The Importance of Inventory Management as a Tool for Cost Reduction in Manufacturing Companies

THE IMPORTANCE OF INVENTORY MANAGEMENT AS A TOOL FOR COST REDUCTION IN MANUFACTURING COMPANIES. (A CASE STUDY OF NIGERIAN BREWERIES, PLC 9^TH MILE CORNER)

The economic boom of the last two decades or so appear to have given way to a slight form of depression globally especially in the third world and some developing countries. Some developing country such as Singapore, Malaysia, Thailand, Indonesia, and generally the Asian Tigers are doing fine though and are economically very important. Back home here is Nigeria the situation is that of depression and absolute poverty, high inflation very low purchasing power resulting from very low Gross national product per capital income, and al these have led to disappearing interest in luxury goods especially. As a result, business organizations particularly those involved in the manufacturing of luxury goods are each passing day finding it more and more difficult to survive. Most business outfits now shift towards and insist on the development of logistics division with a view to planning the sourcing of raw materials, the flowing of materials to finished product stage and from finished product stage to consumption.

In other words , there is a shift of emphasis towards proper planning of inventories, their management and control with a view to, among others, reduce cost, maximize profit and thus increase wealth. Failure of many companies to manage and control inventories has force them to close down and cease to exist. There is thus the need to identify the different manners of inventory control and management in our manufacturing companies, the  identification of problems  of present ways of inventory control proffer solutions to these problems and therefore to achieve reduction in cost all necessitated the need for this research work.

Eminent scholars have done a lot of work in the areas of inventory management and inventory control. To enable this researcher therefore successfully carry out this work, some related work on inventory management and control were reviewed.

This chapter has thus been divided into subtopics and reviewed adequately as follows.

2.2     SCHOOL OF THOUGHT WITHIN THE SUBJECT AREA.

The pioneer, the largest and the most profitable brewing company, Nigeria breweries plc was incorporated in 1946 as Nigeria brewery limited. According, a  landmark was recorded about three years later, when is June 1949, the first bottle “star large beer” rolled off the bottling line in the Lagos brewery. In 952, the brewery in Lagos commenced the bottling of soft drinks under the brand names Krola and Taugo. In 1957, the Aba plant/brewery was commission and subsequently, the company’s name was changed to Nigeria breweries limited. Other brewing plants were soon to be commission namely; Kaduna brewery in 1963, ibadan brewery in 1982, and the 9thmile corner Enugu brewery 19993 plus a brewing relationship with Heinekens international. From these breweries/plants, it high quality products are distributed to all parts of Nigeria and beyond.

In 1961, the Nigeria breweries plc public and a year later in 1963, it commenced production of “Samson Stout” and “Schweppes” coming on eventually. In 1965, it began production of Heineken large” beer and its other products include “New Rainbow” range of soft drinks “Gulder” in 1970, “Maltina non alcoholic in 1975. “Legend” extra Stout in 1992, Amstel Malta in 1994, other Schweppes range of drinks (Tonic water, bitter lemon, soda water) in 1996 and crush” in 1997. star large beer include:

Star large beer

Gulder large beer

Maltina range of non alcoholic malt of exotic fruits

Legend extra stout

Heineken Large beer

Amstel malte non-alcoholic low sugar drink

Schweppes range-Tonic water,

Soda water, bitter lemon

Crush orange drink

All these brands have facilitated the strong leadership position of Nigeria breweries plc the total brewed products market in Nigeria.

Their outstanding qualities and consumers franchise complement  company values and capabilities to set the company apart as the house of quality.

The authorized share capital of Nigeria breweries plc is over N475 million with about 55,000 shareholders.  Sixty-five percent (65%) of the shares are held by Nigerians amongst who are company employees of various of the company paid a dividend of N1.00 per share in 1996 amounting to N915 million. In 1995 the company made script issue of  one for one thus increasing its equity base to 915 million ordinary shares, up from 459 million ordinary shares. In 1996, the turnover of the company was n12.256 million and nine months unaudited result for 1997 showed a remarkable increase over the corresponding period of 1996.

A well developed research and development center was established by the company in 1987 to enhance its research activities on all  aspects of the brewing operations.

