Inventory control

Operation Research, Inventory control, EOQ, ABC analysis

1. Operation research Inventory Control Introduction Holding cost or Carrying cost Derive : Economic order quantity (EOQ) Example ABC Analysis

2. Introduction Inventory control The term is generally used to indicate raw material, work-in-progress (intermediate good), finished goods, packaging material and other stock Inventory Decisions The following are the decisions made for every item of inventory. i )  How much amount of an item should be ordered when the inventory of that item is to be restored. ii)  When to restore the inventory of that item

3. Holding cost or Carrying cost Costs associated with carrying or holding goods in stock is known as carrying or holding cost which is denoted by C h  per unit of goods for a unit of time, respectively. However cost is assumed to be varying directly the size of inventory as well as the time for which the item is in stock.

4. The following components constitute the holding cost. i )    Invested capital costs (Interest charged on capital investment) ii)   Record keeping and administrative costs iii)  Handling cost: - It includes all costs associated with movement of stock such as cost of labour , overhead and other machinery required for this purpose. iv)   Storage cost: -  This involves the rent of storage space or depreciation in interest even if own space is used. v)   Depreciation, deterioration or obsolescence cost: -  Such cost is due to the item in stock being out of fashion or the item undergoes chemical changes during storage (e.g. rusting of iron), breakage and spoilage. vi)    Insurance cost Carrying cost= (Cost of carrying one unit of item) x (Average number of units carried)

5. Economic order quantity (EOQ) Definition and explanation Economic order quantity (EOQ) is the order size that minimizes the sum of ordering and holding costs related to raw materials or merchandise inventories. In other words, it is the optimal inventory size that should be ordered with the supplier to minimize the total annual inventory cost of the business. Other names used for economic order quantity are optimal order size and optimal order quantity.

6. The ordering and holding costs The two significant factors that are considered while determining the economic order quantity (EOQ) for any business are the  ordering costs  and the  holding costs .

7. A brief explanation of both the costs is given below: Ordering costs The ordering costs are the costs that are incurred every time an order for inventory is placed with the supplier. Examples of these costs include telephone charges, delivery charges, invoice verification expenses and payment processing expenses etc. The total ordering cost usually varies according to the frequency of placing orders. Mostly, it is directly proportional to the number of orders placed during the year which means If the number of orders placed during the year increases, the annual ordering cost will also increase.

8. Holding costs The holding costs (also known as carrying costs) are the costs that are incurred to hold the inventory in a store or warehouse. Examples of costs associated with holding of inventory include occupancy of storage space, rent, shrinkage, deterioration, obsolescence, insurance and property tax etc. The total holding cost usually depends upon the size of the order placed for inventory. Mostly, the larger the order size, the higher the annual holding cost and vice versa. The total holding cost is some time expressed as a percentage of total investment in inventory.

9. Question : Derive Equation Of EOQ The economic order quantity is the level of quantity at which the combined ordering and holding cost is at the minimum level. Relation between the ordering and holding cost: There is an inverse relationship between ordering cost and holding cost. Keeping the annual demand constant if for example the number of orders decreases, the ordering cost will also decrease but the holding cost will rise and vice versa.

10. At EOQ POINT Both cost are equal ( D/Q ) Co = ( Q/2 ) Ch Q 2 = (2DCo ) / Ch Where, D = Demand per year Co = Cost per order Ch = Cost of holding per unit of inventory

11. Total annual Carrying cost = (Average Inventory) * (Carrying cost/unit/year) = (Q/2) * Co Total annual Ordering Cost = (Optimal number of orders in a year) * (Ordering cost/order) = (D/Q) * Ch Minimum Total annual Variable Cost = TVC = = Total annual Ordering Cost + Total annual carrying cost = (Q/2) * Co + (D/Q) * Ch Cost of Material Per year = Annual Demand * Price of Material = D*C

12. Total Cost TC = DC + TVC

13. Example: 1 The material is used uniformly throughout the year. The data about annual requirement, ordering cost and holding cost of this material is given below: Annual requirement: 2,400 units Ordering cost: $10 per order Holding cost: $0.30 per unit Determine The economic order quantity (EOQ) of material, Number of orders per year, Reorder cycle time, Combined ordering and holding cost,

14. Solution EOQ =

15. N=D/EOQ Where N=Number of orders per year N= Annual demand/EOQ N= 2,400 units/400 units N= 6 orders per year Reorder cycle time t = EOQ/D =400/ 2400= (1/6) year = 12months/6 = 2 Months Ordering cost Co = Number or orders per year × Cost per order = 6 orders  × $10 = $60

16. Holding cost = Average units × Holding cost per unit = (400/2) × 0.3 = $60 Combined ordering and holding cost at economic order quantity (EOQ): = Ordering cost + Holding cost = $60 + $60 = $120 Notice that both ordering cost and holding cost are $60 at economic order quantity. The holding cost and ordering cost at EOQ tend to be the same.

17. Example: 2  A company uses 3000 units of a product, its carrying cost is 30%of average inventory. Ordering cost is Rs. 100 per order. Unit cost is Rs. 20. Calculate EOQ and the total cost. Solution D = Total Demand=3000 units C h  = carrying cost =30% of Rs. 20=Rs.6 C o  = Ordering cost =Rs.100

18. Optimum lot size is EOQ =   The total cost is equal to Total cost = Material cost + Total variable cost =DC + TVC     = Rs. 61897 .36

19. The production department for a company requires 3600kg.of row material for manufacturing a particular item per year. It has been estimated that the cost of placing an order is Rs.36& the cost of carrying inventory is 25 percentage of the investment in the inventories. The price is Rs.10 per kg. The purchase manager wishes to determine an ordering policy for raw material. Calculate The optimal lot size , EOQ The optimal order cycle time The minimum yearly variable inventory cost The minimum yearly total inventory cost Example: 3

20. Question : Discuss ABC Analysis

21. Classification of Inventory in ABC analysis