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Inventory Management^253

A big problem with work-in-progress is that work passes in sequence through a series
of operations. What is an economic batch for lathe work may not be economic for
drilling, milling or assembly operations. Applying EBQ calculation to one operation in
isolation can cause bottlenecks in the flow or production - creating excessive holdings
of partly-completed work because it could be produced cheaply in a large batch, even
though there will be no demand for that work for some time ahead.

A similar problem is that of keeping skilled work people steadily occupied, since their
wages are basically fixed in relation to time, even though outside customer demand
may be seasonal or erratic.

Because these problems are concerned with the uneven timing of cash flows they are
best solved by the use of discounted cash flow techniques. If, however, there is a
capability of a rate of production which is in excess of a steady rate of demand (internal
or external) then the problem is to decide what is the economic length of a production
run, the facilities then being switched to other work until the next run is required.

As the number of items could be very large in case of raw materials it is necessary to
find ways to selectively pay attention to those items that represent the highest value. A
categorisation method known as ABC analysis is used for the same purpose. The idea
behind ABC analysis is that attention is focussed on the highest value items that are
usually small in number categorised as A-category items and the lowest value items
are categorised as C and are ordered in more quantities so that less attention is required
there.

For example in the figure 3.6 below, the A category items represent only 10 % of total
inventory items but represent 57 % of the total value. While C category items represent
50 % of the total items but only 16 % of the value. By concentrating more on the A
category items the company is able to manage its raw material inventory better.

Figure: ABC Inventory Analysis

Percent of

inventory

value

Percent of

inventory

items

100

80

60

40

20

0

20

40

60

80

100

A

Group

B

Group C

57% Group

10%

27%

40%

16%

50%