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Inventory Control Model

This document discusses inventory control models and concepts. It defines different types of inventories like raw materials, work-in-progress, and finished goods. It then lists reasons for holding inventory like ensuring supply to meet demand and absorbing fluctuations. It discusses costs associated with inventory like holding, ordering, and stockout costs. It introduces key inventory control concepts and formulas like economic order quantity, reorder level, and cycle time.

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Ann Okoth
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132 views

Inventory Control Model

This document discusses inventory control models and concepts. It defines different types of inventories like raw materials, work-in-progress, and finished goods. It then lists reasons for holding inventory like ensuring supply to meet demand and absorbing fluctuations. It discusses costs associated with inventory like holding, ordering, and stockout costs. It introduces key inventory control concepts and formulas like economic order quantity, reorder level, and cycle time.

Uploaded by

Ann Okoth
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Inventory control model

Types of inventories
Raw materials – materials, components and fuel used in
the manufacture of products
Work-in-progress –partly processed goods and materials
held between manufacturing stages.
Finished goods – completed products ready for sale
The classification of items in each of the categories depend
on the type of firm. For example, milk to a farmer is a
finished product, ready for sale. To a dairy processing
company it is a work in progress waiting to be processed
further. To an yoghurt maker, it is a raw material awaiting
to be used for the manufacture of yoghurt.
Reasons for holding stocks
• Ensure sufficient goods are available to meet expected demand.
• Absorb the variations in demand and production.
• Provide a buffer between production processes.
• Take advantage of bulk purchasing discounts.
• Meet possible shortages of raw materials in the future.
• Absorb seasonal fluctuations in usage or demand.
• Ensure production processes flow smoothly and efficiently
without any interruptions.
• As a necessary part of the production process e.g. fermenting
processes.
• Deliberate investment policy especially in times of inflation.
Other undesirable reasons for holding stock

• Retention of obsolete items.


• Poor or inexistent inventory measures leading
to too large orders.
• Inadequate or inexistent stock records.
• Poor liaison between production, purchasing
and marketing departments.
• Sub-optimal decision making in production
departments.
Costs of stock
• The stock held in an organization is an investment,
whether held intentionally or unintentionally.
• There is need to compare the benefits gained by
holding the stock with the costs of not keeping the
stock.
• There is need to identify all the costs involved
when a firm is holding stocks.
• There are three types of costs: stock holding costs,
costs of acquiring the stock and the stockout costs.
Costs of holding stock/carrying costs
• They are the costs of carrying/keeping the stock in
the firm. They include some or all of the following:
Interest on the capital invested in the stock.
Storage charges- rent, refrigeration for perishable
items, lighting etc.
Stores staffing and running costs.
Costs of stock handling(packaging, loading etc).
Audit and stock taking.
Insurance and security charges.
Deteriorating and obsolescence.
Pilferage, vermin destruction etc.
Costs of obtaining stock/ordering costs

Clerical and administrative costs incurred


during purchasing, accounting and receiving
the ordered stock.
Transport costs.
If goods are manufactured internally, the set-
up costs.
Stock-out costs
• These are costs incurred if the items required are out of
stock. One of the reason why a firm holds stock is to avoid
the stock out costs.
• These costs can include:
Lost contribution/profits through the lost sales when there
is a stock out.
Loss of future sales as customers go elsewhere (i.e.
customers who were loyal are given a chance to find out
what competitors offer and may not come back).
Loss of customers goodwill.
Cost of production stoppages such as idle workers and
machines due to raw materials stock-outs.
Extra costs associated with urgent, often small quantity
replenishments.
Objective of inventory control
• The major objective of inventory control is to
maintain stock levels that would ensure that
the combined costs are minimised. This can be
done by deciding on the best time to order
and the size of the order.
Basic terminologies used in inventory control
• Lead/procurement time: period expressed in days, weeks, months etc
between the time an order is placed and the time the goods are delivered.
• Demand: Amount required by sales or by the production depts per time
period. Eg. We can have demand per week, month etc.
• Economic ordering quantity(EOQ)/economic batch quantity (EBQ): the
order quantity which minimises the balance between stock ordering and
holding costs.
• Buffer stock/minimum stock/safety stock: stock allowance to cover any
errors in forecasting or any delays in getting the stock during the lead time.
• Maximum stock: The maximum desirable stock level used as an indicator to
show when stocks are too high.
• Reorder level: Level of stock at which a new order should be placed. This
depends on the lead time and the demand per time period.
• Reorder quantity: This is the amount of stock to be ordered. It can be
equivalent to the EOQ.
Illustration of stock terminologies

Reorder
100 level=70
90 Maximum
80 Stock=80
70
60 Reorder
50 quantity
40
Lead time
30
5 weeks
20 Minimum
10 stock
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Calculation of the economic order quantity
• As noted earlier, this is the order size that would
ensure that the balance between holding and ordering
costs is minimised.
• In order to calculate the EOQ, some assumptions are
made:
Stock holding costs per time period is known and it is
constant.
There is a known constant ordering cost.
The rate of demand is known.
There is a known, constant price per unit.
Replenishment is done instantly, ie. If you make an
order the entire order is delivered at once.
EOQ formula
• The EOQ can be calculated using a formula given
as:
• EOQ = √(2.Co.D)/Ch)
Where:
Co=ordering cost per order
D=demand per annum
Ch=holding cost per item per annum
example
• A company uses 500,000 kg of a raw material per year.
The purchase cost is 100 per kg. The ordering costs is
1500 shilling per order while the holding cost is 15
percent of the purchase price. Determine the EOQ and
the cycle time.

Co=Kshs. 1500
D= 500,000 kg
Ch= 15% *100=15
EOQ = √(2*1500*500000)/15)=10,000
Cycle time
• This is the time between one order and another. If
the firm makes the items, it is the time between
one production run and another one.
• The formula is given as:
• T*=EOQ/D
• Where:
• D=demand rate per time period
• In our example:
• T*=10,000/500,000=(1/50)*360 days=7.2 days
Example 2
• A television manufacturing company produces its own speakers, which are
used in the production of television sets. The TVs are assembled on a
continuous production line at a rate of 8000 per month, with one speaker
needed per TV. The speakers are produced in batches because they do not
warrant setting up a continuous production line and relatively large
quantities can be produced in a short time. The speakers are therefore
placed in an inventory until they are needed for assembly into TV sets on
the production line. The company is interested in knowing when to
produce a batch of speakers and how many speakers to produce in each
batch.
Costs:
Set-up costs per batch- $12,000
Unit production costs- $10
Holding costs- $0.30
Solution
• Using the formula:
• D=8000
• Co=12,000
• Ch=0.30
• EOQ= √(2*12000*8000)/0.30)=25,298
• T* = 25,298/8000=3.2 months
• The company should produce 25,298 speakers
after every 3.2 months.
EOQ with planned shortages
• EOQ= √[(2.D.Co)/Ch]* √[(P+Ch)/P]
• Where P= shortage cost per unit
• T*=EOQ/D
• Assume in our above example p=1.10
• EOQ = √[2.8000.12000/0.30]* √[1.1+0.30/1.1]
• = 28,540 speakers
• T*=28,540/8000=3.6 months

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