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M&DC Purchasing & Supply Chain: Material Management

 

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Physical Inventory and Warehouse Management

 

Contents

  • Because inventory is stored in warehouses, the physical management of inventory and warehousing are intimately connected. In some cases, inventory may be stored for an extended time. In other situations, inventory is turned over rapidly, and the warehouse functions as a distribution center.

  • In a factory, “stores” perform the same functions as warehouses and contain raw materials, work-in-process inventory, finished goods, supplies, and possibly repair parts. Since they perform the same functions, stores and warehouses are treated alike in this chapter.

  • As with other elements in a distribution system, the objective of a warehouse is to minimize cost and maximize customer service. To do this, efficient warehouse operations perform the following:

    1. Provide timely customer service.

    2. Keep track of items so they can be found readily and correctly.

    3. 3. Minimize the total physical effort and thus the cost of moving goods into and out of storage.

    4. 4. Provide communication links with customers.

  • The costs of operating a warehouse can be broken down into capital and operating costs. Capital costs are those of space and materials handling equipment. The space needed depends on the peak quantities that must be stored, the methods of storage, and the need for ancillary space for aisles, docks, offices, and so on.

  • The major operating cost is labor, and the measure of labor productivity is the number of units (for example, pallets) that an operator can move in a day. This depends on the type of material handling equipment used, the location and accessibility of stock, warehouse layout, stock location system, and the order-picking system used.

Warehouse Activities

  • Operating a warehouse involves several processing activities, and the efficient operation of the warehouse depends upon how well these are performed. These activities are as follows:

    1. Receive goods. The warehouse accepts goods from outside transportation or an attached factory and accepts responsibility for them. This means the warehouse must:

      1. Check the goods against an order and the bill of lading.

      2. Check the quantities.

      3. Check for damage and fill out damage reports if necessary.

      4. Inspect goods if required.

    2. Identify the goods. Items are identified with the appropriate stock-keeping unit (SKU) number (part number) and the quantity received recorded.

    3. Dispatch goods to storage. Goods are sorted and put away.

    4. Hold goods. Goods are kept in storage and under proper protection until needed.

    5. Pick goods. Items required from stock must be selected from storage and brought to a marshalling area.

    6. Marshal the shipment. Goods making up a single order are brought together and checked for omissions or errors. Order records are updated.

    7. Dispatch the shipment. Orders are packaged, shipping documents prepared, and goods loaded on the right vehicle.

    8. Operate an information system. A record must be maintained for each item in stock showing the quantity on hand, quantity received, quantity issued, and location in the warehouse. The system can be very simple, depending on a minimum of written information and human memory, or it may be a sophisticated computer-based system.

  • In various ways, all these activities take place in any warehouse. The complexity depends on the number of SKUs handled, the quantities of each SKU, and the number of orders received and filled. To maximize productivity and minimize cost, warehouse management must work with the following:

    1. Maximum use of space. Usually the largest capital cost is for space. This means not only floor space but cubic space as well since goods are stored in the space above the floor as well as on it.

    2. Effective use of labor and equipment. Materials handling equipment represents the second largest capital cost and labor the largest operating cost. There is a tradeoff between the two in that labor costs can be reduced by using more materials handling equipment. Warehouse management will need to:

      • Select the best mix of labor and equipment to maximize the overall productivity of the operation.

      • Provide ready access to all SKUs. The SKUs should be easy to identify and find. This requires a good stock location system and layout.

      • Move goods efficiently. Most of the activity that goes on in a warehouse is materials handling: the movement of goods into and out of stock locations.

      Several factors influence effective use of warehouses. Some are:

      • Cube utilization and accessibility.

      • Stock location.

      • Order picking and assembly.

      • Packaging.

      With the exception of packaging, these are discussed in the following sections.

Cube Utilization and Accessibility

  • Goods are stored not just on the floor, but in the cubic space of the warehouse. Although the size of a warehouse can be described as so many square feet, warehouse capacity depends on how high goods can be stored.

