5-1 Introduction
This chapter contains 32 measurements related to inventory that can selectively be used to track changes in new product design, computer files, receiving, putaway, production, picking, shipping, and inventory storage—in that sequential order.
Don’t feel compelled to use all 32 measurements. Instead, use only those mea- surements needed to track the most important parts of the inventory process flow.
Too many measurements constitute an overflow of information and require an ex- cessive amount of effort to calculate. For reference, the measurements are noted in their order of presentation in the following table:
5-2 Percentage of New Parts 5-13 Average Picking Time
Used in New Products 5-14 Picking Accuracy
5-3 Percentage of Existing Parts for Assembled Products Reused in New Products 5-15 Average Picking Cost 5-4 Bill of Material Accuracy 5-16 Order Lines Shipped per
5-5 Item Master File Accuracy Labor Hour
5-6 On-Time Parts Delivery Percentage 5-17 Shipping Accuracy
5-7 Incoming Components 5-18 Warehouse Order Cycle
Correct Quantity Percentage Time
5-8 Percentage of Receipts 5-19 Inventory Availability Authorized by Purchase Orders 5-20 Delivery Promise Slippage 5-9 Percentage of Purchase 5-21 Average Back Order Length
Orders Released with Full Lead Time 5-22 Dock Door Utilization
5-10 Putaway Accuracy 5-23 Inventory Accuracy
5-11 Putaway Cycle Time 5-24 Inventory Turnover
5-12 Scrap Percentage 5-25 Percentage of Warehouse
Stock Locations Utilized
1The measurements in this chapter are adapted with permission from Chapter 13 of Bragg, Inventory Best Practices, John Wiley & Sons, 2004. The forms and reports in this chapter are adapted with permission from Chapter 4 of Bragg, GAAP Implementation Guide, John Wiley & Sons, 2004.
5-26 Storage Density Percentage 5-31 Obsolete Inventory
5-27 Inventory per Square Foot Percentage
of Storage Space 5-32 Percentage of Inventory
5-28 Storage Cost per Item More Than XX Days Old
5-29 Average Pallet Inventory per SKU 5-33 Percentage of Returnable
5-30 Rate of Change in Inactive, Inventory
Obsolete, and Surplus Inventory
In addition, this chapter contains three forms and seven reports related to the inven- tory function, including inventory tags, inventory sign-out and return forms, a cycle counting report, and an inventory accuracy report. One should consider integrat- ing a selection of these offerings into one’s accounting for and tracking of a cor- porate inventory system.
5-2 Percentage of New Parts Used in New Products
A continuing problem for a company’s logistics staff is the volume of new parts that the engineering department specifies for each new product. This can result in an extraordinary number of parts to keep track of, which entails additional purchasing and materials handling costs. From the perspective of saving costs for the entire company, it makes a great deal of sense to encourage engineers to design products that share components with existing products. This approach leverages new products from the existing workload of the purchasing and materials handling staffs and has the added benefit of avoiding an investment in new parts inventory. For these rea- sons, the percentage of new parts used in new products is an excellent choice of performance measurement.
Divide the number of newparts in a bill of materials by the totalnumber of parts in a bill of materials. Many companies may not include fittings and fasteners in the bill of materials, because they keep large quantities of these items on hand at all times and charge them off to current expenses. If so, the number of parts to include in the calculation will usually decline greatly, making the measurement much eas- ier to complete. The formula is as follows:
Number of new parts in bill of materials
————————————————–—
Total number of parts in bill of materials
Engineers may argue against the use of this measurement on the grounds that it pro- vides a disincentive for them to locate more reliable and/or less expensive parts with which to replace existing components. Although this measure can act as a block to such beneficial activities, a measurement system can avoid this problem by also fo- cusing on long-term declines in the cost of products or increases in the level of qual- ity. A combined set of these measurements can be an effective way to focus on the most appropriate design initiatives by the engineering department.
