Module 02 - Section 12 Inventory Carrying Costs Calculations.
Day 1 Simulation
Carrying cost is a measure usually expressed as a percentage of the cost to hold inventory.
Simply put, inventory that sits in the plant has a cost associated to it.
This cost is a result of:
Course notes, Lean 101, Module 2 Section 12
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What happens yearly at every company is they give a yearly inventory count.
Course notes, Lean 101, Module 2 Section 12
[Link]
Let us assume that the bank uses a bank for financing.
The bank calculates what it needs to charge on interest on the overall annual inventory tied up by the
company. In order to count the amount of physical inventory, they make the count happen.
That is they count material or physical inventory between machines, processes, or activities waiting to be
processed. The assumption is that the amount of inventory does not fluctuate high or low. As long as this
system remains the same, this count is a valid measure with which to determine your monthly average.
The bank charges 24% interest per year on the carrying costs for your inventory.
This means it charges 2% per month.
Course notes, Lean 101, Module 2 Section 12
[Link]
We calculate the carrying cost by multiplying the inventory value by 2%
So at the end of day 1, we stop after 8 hours of work.
At this point we ask ourselves, what if that were the amount of the inventory at the end of the month. We
assume that this is true.
And our count becomes the amount we use to represent the physical inventory at the end of the month.
For example, $ might have been $250,000.00 worth of inventory. Multiply that by 2% and our inventory
costs become $5000.00 per month. So in some ways that 2% is the cost of borrowing money from the
bank.
Course notes, Lean 101, Module 2 Section 12
[Link]
Lets take a look now at the inventory carrying costs for Sky View operations. This table shows all our
inventory carrying cost calculations. That is for Work in Progress.
Our first step is to calculate the amount of inventory between WS 1 & 2. There are more now because we
have completed the last two hours of our work day. Once again we count all of the finished assemblies in
WS 1 and in the queue of WS 2.
As we said then each Lego piece in our assembly has a cost.
The pin cost remains the same as in the earlier calculations. We calculate the cost of assemblies in the
same fashion as in the scrap table. Thus, in this example the total cost for the 16 pin assemblies is
$940,000.00. For the 8 pin assemblies the cost is $775,000.00 and for the 4 pin assemblies,
$108,000.00 giving a total inventory cost for stock between WS1 to WS 6 of $1,823,000.00. At 2% per
month, this works out to be $36,460.00 per month. This means that the manner that we are doing
business on day one costs our company $36,460.00 per month for the inventory carrying costs. It will be
our goal to reduce the amount of inventory that sits between our Work Stations. This in turn will bring our
costs down. If you wish, study this table for a moment before leaving this section.
Course notes, Lean 101, Module 2 Section 12
[Link]
Course notes, Lean 101, Module 2 Section 12
[Link]