FORMULATION
Specially,
this section serves as a guide to the research work. With the problems
identified and the objectives stated, certain assumptions are made which will
be tested during the course of the project work. These hypothetical statement
are:
1. Most
inventory managers do not known about the existence of the Economic Order
Quantity (EOQ).
2. A
significant number of them do not apply EOQ model in making inventory
decisions.
3. Inadequate
leads the disruption of production and loss of sales.
4. There
is no significant relationship between inventory level and turnover in
production concern.
5. Inventory
management problems revolve around the determination of the optimum level to
hold/carry at any point in time.
1.5 SIGNIFICANCE OF THE STUDY
Inventory
constitutes a large proportion of the operating costs of a business, hence its
effective management would enhance the survival and growth of the business
while contributing to a satisfactory profit level of operations by minimizing
costs. No company can afford to invest its scare resources in areas of
considering risks and uncertainties. Therefore, the need to study the means of
evaluating the profitability of an organization, its inventory system and costs
involved can never be over emphasized.
Given
the financial position of the Nigerian Cement Company, Nkalagu, as a profit
oriented concern and its social and economic commitment to the growth of the
country, it is therefore of considerable importance that all avenues that will
enhance the growth of the company need to be exploited. It is therefore the
hope of the researcher that this study would be found useful by the owner,
management of the company and others.
1. This
research project would help the management of the Nigerian Cement Company,
Nkalagu to identify the most influential variables of inventory management and
production. Furthermore, the study will also help the management of the
company, to guide against risk of losses through obsolescence. Above all, it
will guide them in determining the economic lost size of gypsum.
2. This
research project will also be very useful for research students, who may want
to extend their studies in the area of inventory management. This work will
provide a base of literature to such students.
3. Finally,
it is hoped that this study would offer useful suggestions on ways to improve the
inventory control system of the company.
1.6 SCOPE OF THE STUDY
Inventory
managements is really a very broad area, but this study is limited to
production concern, with special reference to the Nigeria Cement Company,
Nkalagu.
The
study investigates the genera practices of managing gypsum and control system
adopted in the Nigeria Cement Company, Nkalagu, the nature, types and other
factors which influence the size of gypsum and other raw materials in the
company. It is an analytical survey of the problems of the Nigeria Cement
Company, Nkalagu with respect to the application of raw material (gypusm)
management techniques. Practically, the study is based on the analysis of
gypsum management of the company for a period of five years (19994-1998).
Investigations
are carried out in this project as to determine to what extent the inventory
policies have affected total corporate objectives of the firm such as
profitability, efficiency etc. in analysis the data gathering, and quantitative
techniques are employed to calculate the economic order quantity and re-order
point (ROP). Furthermore, attempts are made to analyze any cost savings or
otherwise that resulted from such computations. Efforts are also made to relate
the level of inventory to the level of production and sales.
Finally,
inventory costs are related to the levels of profit with the aid of basic
statistical tools namely correlation and regression analysis.
1.7 RESEARCH QUESTIONS
The
research questions for this study are:
1. What
is the Economic Order Quantity of gypsum in the Nigeria Cement Company?
2. Is the
company buying gypsum at the Economic Order Quantity?
3. If no
to 2 above, how much is the company losing annually for failing to buy the
inventory at the Economic Order Quantity lot sizes?
4. What
basic inventory models are most common to production concern?
5. Why
are most companies always running out of?
6. How
big should inventory be?
7. Is
there any relationship between inventory level and profitability?
8. Finally,
do most manages apply various inventory management models?
1.8 LIMITATION OF STUDY
In
a study of this nature, a lot of problems are bound to appear. It was left to
the researcher to strive to achieve the best he could inspite of these
problems. Some of the limiting factors of this research project are:
1. Inadequate
information was a limiting factor in the sense that the extent the research
could go depended on the available data. Most data which the researcher
intended using for his analysis were not available as complete records were not
kept by the company. Attitudes of some heads of department of the company also
place a check on the success of easy accessibility to relevant information. To
this end, a lot of assumptions were made especially to arrive at the figure
used for the computation. Also arbitrary rate was used to covert dollars to
Naira as there is no standard rate.