  • Space is also required for aisles, receiving and shipping docks, offices, and order picking and assembly. In calculating the space needed for storage, some design figure for maximum inventory is needed. Suppose that a maximum of 90,000 cartons are to be inventoried and 30 cartons fit on a pallet. Space is needed for 3000 pallets. If pal. lets are stacked three high, 1000 pallet positions are required. A pallet is a platform usually measuring 48” X 40” X 4”.

  • Pallet positions. Suppose a section of a warehouse is as shown in Figure 12.1. Since the storage area is 48” deep, the 40” side is placed along the wall. The pallets cannot be placed tight against one another; a 2” clearance must be allowed between them so they can be moved. This then leaves room for (120’ x 12”) /42” = 34.3, or 34, pallet positions along each side of the aisle. Since the pallets are stacked three high, there i room for 34 x 3 x 2 = 204 pallets.

Figure 12.1 Cube utilization.

Example Problem

  • A company wants to store an SKU consisting of 13,000 cartons on pallets each containing 30 cartons. How many pallet positions are needed if the pallets are stored three high?

Answer

Number of pallets required = 13,000 ± 30 = 433.33  434 pallets

Number of pallet positions = 434 3 = 144.67  145 pallet positions

  • Notice one pallet position will contain only two pallets.

Accessibility

  • Accessibility means being able to get at the goods wanted with a minimum amount of work. For example, if no other goods had to be moved to reach an SKU, the SKU would be 100% accessible. As long as all pallets contain the same SKU, there is no problem with accessibility. The SKU can be reached without moving any other product. When several SKUs are stored in the area, each product should be accessible with a minimum of difficulty.

Cube utilization

  • Suppose items are stacked along a wall, as shown in Figure 12.2. There will be excellent accessibility for all items except item 9, but cube utilization is not maximized. Cube utilization is the use of space horizontally and vertically. There is room for 30 pallets, but only 21 spaces are being used for a cube utilization of 709~ (21 ± 30 x 100). Some method must be devised to increase cube utilization and main~ tam accessibility. One way is to install tiers of racks so lower pallets can be removed

1 1 2 3 4          
1 1 2 3 4         10
1 1 2 3 4 5 6 7 8 9

Figure 12.2 Cube utilization versus accessibility.

  • without disturbing the upper ones. This represents a tradeoff between the capital cost of the racking and the savings in the operating cost of extra handling. Whether the additional cost is worthwhile will depend on the amount of handling and the savings involved.

Example Problem

  • A small warehouse stores five different SKUs in pallet loads. If pallets are stacked three high and there is to be 100% accessibility, how many pallet positions are needed? What is the cube utilization?

SKU A

4 pallets

SKU B

6 pallets

SKU C

14 pallets

SKU D

8 pallets

SKU E

5 pallets

Total

37 pallets

Answer

SKU

Pallet positions

A: 4 pallets

2

B: 6 pallets

2

C: 14 pallets

5

D: 8 pallets

3

E: 5 pallets

2

Total

14

  • In 14 pallet positions, there is room to store 14 x 3 = 42 pallets. Number of pallets actually stored = 37

    Cube utilization = 37/ 42 x 100% = 88%

Stock Location

  • Stock location, or warehouse layout, is concerned with the location of individual items in the warehouse. There is no single universal stock location system suitable for all occasions, but there are a number of basic systems that can be used. Which system. or mix of systems, is used depends on the type of goods stored, the type of storage

  • facilities needed, the throughput, and the size of orders. Whatever the system, management must maintain enough inventory of safety and working stock to provide the required level of customer service, keep track of items so they can be found easily, and reduce the total effort required to receive goods, store then~, and retrieve them for shipment.

    The following are some basic systems of locating stock:

    • Group functionally related items together Group together items similar in their use (functionally related). For example, put all hardware items in the same area of the warehouse. If functionally related items are ordered together, order picking is easier. Warehouse personnel become familiar with the locations of items.

    • Group fast-moving items together If fast-moving items are placed close to the receiving and shipping area, the work of moving them in and out of storage is reduced. Slower moving items can be placed in more remote areas of the warehouse.

    • Group physically similar items together Physically similar items often require their own particular storage facilities and handling equipment. Small packaged items may require shelving whereas heavy items, such as tires or drums, require different facilities and handling equipment. Frozen foods need freezer storage space.

