inventory management fin 301

8/7/2019 Inventory Management FIN 301

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MANAGEMENT OF STOCK /

INVENTORY


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Management of Stock

Almost every company carries stocks of some sort, even

if they are only stocks of consumables such asstationery. For a manufacturing business, stocks (or

inventories), in the form of raw materials, work in

progress, and finished goods, may amount to a

substantial proportion of the total assets of the business.


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Types of inventory costs Carrying or holding costs storage and

handling costs, insurance, property taxes,depreciation, and obsolescence.

Ordering costs cost of placing orders,shipping, delivery and handling costs.

Costs of running short loss of sales orcustomer goodwill, extra cost of emergencystock, and cost of lost production and sales in astock-out.

Reducing the average amount of inventorygenerally reduces carrying costs, increasesordering costs, and may increase the costsof running short.


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Some businesses attempt to control stocks on a scientific

basis by balancing the cost of stock shortages against cost

carrying or holding stock. The scientific control of stocks

may be analyzed into three parts:

a) The Economic Order Quantity (EOQ) model can be used

to decide the optimum order size for stocks which will

minimize the costs of ordering stocks plus stockholding

costs.

b) If discounts for bulk purchases are available, it may be

cheaper to buy stocks in large order sizes so as to obtain

the discounts.c) Uncertainty in the demand for stocks and / or the supply

lead time may force a company to decide to hold buffer or

safety stocks in order to reduce or eliminate the risk of

running out of stocks


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The Economic Order Quantity (EOQ)

EOQ is the optimal ordering quantity for an item of stock which will

minimize costs.

Where, D = Usage in Units for one period (the demand)

Co = Cost of placing an order

CH = Holding cost or carrying cost per unit of stock for one

period

Q = Reorder Quantity

The Total Annual Cost of having Stock:

= Holding Cost + Ordering Cost The objective is to

minimize cost and the

EOQ will minimize this

total cost.


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QS: The demand for a commodity is 40,000 units a year,

at a steady rate. It cost TK20 to place an order, and 40

paisa to hold a unit of stock for a year. Find

(i) order size to minimize stock costs (ii) the number of

orders placed each year (iii) the length of stock cycle

and (iv) the annual cost of EOQ?.

SOLUTION: (i)


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= 2000 units (this is the order size that will minimize stock costs)

ii) The number of orders placed each year would be

40,000=------------------------ = 20 times orders placed each year.

2,000

iii) The stock cycle would be once every: 52 weeks / 20 = 2.6 weeks

(each order will be placed every 2.6 weeks)

Where, D = Usage in Units for one period (the demand)=40,000Co = Cost of placing an order= taka 20

CH = Holding cost per unit of stock for one period= 0.40


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Total Costs will be:

iv) Total cost of having stock = Holding Cost + Ordering Cost

Where, D = Usage in Units for one period (the demand)=40,000

Co = Cost of placing an order= taka 20

CH = Holding cost per unit of stock for one period= 0.40

Q =Re-order quantity = 2000 units (EOQ)


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Re-order Point: The problem of how much to order can be solved by

determining EOQ that minimizes total cost. But Re-order Point, is

the inventory level at which order should be placed to replenish

the inventory. To determine re-order point, under certainty, weshould know:

a) Lead time b) Average usage of inventory and c) EOQ

Lead time is the time normally taken to replenish inventory after the

order has been place. By certainty, we mean that, average usageand Lead time do not fluctuate . Hence, in certainty, re-order point

will be: Re-order Point =Lead time X Average Usage

But in practice, there is uncertainty about the lead time and/or usage

rate. Therefore, firm maintains Safety Stock which acts as a

buffer or cushion to meet contingencies. In such case, Re-order

point will be:

Re-order Point = Safety Stock + Lead time X Average Usage

Average Usage= Demand or Usage of Stock per year / 360 days


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QS: ABC Company has an expected usage of 50,00 units of

certain products during the next year. The cost of

processing an order is taka 20 and the carrying cost per

unit is Tk 0.50 for one year. Lead time on an order is 5days and the company will keep a reserve supply of two

days usage. You are required to calculate: (assume 250

days a year)

a)EOQ (b) The re-order point

SOLUTION

Where, D = Usage in Units for one period (the demand) = 50,000

Co = Cost of placing an order= TK 20

CH = Holding cost per unit of stock for one period= TK 0.50


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Average Usage = 50,000 units / 250 days = 200 units

Re-order Point = Safety Stock + Lead time X Average Usage

= 2 x 200 units+ 5 X200 units= 1400 units


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QS: A company has taka 50 per year carrying cost on

each unit of inventory, an annual usage of 2500 units

and an ordering cost of taka 400 per order. The safety

stock is set at 25% of the EOQ. Lead time is 10 days.Assume 250 days a year.

Find:

(i) order size to minimize stock costs or EOQ (ii) the

number of orders placed each year (iii) the length of

stock cycle and (iv) the annual cost of EOQ and (v)

safety stock (vi) daily or average usage (viii) the reorder

point.

inventory management fin 301

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