The establishment of ancillary business such as manufacturing of crown cooks, bottles, labels, cartons, plastic crates and such services as catering club are greatly encouraged by the company. Nigeria breweries plc is a socially responsible corporate citizen with an enviable track record of philanthropy especially in the areas of education, sports and health. It recently established a N100 million education Trust Fund in furtherance of its consistent effort in funding education and research in higher institutions, to provide for and encourage academic excellence in Nigeria. The company also has secondary and university scholarships  programmes for children of its employees and a foremost sponsor of variety of sports in the country.

Nigeria breweries plc is a model of success in the private sector, an investor’s  dream and any day, a blue-chip company good product qualities, efficient management of operations strategic penetration into the market environment, proper understanding of social responsibilities rating at national and zonal levels are responsible for its high profits profitability and successful operations.

2.3     SCHOOL RELEVANT TO THE PROBLEMS OF STUDY

It is proper at this stage, before classifying inventories, to define inventory management and control.

Inventory management has been defined variously by many authors and as expected, these definitions have been governed by the perceptions of the authors of the subject matter. According, Collins D. Lewis explained inventory control as a “science-based at of ensuring that just enough inventory (or slock) is held by an organization to meet both its internal and external demand commitments economically and he now defined it as.

“The  application of management functions like planning.                         Organizing, directing and controlling in the clerical and physical     check of all materials in stock to ensure maximum usage at a      reduced cost.

Also Hano Johnson et al define inventory management as the “use of various techniques to optimize levels of all types of stock, raw material work-in-progress and finished goods.

Adding that, inventory management takes into account such factors as sales forecast, economic batch quantum, production planning control, plant,  equipment.

In line with Collins D. Lewis, Michael Armstrong defined inventory as control by stating that  “inventory control ensures that the optimum amount of inventory (or stock) is held by a company so that its internal and external demand requirements are met economically.

However, while taking the issue of inventory procurement into consideration, G.K. Lysons said that material management concept, where applied should be able to perform the function of material flow. And these functions include planning, procurement, storage, controlling producing and distributing.

Niyi Fadipe described material management as a confederacy of traditional materials activities bound by a common idea, the idea of an integrated approach to planning acquisition, conversion flow and distribution of production material from the raw materials stage to the finished product stage”. Again, he highlighted the concept of the down stream and up stream flow of materials of logistic management when he opined that the concept looks at the white flow of materials and parts from supplier to the manufacturing establishments, stores, and products through warehouse and distribution centers and to customer. The aim of inventory control as enunciated by Michael Armstrong include :

1. To minimize the cost of ordinary and holding inventory, which is often largest single investment a company makes.
2. To maintain acceptable levels of customer service by minimizing stock outs (ie, good not being available from when required)
3. To reconcile the potential conflict between these objectives. Clearly a policy of minimizing stock can produce an unacceptable levels of customer service.

Finally, Ben O. Nweke (Collins) asserted material management is that aspect of management which combines the function of management (planning, organizing, directing and controlling) to achieve effective control of the movement of materials into and through production unit. this movement involves stages that represent the various sub-units of material management department. In a nutshell therefore, inventory control policies and techniques aim at optimizing stock levels visvis  customer service requirements.

In consonance with the above definition inventories are classified based on the different views of the authors. Some authors make classifications the basis of the reason for holding inventories.

Consequently. N.D.  Vohva classified inventories as follows namely;

1. Movement inventories
2. Buffer inventories
3. Anticipation inventories
4. Decupling inventories
5. Cycle inventories.

Movement inventories also called transit or pipeline inventories owe its existence to the fact that transportation time is involved in transferring substantial amounts of resources. For instance, when beer is transferred (transported) from the brewery’s finished products store to a customer, the beer, while in transit cannot provide any service to the customer or consumer for either profit generation or satisfaction of thirst for beer.

Buffer inventories sometimes referred to as safety stock are such inventories held  to protect or guard against the uncertainties of demand and supply.

Anticipation inventories are held for the reason that a future demand for the product is anticipated. For example, production of umbrellas and rain coats in anticipation of the rains, and production of beer in anticipation of large volume seasonal sales such as during Christmas period.

The idea of decoupling inventories is to decouple or disengage different parts or components of the production system. Different people and material usually work at different rates. A machine for example, might be producing half the installed output capacity. Inventories in between machines are held in order to disengage the processing on those machines and in the absence of such inventories, different machines and people cannot work simultaneously on a continuous basis. With these types of inventories in operation, work on other machines would  not stop when one breaks down.

Decoupling inventories therefore act as shock absorbers and have a cushioning effect in the face of varying work rates and machinery breakdowns and failures.

