Inventory Management

Definition of Inventory

Tangible property owned by a company which is held for the purposes of sale in ordinary course of business.

Why do businesses carry inventory?

Avail supplier discount To stabilize employment To avoid stock out Anticipatory demand Seasonal trends

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Inventory Types

Classifications of Inventory

Raw Material (RM) Work in Process (WIP) Finished Goods (FG)

Components of Inventory Cost

Raw Material Labor Factory Overheads

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Branches of Inventory Management

Inventory Control

When to purchase How much to purchase

Inventory Control Techniques

Periodic Review

Also known as fixed time models. When to purchase remains constant and how much to purchase varies.

Continuous Review

When to purchase varies and how much to purchase is constant.

Integrated Models

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Answers both questions simultaneously

Inventory Control

Continuous Review

Economic Order Quantity (EOQ) Assumptions of EOQ

Demand is deterministic and constant(determined with certainty) Where, C3 = Cost per order Carrying cost and ordering cost is known C1 = Holding Cost per unit No Stock out costs D = Demand Instantaneous receipt of goods Purchase Price is constant

Formula

EOQ =

2 C3 D

C1

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Inventory Control

Continuous Review (cont.)

Examples of Costs

Holding Cost (C1)

OC Qty

HC

Interest Insurance Obsolescence Warehousing Costs

EOQ

Ordering Costs (C3)

Purchase Order Phone Bank Charges Documentation

Cost

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Question

Demand = 2500 Units Ordering Cost = Rs. 20 per order Carrying Cost = 30% of Unit P.Price of Rs. 6 per unit Find out EOQ and Total Cost Answers. EOQ = 235.7 or 236 units. TC = 424.26
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Answer - Working

EOQ = 2 (20) (2500) (6 x 0.30) EOQ = 235.7 or 236 units Annual Variable or Total Cost

Total Ordering Cost + Total Holding Cost (No. of Orders x C3) + (Avg. Inv x C1) ((D / EOQ) x C3) + ((EOQ / 2) x C1) ((2500 / 235.7) x 20) + ((235.7 / 2) x 1.8) 212.13 + 212.13 = 424.26

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Decision Making in Inventory Question

If we reduce our average inventory by 20% we will free up our cash. What is the minimum rate of return that we have to invest the excess cash to justify the reduction in the average inventory?

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Decision Making in Inventory Answer

Average Inventory is reduced by 20% Avg. Inv = 236 / 2 = 118

118 x 0.8 = 94 units (reduction of 24 units) OQ = 94 x 2 = 188 units ((D / OQ) x C3) + ((OQ / 2) x 1.8) ((2500 / 188) x 20) + ((188 / 2 x 1.8)\ 265.96 + 169.2 = Rs. 435.16 Increase in cost = 435.16 424.26 = Rs. 10.90 from switching to OQ from EOQ Decrease in investment in inventory = Rs.6 x 24 = Rs.144

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Problems
Q.1) Clean Air company is a distributor of air filter to retail stores. It buys its filters from several manufacturers. Filters are ordered in lot sizes of 1,000, and each order costs Rs 40 to place. Demand from retails stores is Rs 20,000 filters per month, and carrying cost is Rs 0.10 a filter per month.

What is the optimal order quantity with respect to so many lot sizes (that is, what multiple of 1,000 units should be ordered)?

What would be the optimal order quantity if the carrying cost were cut in half to Rs 0.05 a filter per month? would be the optimal order quantity

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