5-3 Percentage of Existing Parts Reused in New Products The inverse of the preceding measurement can be used to determine the proportion of existing parts that are used in new products. However, as the formula reveals, this measurement is slightly different from an inverse measurement. Companies that have compiled an approved list of parts that are to be used in new product de- signs, which is a subset of all existing parts, use this variation. By concentrating on the use of an approvedparts list in new products, a company can incorporate high- quality, low-cost components into its products.
Divide the number of approved parts in a new product’s bill of materials by the total number of parts in the bill. If there is no approved components list, then the only alternative is to use the set of all existing components from which to select items for the numerator, which will likely result in a higher percentage. The formula is as follows:
Number of approved parts in bill of materials
———————————————————–
Total number of parts in bill of materials
Because a complex product will probably contain one or more subassemblies rather than individual components, one should verify that selected subassemblies are also on the approved parts list; otherwise, subassemblies will be rejected for the purposes of this measurement.
5-4 Bill of Material Accuracy
The engineering department is responsible for the release of a bill of materials for each product that it designs. The bill of materials should specify exactly what com- ponents are needed to build a product, plus the quantities required for each part.
The logistics staff uses this information to ensure that the correct parts are available when the manufacturing process begins. At least a 98% accuracy rating is needed for this measurement in order to manufacture products with a minimum of stoppages caused by missing parts.
To calculate the measurement, divide the number of accurate parts (defined as the correct part number, unit of measure, and quantity) listed in a bill of material by the total number of parts listed in the bill. The formula is as follows:
Number of accurate parts listed in bill of materials
—————————————————————––
Total number of parts listed in bill of materials
Although the minimum acceptable level of accuracy is 98%, this is an area where a 100% accuracy level is required in order to ensure that the production process runs smoothly. Consequently, a great deal of attention should be focused on this measurement.
The timing of the release of the bill of materials is another problem. If an engi- neering staff is late in issuing a proper bill of materials, then the logistics group must scramble to bring in the correct parts in time for the start of the production process.
Measuring the timing of the bill’s release as well as its accuracy can avoid this problem by focusing the engineering staff’s attention on it.
5-5 Item Master File Accuracy
The item master file contains all of the descriptive information about each inventory item, such as its unit of measure and cubic volume. This information must be cor- rect or several downstream materials planning functions will issue incorrect results.
Consequently, one should conduct a periodic audit of the file and report its accu- racy to management.
To calculate the item master file accuracy, conduct an audit of a random sample of all item master records, verifying each field in the selected batch. Then divide the total number of records containing 100% accurate information by the total num- ber of records sampled. The calculation is as follows:
Total number of records reviewed having 100% accurate information
———————————————————————————–—–
Total number of records sampled
An alternative approach is to divide the total number of accurate fields within the records by the total number of fields reviewed. However, this tends to result in an extremely high accuracy percentage, because there are many fields within each record, most of which are probably accurate. Because the point of using the mea- surement is to highlight problem areas, it is best to base the calculation on records reviewed, rather than fields, so that a lower accuracy percentage will be more likely to initiate corrective action by management.
5-6 On-Time Parts Delivery Percentage
One of the key performance measures for rating a supplier is its ability to deliver ordered parts on time, because a late delivery can shut down a production line. Fur- thermore, a long-standing ability to always deliver on time gives a company the ability to reduce the level of safety stock kept on hand to cover potential parts short- ages, which represents a clear reduction in working capital requirements. Conse- quently, the on-time parts delivery percentage is crucial to the logistics function.
Subtract the requested arrival date from the actual arrival date. If one’s intent is to develop a measurement that covers multiple deliveries, then one can create an average by summarizing this comparison for all of the deliveries and then dividing by the total number of deliveries. Also, if an order arrives before the requested ar- rival date, the resulting negative number should be converted to a zero for measure- ment purposes; otherwise, it will offset any late deliveries, when there is no benefit to the company of having an early delivery. Because a company must pay for these
early deliveries sooner than expected, they can even be treated as positive variances by stripping away the minus sign. Any of these variations are possible, depending on a company’s perception of the importance of not have early deliveries. The basic formula is as follows:
(Actual arrival date) – (Requested arrival date)
This is an excellent measurement, but it does not address other key aspects of sup- plier performance, such as the quality of the goods delivered or their cost. These additional features can be measured alongside the on-time delivery percentage or melded into an overall rating score for each supplier.