Cycle inventories also lot-size inventories are held for reasons that purchases are usually made in lots rather than for the exact amounts which my be needed at a point in time.

According to I.M Pandey, inventories are stock of the product a company is manufacturing for sale and the component that makes up the product. Equally, James C. Van Home defined inventories as the resources that help in forming a link between production and sale of a product. Three peculiar things are discernible from these two definitions of inventories namely; that inventories can be classified as follows;

1. Raw materials
2. Work-in-progress
3. Finished goods

In addition, to also classifying inventories as agreeing with the two authors above C.Nzekibe went  further to opine that inventories can be seen as “maintenance, repair or operating supplies materials which are required for the administration e.g spare parts, fuel dump, stationery and other operating material.

According to Nwachukwu, C.C, inventories are classified as follows;

1. Raw materials inventories, which include all items purchases by the plant for further processing.
2. Work-in-progress, which is an intermediate stage of raw materials inventory that is yet to be finished by the plant to enter the last stage.
3. Finished goods inventory, which is the stock of finished goods.

there are yet other authors such as Bushan and Koengsbery who include in their classifications of inventories such items as machine, machine parts tool and even personnel, trucks cash and auxiliary equipment of all kinds of required to run a business of manufacturing.

Ben O. Nweke (Collins) eruditely  asserted that materials in store elsewhere represent money in stock. And stock refers to all tangible material assets of a company other than the fixed assets; comprise all raw materials, finish or saleable product and all the items to be consumed in the process of manufacturing the product or in carrying out the business. It can thus rightly be inferred from the classifications enumerate above and for the purpose of this research work that inventory classifications are on the basis of

1. Raw materials
2. Work-in-progress
3. Finished goods.

RAW MATERIALS INVENTORY

Raw materials are commodities (steel, lumber, asbestos, fabric) and purchased parts that  into the final product. It therefore include the tangible goods acquired for direct use in the production process.

There are also materials which are not directly incorporated in the manufacturing process but are essential for its successful operation and which are sometimes include in the raw material inventory. There materials are normally isolated and are called MRO inventories, that is , maintenance, repairs  operating supplies which are consumed in production process , but which do not becomes part of the product. Example are lubricants, soap, machine repair parts, and these items are characterized by the small quantity usage.

WORK-IN-PROGRESS

These are partly manufactured/processed inventories awaiting further manufacturing /processing including material lying with sub-contractors. They are sometimes called goods-in-process.

FINISHED GOODS INVENTORY

This is the inventory of the final product which is ready for shipment and is awaiting delivery to the customer either on the basic of orders already received or anticipated. Finished goods of one manufacturing company may as well as raw materials for another manufacturing company. For instance, cement which is a finished product of the cement factory, is a raw material for the construction/building industry and flour from flour mills is a raw material for the bakery industry.

2.4     DIFFERENT METHOD OF STUDY THE PROBLEM

Stock are considered current assets on the balance sheet of a company. The objective of stores administration is therefore aimed at minimizing the amount of money spent on materials by controlling the cost of storage, materials by controlling the cost of storage, cost of ordering and cost of transportation.

A typical industrial firms inventory comprises ten thousand (10.000) to fifty thousand (50,000) items. Initial planning and subsequent control of such inventories are accomplished on the basis of knowledge about each of the individual items and the finished products of which each ia s part. The beginning of sound inventory management therefore, is the development of a complete inventory catalogue followed by a thorough ABC analysis.

INVENTORY CATALOGUE

Some  form of inventory catalogue should be prepared for  use by all personnel described identified by manufacture’s part number, cross-indexed by user’s identification number, if necessary, and classified generically for indexing purpose. Careful preparation and maintenance of such a catalogue yield two important  dividends as follows.

Firstly, an inventory catalogues serves as a medium of communication and enables personnel located in different  departments to perform their respective jobs most effective where for example, a design engineer has a choice between using either of two standard  catalogue quickly tells which part is carried in inventory and may immediately be available for use in the experimental work.

A second significant benefit derivable from an inventory catalogue accrues to the inventory control operation itself. This is in the form of the more complete and correct records through the reduction of duplication records for identical parts.  Though the use of an inventory catalogue does not eliminate the  possibility of undetected duplicate records, but if carefully development and maintained, it significantly reduces such a possibility.