    • Locate working stock and reserve stock separately Relatively small quantities of working stock—stock from which withdrawals are made—can be located close to the marshalling and shipping area whereas reserve stock used to replenish the working stock can be located more remotely. This allows order picking to occur in a compact area and replenishment of the working stock in bulk by pallet or container load.

  • There are two basic systems for assigning specific locations to individual stock items: fixed location and floating location. Either system may be used with any of the above location systems.

Fixed location

  • In a fixed-location system, an SKU is assigned a permanent location or locations, and no other items are stored there. This system makes it possible to store and retrieve items with a minimum of record keeping. In some small, manual systems, no records are kept at all. It is like always keeping cornflakes on the same shelf in the kitchen cupboard at home. Everything is nice and simple so things are readily found. However, fixed-location systems usually have poor cube utilization. If demand is uniform, presumably the average inventory is half the order quantity, and enough space has to be allocated for a full-order quantity. On the average, only 50% of the cube space is utilized. Fixed-location systems are often used in small warehouses where space is not at a premium, where throughput is small, and where there are a few SKUs.

Floating location

  • In a floating-location system, goods are stored wherever there is appropriate space for them. The same SKU may be stored in several locations at the same time and different locations at different times. The advantage to this system is improved cube utilization. However, it requires accurate and up-to-date information on item location and the availability of empty storage space so items can be put away and retrieved efficiently. Modern warehouses using floating-location systems are usually computer based. The computer assigns free locations to incoming items, remembers what items are on hand and where they are located, and directs the order picker to the right location to find the item. Thus, cube utilization and warehouse efficiency are greatly improved.

Point-of-use storage

  • Sometimes, particularly in repetitive manufacturing and in a JIT environment, inventory is stored close to where it will be used. There are several advantages to point-of-use storage.

  • Materials are readily accessible to users.

  • Material handling is reduced or eliminated.

  • Central storage costs are reduced.

  • Material is accessible at all times.

  • This method is excellent as long as inventory is kept low and operating personnel can keep control of inventory records. Sometimes C items are issued as “floor stock” where manufacturing is issued a large quantity which is used as needed. Inventory records are adjusted when the stock is issued, not when it is used.

Central storage

  • As opposed to point-of-use storage, central storage contains all inventory in one central location. There are several advantages:
    Ease of control.

  • Inventory record accuracy is easier to maintain.

  • Specialized storage can be used.

  • Reduced safety stock, since users do not need to carry their own safety stock.

Order Picking and Assembly

  • Once an order is received, the items on the order must be retrieved from the warehouse, assembled, and prepared for shipment. All these activities involve labor and the movement of goods. The work should be organized to provide the level of customer service required and at least cost. There are several systems that can be used to organize the work, among which are the following:

    1. Area system. The order picker circulates throughout the warehouse selecting the items on the order, much as a shopper would in a supermarket. The items are then taken to the shipping area for shipment. The order is self-marshalling in that when the order picker is finished, the order is complete. This system is generally used in small warehouses where goods are stored in fixed locations.

    2. Zone system. The warehouse is broken down into zones, and order pickers work only in their own area. An order is divided up by zone, and each order picker selects those items in their zone and sends them to the marshalling area where the order is assembled for shipment. Each order is handled separately and leaves the zone before another is handled.
      Zones are usually established by grouping related parts together. Parts may be related because of the type of storage needed for them (for example, freezer storage) or because they are often ordered together.
      A variation of the zone system is to have the order move to the next zone rather than to the marshalling area. By the time it exits the last zone, it is assembled for shipment.

    3. Multi-order system. This system is the same as the zone system except that, rather than handling individual orders, a number of orders are gathered together and all the items divided by zone. The pickers then circulate through their area, collecting all the items required for that group of orders. The items are then sent to the marshalling area where they are sorted to individual orders for shipment.

  • The area system is simple to manage and control, but as the warehouse throughput and size increase, it becomes unwieldy. The zone systems break down the order-filling process into a series of smaller areas that can be better managed individually. The multi-order system is probably most suited to the situation in which there are many items or many small orders with few items.