5-7 Incoming Components Correct Quantity Percentage If the quantity of items received in comparison to the amount ordered is too low, then the company may be faced with a parts shortage in its production operation.
If the quantity is too high, then it may find itself with more inventory than it can use. Also, if an odd lot size is received, it may be difficult for the receiving staff to find a location in the warehouse in which to store it. For these reasons, the incom- ing components correct quantity percentage is commonly used.
Divide the number of orders to suppliers for which the correct quantity is deliv- ered by the total quantity of orders delivered. This measurement is commonly sub- divided by supplier, so the performance of each one can be measured. A variation on the formula is to only include in the numerator those orders received for which the entire order amount is shipped; this approach is used by companies that do not want to deal with multiple partial orders from their suppliers because of the in- creased cost of receiving and related paperwork. The formula is as follows:
Quantity of orders with correct parts quantity delivered
———————————————–————————–
Total quantity of orders delivered
The formula can result in a low correct quantity percentage if the quantity received is only off by one unit. This may seem harsh if an order of 10,000 units is incorrect by one unit. Consequently, it is common for companies to consider an order quan- tity to be accurate if the quantity received is within a few percent of the ordered amount. The exact percentage used will vary based on the need for precision and the cost of the components received, although 5% is generally considered to be the maximum allowable variance.
5-8 Percentage of Receipts Authorized by Purchase Orders One of the most difficult tasks for the receiving staff is to decide what to do with orders that are received with no accompanying purchase order. Because the orders are not authorized, the staff could simply reject them. However, they run the risk of
rejecting some item that may have been bought on a priority basis and that will cause undue trouble for the logistics manager when projects in other parts of the com- pany are held up. Accordingly, these orders are often set to one side for a few hours or days, while the receiving staff tries to find out who ordered them. This can be a significant waste of receiving time and storage space and is worth measuring on a trend line to see if the problem is worsening.
The receiving department should maintain a receiving log, on each line of which is recorded the receipt of a single product within an order. Using the line items in the receiving log that correspond to the dates within the measurement period, sum- marize the number of receipt line items authorized by open purchase orders by the total number of receipt line items in the log. The formula is as follows:
Receipt line items authorized by open purchase orders
———————————————————–————
Total receipt line items
This is an excellent measurement, because the use of purchase orders is one of the best controls over unauthorized buying, and the measurement clearly shows the extent of control problems in this area. However, it does not include other types of purchases that never run through the receiving area, such as services, subscriptions, or recurring lease payments. These other types of costs can constitute the majority of all nonpayroll costs in services industries; consequently, the measurement is of most use in businesses dealing in tangible goods.
5-9 Percentage of Purchase Orders Released with Full Lead Time If the purchasing department is not preparing purchase orders on time, they will be forcing suppliers to deliver in less than standard lead times or incur expensive overnight air freight to bring items in on time. This may be a problem with an in- efficient purchasing staff or be caused by sudden near-term changes in the produc- tion schedule. Whatever the reason may be, one should track the proportion of purchase orders released with full lead time and investigate those that are not.
To calculate the proportion of purchase orders released with full lead times, have the computer system summarize all purchase order lines in the measurement period for which there were full lead times, and divide this by the total number of purchase order lines released during the period. The calculation is as follows:
Purchase order lines released with full lead time
———————————————————––
Total purchase order lines released
Given the quantity of purchase order lines involved, the summarization of data almost certainly will require a report from the computer system—manual summa- rization is notrecommended! One should also use an additional report that itemizes each order line released with less than the full lead time, so that management can investigate the problem.
This measurement is not intended to apply in cases where a company orders standard parts for its manufacturing processes through the use of rolling schedules or just-in-time systems. In these instances, there should be no purchase orders at all.
