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8. Lecture 8 - Inventory Control & Management

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Shahriar Alam Abir
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4 views

8. Lecture 8 - Inventory Control & Management

Uploaded by

Shahriar Alam Abir
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Lecture 8

Inventory Control & Management


Costs of High & Low Inventory Levels
Inventory is a major investment for many entities.
Entities carry 3-6 month’s inventory depending on
sources of inventory collection and the relative power
of Suppliers. Therefore, it is essential to reduce the
levels of inventory held to the necessary minimum.
Costs of High Inventory Levels are:
 Once goods are purchased, capital is tied up in them
and until sold on, the capital earns no return. This lost
return is an opportunity cost of holding the inventory
 Holding Cost of Inventory; such as storage cost, store
administration, risk of theft/damage/ obsolescence.
Costs of Low Inventory Levels:
 Stockouts: If a business runs out of a particular
product used in manufacturing it may cause
interruptions to the production process – causing
idle time, stockpiling of WIP or possibly missed
orders.
 Running out of finished goods or inventory can
result in dissatisfied customers and perhaps future
lost orders.
 High re-order and setup cost
 Low Quantity Discount: Purchasing items in bulk
often attract a discount from the supplier. If only
small amounts are bought the quantity discounts
will not be available.
Objectives of Good Inventory Management

• The Optimum Re-order Level: How many


items should be left in inventory when the
next order is placed, and
• The optimum re-order quantity: How many
items should be ordered when the order is
placed.
Therefore, the main objective is striking a
balance between holding costs on the one
hand and stock-out and re-order costs on the
other.
Terminology of Inventory Management
• Lead Time: The lag between when an order is
placed and the item is delivered.
• Buffer Inventory: The basic level of inventory
kept for emergencies. A buffer is required
because both demand and lead time will
fluctuate and predictions can only be based on
best estimates.
Economic Order Quantity (EOQ)
The aim of the EOQ Model is to minimize the total cost of
holding and ordering inventory.
The EOQ can be found using a formula:
Where,
Co = Cost Per Order
D = Annual Demand
CH = Cost of Holding one unit for one year
Following assumptions are made:
• Demand and Lead time are constant and known
• Purchase price is constant
• No buffer inventory held as it is assumed that it is not
needed since demand and lead times are known with
certainty.
TYU - 01
Soln
• Holding Cost: The model assumes that it costs a certain amount
to hold a unit of inventory for a year. Therefore, as the average
level of inventory increases, total annual holding cost also
increases.
Because of the assumption that demand per period is known and is
constant, conclusions can be drawn over the average inventory
level in relationship to the order quantity.
Inventory
(Units)
Average Quantity
Order
(x/2)
Quantity

Time
If X is the quantity ordered, the annual holding
cost would be calculated as:
Holding Cost per Unit (CH) x Average Inventory:
CH x
• Ordering Costs: The model assumes that a fixed cost is
incurred every time an order is placed (Co). Therefore, as
the order quantity increases, there is a fall in the number
of orders required, which reduces the total ordering
cost.
If D is the annual expected sales demand, the annual order
cost is calculated as:
Order Cost Per Order x No. of orders per annum.
(Co x ) Annual
Cost

Ordering Cost

Re-order Quantity
• Total Cost: Total costs will always be minimized at the
point where the total holding costs equals the total
ordering costs. This point will be the Economic Order
Quantity.
Annual
Cost Holding
Cost
Total Cost

Ordering Cost

EOQ
Dealing with Quantity Discounts
Discounts may be offered for ordering in large quantities.
Step 1: Calculate the EOQ, ignoring discounts
Step 2: If the EOQ is below the quantity for qualifying the
discount, calculate the total annual inventory cost
arising from using the EOQ.
Step 3: Recalculate total annual inventory cost using the
order size required to just obtain each discount.
Step 4: Compare the cost of Steps 2 & 3 with the saving
from the discount and select the minimum cost
alternative.
Step 5: Repeat for all discount levels.
TYU 02
Soln:
Criticism of EOQ
• It is based on simplifying assumptions, such as
constant and predictable material usage rates.
• It will not indicate the optimal purchase
quantity when there are price discounts for
buying in larger quantities.
• It ignores the problem of managing stock-
outs.
• It is inconsistent with the philosophy of just-
in-time management and Total Quality
Management (TQM).

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