Working stock and reserve stock

  • In addition to the above systems, reserve stock and working stock may be separated. This is appropriate when the pick unit for a customer's order may be a box or a case that is stored on pallets. A pallet can be moved into the working area by a lift truck and cartons or boxes picked from it. The working stock is located close to the shipping area so the work in picking is reduced. A separate workforce is used to replenish the working stock from the reserve stock.

 

  • Because inventory consists of tangible things, items have a nasty habit of becoming lost, strayed, or stolen, or of disappearing in the night. It is not that people are dishonest, rather that they are forgetful. What is needed is a system that makes it difficult for people to make mistakes or be dishonest. There are several elements that help.

    • A good-part numbering system. Part numbering was discussed in Chapter 4 on material requirements planning.

    • A simple, well-documented transaction system. When goods are received, issued or moved in any way, a transaction occurs. There are four steps in any transaction: identify the item, verify the quantity, record the transaction, and physically execute the transaction.

      1. Identify the item. Many errors occur because of incorrect identification. When receiving an item, the purchase order, part number, and quantity must be properly identified. When goods are stored, the location must be accurately specified. When issued, the quantity, location, and part number must be recorded.

      2. Verify quantity Quantity is verified by a physical count of the item by weighing or by measuring. Sometimes standard-sized containers are useful in counting.

      3. Record the transaction. Before any transaction is physically carried out, all information about the transaction must be recorded.

      4. Physically execute the transaction. Move the goods in, about, or out of the storage area.

Limited access

  • Inventory must be kept in a safe, secure place with limited general access. It should be locked except during normal working hours. This is less to prevent theft than to ensure people do not take things without completing the transaction steps. If people can wander into the stores area at any time and take something, the transaction system fails.

A well-trained workforce

  • Not only should the stores staff be well trained in handling and storing material and in recording transactions, but other personnel who interact with stores must be trained to ensure transactions are recorded properly.

  • The usefulness of inventory record is directly related to its accuracy. Based on the in¬ventory record, a company determines net requirements for an item, releases orders based on material availability, and performs inventory analysis. If the records are not accurate, there will be shortages of material, disrupted schedules, late deliveries, lost sales, low productivity, and excess inventory (of the wrong things).

  • These three pieces of information must be accurate: part description (pan number), quantity, and location. Accurate inventory records enable firms to:

    • Operate an effective materials management system. If inventory records are inaccurate, gross-to-net calculations will be in error.

    • Maintain satisfactory customer service. If records show the item is in inventor) when it is not, any order promising it will be in error.

    • Operate effectively and efficiently. Planners can plan, confident that the parts wit be available.

    • Analyze inventory. Any analysis of inventory is only as good as the data it is based on.

    Inaccurate inventory records will result in:

    • Lost sales.

    • Shortages and disrupted schedules.

    • Excess inventory (of the wrong things).

    • Low productivity.

    • Poor delivery performance.

    • Excessive expediting, since people will always be reacting to a bad situation rather than planning for the future.

Causes of Inventory Record Errors

  • Poor inventory record accuracy can be caused by many things, but they all result from poor record-keeping systems and poorly trained personnel. Some examples of causes of inventory record error are:

    • Unauthorized withdrawal of material.

    • Unsecured stockroom.

    • Poorly trained personnel.

    • Inaccurate transaction recording. Errors can occur because of inaccurate piece counts, unrecorded transactions, delay in recording transactions, inaccurate material location, and incorrectly identified parts.

    • Poor transaction recording systems. Most systems today are computer based and can provide the means to record transactions properly. Errors, when they occur, are usually the fault of human input to the system. The documentation reporting system should be designed to reduce the likelihood of human error.

    • Lack of audit capability. Some program of verifying the inventory counts and locations is necessary. The most popular one today is cycle counting, discussed in the next section.

Measuring Inventory Record Accuracy

  • Inventory accuracy ideally should be 100%. Banks and other financial institutions reach this level. Other companies can move toward this potential.