ABC ANALYSIS

It is imperative that the controlling manager recognizes the naira  importance of each in terms of its prices usage (demand) and load time, as well as specified procurement or technical problems as soon as an inventory is reasonably well identified well identified and described. With out the information thus provided, controlling managers normally find themselves with scanty. Basis, at best, on which to allocate departmental effort and expense to tasks of controlling  thousands of inventory items.

ABC analysis can be made on the basis of either the average investment on each item or the annual naira or money usage of each item. This analysis easy to conduct once inventory has been properly identified and usage records maintained for a complete operating cycle. Items are simply ranked in order of  their average inventory investment (or money) usage. Total of their average inventory investment or annual usage for all inventory items is then computed.

The value of such analysis to management cannot be over-emphasized. It provides a secondary basis on which to allocate finds and item of personnel with respect to the refinement of  control over the individual inventory items. In this regard control may take several forms it may be reflected in minimizing inventory investment, in minimizing indirect costs associated with inventory, in utilizing personnel effectively, or in ensuring effective storage, handling and delivering of materials to production operations as scheduled. This concept permeates a number departmental operations such as purchasing production control, stores and accounting.

PROCUREMENT OF INVENTORY

The actual procurement process is triggered off by the need for a client or user department purchase of materials by the department responsible for purchase takes different forms. It could be made  using advertisements to obtain quotation from approved suppliers or by selection of a supplier from the pool of approved supplier or by the use of the buying committee. The researcher has noticed with satisfaction the inclination of the manufacturing companies for the use of the buying committee, inventories form a large proportion of current assets of a manufacturing company, and as such, the decision of a buying committee which is always superior to that of a sole buyer is always preferable.

In this contribution to inventory procurement, C.K. Lyson wrote that, large area of expenditure such as purchasing offers scope for substantial economics. Expenditures on inventories influence product pricing, availability and quality of finished goods and thus the profitability of the company.

Generally, when materials form a high proportion of total costs, a modest saving on “bought” out items will result in similar contribution to profit and a  considerable increase in sales. A given percentage reduction cost makes the same expansion in turn over.

An important tool for effective procurement is communication and this has been emphasized by Stanley Goldhaber  et al when they opined that tool for various groups responsible for materials procurement such as  personnel responsible for specifications, contract scheduling, purchasing and stock control” is communication.

For each inventory to replenish stock, a re-order level is established and this is necessary because running out of stock can be very costly. To avoid this, a good record keeping procedure should be established. Financial  considerations can be very important for large or experience purchases.

A company may have to adopt a policy of postponing all purchases which can be postpones in small lots hand-to-mouth purchases, when it has liquidity problems. Bairly and Farme remarked that even if there is no cash shortage, it must be recognized that it costs money to tie up cash resources in stock. In the same vein Walaenbah asserted that purchasing and holding of stock is one of the critical and viable decisions that has to be made by financial managers for efficiency and profitability.

From the above therefore, two pertinent questions are posed which, according to Nzehbe C. are:

–        How much to order at one time

–        When to order this quantity.

Ben .O. Nweke (Collins) defined purchasing as the process involved in making available the raw materials requirement of an organization at a reasonable cost. Lee and Dodder contena that the primary responsibility of purchasing include buying (involving intervi sales men; negotiating with vendors, analyzing bids and making awards with suppliers and keeping appropriate records), value analysis and purchasing research.

Also A.K Compton share the same view with Lee and Dodder and amplified the responsibilities of purchasing by saying that in practice, most purchasing officers find themselves covering the entire suppliers and materials management field.

STOCK COSTS

According to T. Luccy, whether as a result of deliberate policy or not, stock represents an investment by the organization. As with any other investment, the costs of holding stock must be related to the benefits to be grained. To do this effectively the costs must be identified. Four categories of stock costs were recognized by him namely;

1. Cost of holding stock

• Cost of obtaining stock
• Stock out cost
• Cost of stock itself.

According to Nezelibe C. a major objective of sound inventory management is that of minimizing total inventory costs. She identified two types of increment costs as

1. Ordering cost
2. Carrying cost

To her, carrying costs are costs incurred because the business maintains inventories and examples in dude warehouse space costs, interest on money invested on inventory; insurance on the same goods taxes, obsolesces and  depreciation on ordering costs. She stated further that they are costs that relate to the acquisition of purchasing orders, goods and constitute such costs as those of getting on item with the company inventory which in dude purchase order, follow-up, receiving the goods, quality control, placing the goods with inventory and paying venders.