2. Finance: The researcher was forced by
lack of money to limit the study to certain periods and to limit respondent to
a certain number. This is the case as a lot of expenses were incurred in typing
questionnaires and conducting interviews.
3. Time: This research project, being a
requirement for the award of B.Sc. Degree had time interval allocated to it by
the University authority. The allotted time is also the same for other
coursework and various assignments, hence, there is always a consistent conflict
between lecture hours and appointed schedule with company executives. Because
of all these constraints, the researcher could not carry out this study as
envisaged; hence he strenuously investigated the relevant areas of the study
for the period under review.
4. Illiteracy: The researcher encountered
problems in administration his questionnaire as a result of illiteracy on the
side of some respondents. The researcher spent quite some time helping some of
his respondents to complete the questionnaire; by asking the question and
recording the response himself.
1.9 DEFINITION OF TERMS
1. Inventory: According to Pandey,
‘Inventory is of goods and components that make up the product that a
manufacturing company is producing for sales.”
a. Raw Materials Inventory: Raw materials
inventory are those units of production which have been acquired and stored for
future production. They are those basic materials that are converted into
finished products through the manufacturing process.
b. M.R.O. Inventory: Maintenance, Repairs
and Operating supplies are these inventories which are consumed in the
production.
c. Work-In-Progress Inventory: These are
semi-manufacturing product. They represent products that need more work before
they become finished products for sale.
d. Inventory of Supplies: Supplies are
maintained by firms and include office and plant cleaning materials (soap and
broom) Oil, Fuel, light, bulbs and their like. These materials do not directly
enter into the production process.
e. Finished Goods Inventory: These are
manufacturing goods ready for sale.
2. Lead or Procurement Time: The period of
time expressed in days, weeks, months, etc., between ordering (either
externally or internally) and replenishment i.e. when the goods are available
for use.
3. Demand: The amount or quantity required
for production; usually expressed per week, month or year. Estimates of the
rate of demand during the lead time are critical factor in inventory control
system.
4. Economic Order Quantity (EOQ): This is
calculated order quantity which minimizes the balance of costs between
inventory holding and re order cost.
5. Physical: These are numbers of items
physically in at any given time. The physical quantity of goods on hand can be
determined by physical count by the employee of the firm and by the employee of
the firm and by maintaining record of all decreases (due to sales).
6. Buffer: The serve held no guard against
a out due to usage or lead time exceeding the average.
7. Inventory Carrying Costs: They are also
known as holding cost or storage cost. They are real out of pocket associated
with carrying inventory on hand.
8. Out Costs: The out costs refer to costs
incurred by a firm as a result of running out of items. They include
contribution margin or lost sales, loss of customer goodwill and confidence,
and extra purchasing and transportation costs.
9. Safety: This can be defined as the
extra inventory held as a hedge of protection against possibility of a out. In
other words, it is a allowance to cover errors in forecasting the lead time or
the demand during the lead time. By carrying a safety, the firm ensures that
there is protection against the establishment becoming idle because of shortage
of raw materials inventory. Safety immunizes the inventory Control Department
against the risks of out.
10. Maximum Levies: The maximum level is
the level above which s should not normally be allowed to rise. It is set by:
a. The
rates of sales of the finished goods
b. Lead
time
c. Re
order level of inventory
d. Re
order quantity of inventory
e. The
capital available and the opportunity to acquired items at low prices.
f. The
cost of storage and availability of storage space.
g. The
risk of obsolescence and deterioration
h. Insurance
11. Minimum Level:
This is the level below which the must not normally fall. If s go below the
level, then there is the possibility of shortage of supplies, which may lead to
production stoppage. It is set after considering two factors.
a. The
rate of production of goods during the lead time
b. Lead
time which is the same thing as the period necessary to obtain delivery of raw
materials
12. Re-Order Quantity: The re-order
quantity is the quantity a firm orders any time it wants to replenish its. It
is important for an establishment to know not only the size or inventor to
order at a time, but also when the inventory is due for replenishment.
13. Re-Order Level: The level of at which a
further replenishment order should be placed. The re-order level is dependent
upon the lead time and the demand during the lead time.
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