  • Figure 12.3 shows ten inventory items, their physical count, and the quantity shown on their record. What is the inventory accuracy? The total of all items is the same, but only two of the ten items are correct. Is the accuracy 100% or 20% or something else?

Part Number

Inventory

Shelf Count

Record

1

100

105

2

100

100

3

100

98

4

100

97

5

100

102

6

100

103

7

100

99

8

100

100

9

100

97

10

100

99

Total

1000

1000

Figure 12.3 Inventory record accuracy.

Tolerance

  • To judge inventory accuracy, a tolerance level for each part m~ be specified. For some items, this may mean no variance; for others, it may be ye difficult or costly to measure and control to 100% accuracy. An example of the latter might be nuts or bolts ordered and used in the thousands. For these reasons, tolerances are set for each item. Tolerance is the amount of permissible variation between inventory record and a physical count.

  • Tolerances are set on individual items based on value, critical nature of the item availability, lead time, ability to stop production, safety problems, or the difficulty getting precise measurement.

  • Figure 12.4 shows the same data as the previous figure, but includes tolerances This information tells us exactly what inventory accuracy is.

Part

Inventory

Shelf

Tolerance

Within Tolerance

Outside Tolerance

Number

Record

Count

1

100

105

±5%

X

 

2

100

100

±0%

X

 

3

100

98

±3%

X

 

4

100

97

±2%

 

X

5

100

102

±2%

X

 

6

100

103

±2%

 

X

7

100

99

±3%

X

 

8

100

100

±0%

X

 

9

100

97

±5%

 

X

10

100

99

±5%

 

X

Total

1000

1000

 

 

 

Figure 12.4 Inventory accuracy with tolerances.

Example Problem

  • Determine which of the following items are within tolerance. Item A has a tolerance of ±5%; item B, ±2%; item C, ±3%; and item D, ±0%.

Part

Shelf Count

Inventory Record

Tolerance

Number

A

1500

1550

±5%

B

120

125

±2%

C

225

230

±3%

D

155

155

±0%

Answer

Item A.

With a tolerance of ±5%, variance can be up to ±75 units. Item A is within tolerance.

Item B.

With a tolerance of ±2%, variance can be up to ±2 units. Item B is outside tolerance.

Item C.

With a tolerance of ±3%, variance can be up to ±7 units. Item C is within tolerance.

Item D.

With a tolerance of ±0%, variance can be up to ±0 units. Item D is within tolerance.

 

Auditing Inventory Records

  • Errors occur, and they must be detected so inventory accuracy is maintained. There are two basic methods of checking the accuracy of inventory records: periodic (usually annual) counts of all items and cyclic (usually daily) counts of specified items. It is important to audit record accuracy, but it is more important to audit the system to fine the causes of record inaccuracy and eliminate them. Cycle counting does this; periodic audits tend not to.

Periodic (annual) inventory

  • The primary purpose of a periodic (annual) inventory is to satisfy the financial auditors that the inventory records represent the value of the inventory. To planners, the physical inventory represents an opportunity to correct any inaccuracies in the records. Whereas financial auditors are concerned with the total value of the inventory, planners are concerned with item detail.

  • The responsibility for taking the physical inventory usually rests with the materials manager who should ensure that a good plan exists and it is followed. George Plossl once said that taking a physical inventory was like painting; the results depend on good preparation.’ There are three factors in good preparation: housekeeping, identification, and training.

  • Housekeeping. Inventory must be sorted and the same parts collected together so they can easily be counted. Sometimes items can be precounted and put into sealed cartons.

  • Identification. Parts must be clearly identified and tagged with part numbers. This can, and should, be done before the inventory is taken. Personnel who are familiar with parts identification should be involved and all questions resolved before the physical inventory starts.

  • Training. Those who are going to do the inventory must be properly instructed and trained in taking inventory. Physical inventories are usually taken once a year, and the procedure is not always remembered from year to year.

Process

  • Taking a physical inventory consists of four steps:

    1. Count items and record the count on a ticket left on the item.

    2. Verify this count by recounting or by sampling.

    3. When the verification is finished, collect the tickets and list the items in each department.

    4. Reconcile the inventory records for differences between the physical count and inventory dollars. Financially, this step is the job of accountants, but materials personnel are involved in adjusting item records to reflect what is actually on hand. If major discrepancies exist, they should be checked immediately.