5-10 Putaway Accuracy
The ability of the receiving staff to put received items away into stock locations correctly, including the proper recording of the transaction, is critical to all subse- quent inventory transactions. If a putaway is done incorrectly, it is difficult to find an item, or verify that an incorrect part number or quantity has been used. An in- correct putaway also impacts the materials planning staff, which now has incorrect information about how much stock is on hand.
The basic putaway issue can be quantified with the putaway accuracy measure- ment. To calculate it, divide the total number of putaway transactions during the measurement period into the number of items for which an accurate putaway trans- action was recorded. The formula is as follows:
Number of accurate putaway transactions
————————–————————–
Total number of putaway transactions
From a practical perspective, it is usually easier to determine the number of incor- rect putaways than the number of correct ones, so the numerator can be modified to be the total number of putaway transactions, less the number of putaway errors.
This percentage is most easily calculated by periodically testing a sample of all in- ventory items.
This measurement should be clearly posted for the warehouse staff to read, thereby reinforcing the importance of a correct putaway. One should also include this measurement in the performance reviews of the warehouse staff, for the same reason.
5-11 Putaway Cycle Time
The accuracy of a putaway, as noted in the last measurement, is certainly important, but can take so long that it impacts the ability of a company to turn around items for shipment to customers or delivery to the shop floor. Consequently, one must also track the average putaway cycle time to ensure that this is being done in as short a period as possible. It is best to report the putaway cycle time and putaway accuracy measurements together in order to obtain an overall picture of the putaway function.
To measure putaway cycle time, subtract the arrival time of each receipt from its putaway time, summarize this information for all receipts during the measurement period, and divide it by the total number of receipts in the period. The calculation is as follows:
Sum for all receiving transactions [(Putaway date/time) – (Receipt date/time)]
————————————————————————————————
Number of receipts during the measurement period
Given the large number of receiving transactions for all but the smallest warehouses, this measurement is best calculated via the materials management database. Also, because the measurement is based on the timeof receipt and putaway (i.e., the number of minutes and seconds elapsed between these two events), the only way to obtain accurate transaction stamping is to use online, real-time data entry, which calls for the use of portable terminals linked to the materials management database.
If this data collection system is not available, the measurement should not be used.
Another problem is the likely presence at the end of each measurement period of receipts that have not yet been put away. If one ignores these transactions for purposes of calculating the measurement, the average putaway cycle time will al- most certainly be too low, because the items causing putaway problems are not being included. A better approach is to either delay the calculation until the unfin- ished transactions are completed or revise the calculation a month later when the next periodic measurement is made.
5-12 Scrap Percentage
The amount of scrap generated by a production operation is of great concern to the production manager, because it can indicate several problems: poor training of the direct labor work force, improper machine setup, materials handling problems, or even the ordering of substandard raw materials. Another reason for keeping a close watch over the scrap percentage is that inordinate amounts of scrap may require extensive revisions to the production schedule in order to produce extra goods, which in turn will require short-term changes to the purchasing schedule in order to bring in the required raw materials. For these reasons, the scrap percentage is one of the most closely watched performance measurements in the factory.
The amount of scrap that a company produces is difficult to measure, because it can be produced in many parts of a facility and in many cases is not accumulated for measurement purposes. If this is the case, the best approach is to subtract the standard cost of goods sold from the actual cost of goods sold, and divide the result by the standard cost of goods sold. By using this approach, one can compare the ag- gregate cost of what was produced to what should have been produced, without hav- ing to resort to a detailed count of each item scrapped. The formula is as follows:
(Actual cost of goods sold) – (Standard cost of goods sold)
—————————————————————————–
Standard cost of goods sold
A variation on this formula is to track only the scrap generated by the bottle- neck production operation. This is especially important, because the scrap lost through this operation must be manufactured again, which may interfere with the production of other goods that must pass through the same operation, thereby pos- sibly reducing the total amount of gross margin generated by the factory.
There are several problems with comparing the actual cost of goods sold to the standard amount and assuming that the difference is scrap. One problem is that