Ch-9_Physical Inv and Warehouse Mgt.ppt

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Chapter - 9
Physical Inventory and
Warehouse Management

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Introduction
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.

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Introduction
Inventory accuracy is the responsibility of warehousing, and
methods of determining the accuracy of stocks will be covered,
along with a description of how to conduct an annual physical
audit.
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.

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WAREHOUSING MANAGEMENT
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:
• Provide timely customer service.
• Keep track of items so they can be found readily and
correctly.
• Minimize the total physical effort and thus the cost of
moving goods into and out of storage.
• Provide communication links with customers.

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WAREHOUSING MANAGEMENT
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.

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Warehouse Activities
1. Receive goods
The warehouse accepts goods from outside transportation or an attached
factory and accepts responsibility for them. This means the warehouse
must:
a. Check the goods against an order and the bill of lading.
b. Check the quantities.
c. Check for damage and fill out damage reports if necessary.
d. 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 is recorded.

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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.

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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 trade-off between the two in that
labor costs can be reduced by using more materials handling
equipment.

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2. Effective use of labor and 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.

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Factors influencing the effective use of
Warehouses
• Cube utilization and accessibility.
• Stock location.
• Order picking and assembly.
• Packaging.
With the exception of packaging, these are
discussed in the following sections.

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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.
Cube utilization is the use of space horizontally and
vertically.

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Cube Utilization and Accessibility
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.

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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.

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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.

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The following are some basic systems of locating stock:
 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.

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There are two basic systems for assigning specific locations to
individual stock items: fixed location and floating location.
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.
Everything is nice and simple so things are readily found. However,
fixed-location systems usually have poor cube utilization.
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.

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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.

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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.

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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.

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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. 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.

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2. Zone system. The warehouse is divided 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.
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.

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PHYSICAL CONTROL AND SECURITY
Because inventory is tangible, items have a nasty habit of becoming lost,
stray, 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.

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PHYSICAL CONTROL AND SECURITY
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.

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Limited access
Inventory must be kept in a safe, secure place with
limited general access. It should be locked except during
normal working hours.
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.

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INVENTORY RECORD ACCURACY
These three pieces of information must be accurate:
part description (part 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
an item is in inventory when it is not, any order promising
that item will be in error.

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INVENTORY RECORD ACCURACY
• Operate effectively and efficiently. Planners can plan,
confident that the parts will 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.

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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.

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Causes of Inventory Record Errors
• 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.

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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 10 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 2 of
the 10 items are correct. Is the accuracy 100%
or 20% or something else?

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Tolerance. To judge inventory accuracy, a tolerance level for
each part must be specified. For some items, this may mean no
variance; for others, it may be very 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 an
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 of getting precise measurement.

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

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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%.

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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 find the causes of record inaccuracy and
eliminate them. Cycle counting does this; periodic audits tend
not to.

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Auditing Inventory Records
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.

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Periodic (annual) inventory. 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.

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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.

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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.

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Taking an annual physical inventory presents 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.

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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.

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Cycle counting
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 then 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.

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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 system.

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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.

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EXAMPLE PROBLEM
A company has classified its inventory into ABC items. It has
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.

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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.

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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.

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When to count
• 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.

Ch-9_Physical Inv and Warehouse Mgt.ppt

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