  • Taking a physical inventory is a time-honored practice in many companies mainly because it has been required for an “accurate” appraisal of inventory value for the annual financial statements. However, taking an annual physical inventory has several problems. Usually the factory has to be shut down, thus losing production; labor and paperwork are expensive; the job is often done hurriedly and poorly since there is much pressure to get it done and the factory running again. In addition, the people doing the inventory are not used to the job and are prone to making errors. As a result, more errors often are introduced into the records than are eliminated.

  • Because of these problems, the idea of cycle counting has developed.

Cycle counting

  • Cycle counting is a system of counting inventory continually throughout the year. Physical inventory counts are scheduled so that each item is counted on a predetermined schedule. Depending on their importance, some items are counted frequently throughout the year whereas others are not. The idea is to count selected items each day.

    The advantages to cycle counting are:

    • Timely detection and correction of problems. The purpose of the count is first to find the cause of error and to correct the cause so the error is less likely to happen again.

    • Complete or partial reduction of lost production.

    • Use of personnel trained and dedicated to cycle counting. This provides experienced inventory takers who will not make the errors “once-a-year” personnel do. Cycle counters are also trained to identify problems and to correct them.

  • Count frequency. The basic idea is to count some items each day so all items are counted a predetermined number of times each year. The number of times an item is counted in a year is called its count frequency. For an item, the count frequency should increase as the value of the item and number of transactions (chance of error) increase. Several methods can be used to determine the frequency. Three common ones are the ABC method, zone method, and location audit method.

  • ABC method. This is a popular method. Inventories are classified according to the ABC system (refer to Chapter 10). Some rule is established for count frequency. For example, A items might be counted weekly or monthly; B items, bimonthly or quarterly; and C items, biannually or once a year. On this basis, a count schedule can be established. Figure 12.5 shows an example of a cycle count scheduled using the ABC system.

Classification

Number Count

Number

of Items Frequency

of Counts

A

1000

12

12,000

B

1500

4

6000

C

2500

1

2500

Total Counts                                                                20.500

Workdays per Year                                                           250

Counts per Day                                                                  82

Figure 12.5 Scheduling cycle counts.

Example Problem

  • A company has classified its inventory into ABC items. They have decided that A
    items are to be counted once a month; B items, four times a year; and C items, twice
    a year. There are 2000 A items, 3000 B items, and 5000 C items in inventory. Develop
    a schedule of the counts for each class of item.

Answer

Classification

Number Count

Number

of Items Frequency

of Counts

A

1000

12

12,000

B

1500

4

6000

C

2500

1

2500

Total Counts                                                                20.500

Workdays per Year                                                           250

Counts per Day                                                                  82

 

  • Zone method. Items are grouped by zones to make counting more efficient. The system is used when a fixed-location system is used, or when work-in-process or transit inventory is being counted.

  • Location audit system. In a floating-location system, goods can be stored anywhere, and the system records where they are. Because of human error, these locations may not be 100% correct. If material is mislocated, normal cycle counting may not find it. In using location audits, a predetermined number of stock locations are checked each period. The item numbers of the material in each bin are checked against inventory records to verify stock point locations.

  • A cycle counting program may include all these methods. The zone method is ideal for fast-moving items. If a floating-location system is used, a combination of ABC and location audit is appropriate.

  • When to count. Cycle counts can be scheduled at regular intervals or on special occasions. Some selection criteria are:

  • When an order is placed. Items are counted just before an order is placed. This has the advantage of detecting errors before the order is placed and reducing the amount of work by counting at a time when stock is low.

  • When an order is received, inventory is at its lowest level.

  • When the inventory record reaches zero. Again, this method has the advantage of reducing work.

  • When a specified number of transactions have occurred. Errors occur when transactions occur. Fast-moving items have more transactions and are more prone to error.

  • When an error occurs. A special count is appropriate when an obvious error is detected. This may be a negative balance on the stock record or when no items can be found although the record shows some in stock.