J.J. Akano, in his own contribution described material management as the function of ensuring that sufficient goods or materials are retained in stock to meet all requirements without carrying unnecessary large stock. According to him the following factors are to be considered in determining what constitutes large stock namely the amount of capital available for ordering cost, the risk of losses due to deterioration, evaporation, pilferage, obsolescence, change in fashion, change in price, news discoveries-technologies breakthrough and involves hugs sums of money and as such needs proper and efficient management.

In consonance therefore, Collins D. Wams that there can be disadvantages of holding either too much stock or too small inventory. Therefore inventory control is primarily concerned with obtaining the correct balance or compromise between these stock out costs are most difficult to assess and include’’30.

1. Cost depending n the number of lots
2. Production costs

• Handling costs

1. Storage costs
2. Capital investment cost.

It costs real money to keep inventory; such costs include investment rates obsolescence, taxes, insurance and storage. This was the assertion of Luis M. Killen which agrees considerably with the opinions of most of the other authors quoted above. He emphatically stated that one point on which we should be able to agree, however is that total cost should be as low as possible. This is understandable since the total cost of stock impacts very significantly on final cost of the product.

1. Lucey went on to further to classify stock costs as in line with others follows;
2. Cost holding stock also known as carrying costs which include.
3. Interest on capital invested in the stock.
4. Storage charges-rent, power supply refrigeration, air-conditioning.
5. Store staffing, equipment maintenance and running costs.
6. Audit, stock taking or perpetual inventory costs.
7. Insurance, security
8. Deterioration and obsolescence.
9. Pilferage, vermin damage .

2. Cost of obtaining stock sometimes called ordering or procurement costs which include.
3. The clerical and administrative costs associated with the purchasing accounting of goods received department.
4. Transportation costs
5. The set up and tooling costs associated with each production run; that is where goods are manufacture internally

3. Stock out costs are
4. Lost contribution through the lost sale caused by the stock out.
5. Loss of future sales because customers go elsewhere.
6. Loss of customers goodwill
7. Cost of production stoppages caused by stock outs of work-in-progress or raw materials.
8. Labour frustration over stoppages
9. Extra costs associated with urgent, often small quantity, replenishment purchases.

4. Cost of stock are the buying in prices or the direct costs of production. These costs need to be considered for instance when discounts are available for bulk purchase or when savings in production costs are possible with longer batch runs.

 ECONOMIC ORDER QUANTITY

Economic order quantity “EOQ” refers to the quantity of goods which can be purchased at a given time at the most economical value. This quantity should give the least-cost alternative. The primary aim of determining this quantity is to ensure that the sum total of the cost of acquisition and cost of carrying this quantity is drastically (researchers emphasis) reduced” 349. this is in answer to the recurring questions which, according to Rehald M. COPELAND, is that one of the major questions asked in inventory management concern the size of order to be placed. According ordering, storing and opportunity costs described above must be considered in computing the economic order quantity.

Also, for Nzelibe C. Economic order quantity is that size of order which minimizes total annual cost of carrying inventory and ordering since these are const of holding inventories (interest cost, storage cost ), each firm considers the cost of holding or not holding inventories.

Equally, Ben. O. Nweke (Collins) states that the economic order quantity is that quantity at which the cost of procuring (ordering cost) the annual requirement of a material and the cost of carrying the inventory (holding cost) are equal. The quantity of materials to be ordered at a time calculated so as to minimize the total cost incurred in purchasing and stocking the items. When this economic order quantity is determined, the company must purchase a fixed quantity at each internal to make up the total quantity per annum. The quantity with requisite amendments and adjustments. Advantages and disadvantages of each decision must be considered such that what is set out to gain is not lost through wrong application.

Basically, there are three common ways of computing the economic order quantity namely;

1. The tabular approach
2. Graphic approach
3. Algebraic of formula approach

The most efficient and widely used in inventory management in the computation of economic order quantity is the formaul or algebraic approach.

The graphic approach operates with some basic assumptions namely, the annual inventory is constant through all the ordering level, the ordering lot is constant and the carrying cost also known as variable cost is not constant. The graphic approach involves trial and error in the determination of economic order quantity.

The use of algebraic of formular approach. “the most economic pivot in terms of total inventory cost is where the inventory carrying cost equal the ordering cost.

The economic order quantity formula is as follows:

RECOMMENDED TOPICS

[simple-links category=”3220″]