Inventory Management 4-EconomicOrderQnty

In this presentation, we will be exploring a critical component of inventory management—Economic Order Quantity, or EOQ. As organizations aim to optimize their operations and reduce costs, inventory management becomes a key area of focus.

EOQ is a vital tool that helps businesses determine the ideal order quantity to minimize total inventory costs, including ordering and holding expenses. In this presentation, we’ll delve into how EOQ works, its underlying principles, and the significant impact it can have on maintaining a balance between having too much or too little stock.

By the end of this session, you'll gain a clearer understanding of how to apply EOQ in real-world scenarios to enhance operational efficiency and cost-effectiveness. Let’s get started!

1. INVENTORY MANAGEMENT
Session 4
Inventory Levels
Inventory Turnover
Ratio Calculation
EOQ –Economic Order Quantity
Logistics & SCM -Introduction

2. TYPES OF INVENTORY LEVELS
oMinimum Level
Minimum Level of Inventory = Re-order Level –(Average Usage x Average Lead Time)
oMaximum Level
Maximum Level of Inventory = Re-order Level x Reordering Quantity –(Minimum Consumption x Minimum Re-
ordering Period)
oAverage Stock Level
Average Stock Level = Minimum Stock Level + ½ of Re-order Quantity
oDanger Level
Danger Level of Inventory = Average Consumption x Maximum Re-order period for emergency purchases
oRe-ordering Level
Re-order Level or Ordering Level = Maximum Rate of Consumption x Maximum Re-order Period
oDay Sales Inventory
(Average Inventory / Cost of goods sold) x 365

3. oInventorycostsencompassalltheexpensesassociatedwithordering,holding,andmanagingtheinventory
orstocklevelsofaproduct-basedbusiness.Totalinventorycostsarefrequentlybrokendownintothree
distinctcategories:orderingcosts,carryingcosts,andstockoutcosts.
Definition
oInventoryturnoveristheratethatinventorystockissold,orused,andreplaced.Theinventory
turnoverratioiscalculatedbydividingthecostofgoodssoldbyaverageinventoryforthesame
period.Ahigherratiotendstopointtostrongsalesandaloweronetoweaksales.
INVENTORY COST
Advantages
oCalculatingandtrackinginventoryturnoverhelpsbusinessesmakesmarterdecisionsinavarietyofareas,
includingpricing,manufacturing,marketing,purchasingandwarehousemanagement.
oTheinventoryturnoverratiomeasureshowwellthecompanygeneratessalesfromitsstock.NumberofKPIs
thatcanprovideinsightsintohowtoincreasesalesorimprovethemarketabilityofcertainstockorthe
overallinventorymix.
INVENTORY TURNOVER RATIO

4. Theinventoryturnoverratioisthenumberoftimesacompanyhassoldandreplenisheditsinventoryovera
specificamountoftime.Theformulacanalsobeusedtocalculatethenumberofdaysitwilltaketosellthe
inventoryonhand.
Theturnoverratioisderivedfromamathematicalcalculation,wherethecostofgoodssoldisdividedbythe
averageinventoryforthesameperiod.Ahigherratioismoredesirablethanalowoneasahighratiotendsto
pointtostrongsales.
Knowingtheturnoverratiodependsoneffectiveinventorycontrol,i.e.,stockcontrol,wherethecompanyhas
goodinsightintowhatithasonhand.
CALCULATION

5. How to Calculate Inventory Turnover Ratio (ITR) ?
Companies can calculate inventory turnover. This standard method includes either market sales information or the
cost of goods sold (COGS) divided by the inventory.
Start by calculating the average inventory in a period by dividing the sum of the beginning and ending inventory by
two:
Average inventory =(beginning inventory+ending inventory)/2
You can use ending stock in place of average inventory if the business does not have seasonal fluctuations. More
data points are better, though, so divide the monthly inventory by 12 and use the annual average inventory. Then
apply the formula for inventory turnover:
Inventory Turnover Ratio =Cost of Goods Sold/Avg. Inventory
Inventory Turnover Formula and Calculations
Whatever inventory turnover formula works best for your company, you will need to draw data from the balance
sheet, so it’s important to understand what these terms and numbers represent.
Cost of Goods Sold (COGS)
Cost of goods sold, aka COGS, is the direct costs of producing goods (including raw materials) to be sold by the
company.
Average Inventory (AI)
Average inventory smooths out the amount of inventory on hand over two or more specified time periods.
Beginning Inventory+ending inventory/number of months in the accounting period
Inventory Turnover Ratio
The inventory turnover ratio is a measure of how many times the inventory is sold and replaced over a given
period.

6. EconomicOrderQuantity,alsoknownasFinancialPurchaseQuantityorEconomicBuyingQuantity,istheorder
quantitythatminimizesthetotalholdingcostsandorderingcostsininventorymanagement.Itisoneoftheoldest
classicalproductionschedulingmodels.
TheEOQformulaisasfollows.
EOQ=Squarerootof[(2xdemandxorderingcost)/carryingcost]Demand.
ThedemandremainsconstantaccordingtotheassumptionsmadebyEOQ.Thedemandishowmuchinventoryis
usedperyearorhowmanyunitsaresold
ECONOMIC ORDER QUANTITY

7. Annual requirement = 48,000 units
Ordering cost = $9 per order
Carrying cost = 15% of per-unit cost
Per unit cost = $4 per unit
*Where Annual Requirement (AR) refers to Demand
Case:
TheJohnEquipmentCompanyestimatesitscarryingcost
at15%anditsorderingcostat$9perorder.Theestimated
annualrequirementis48,000unitsatapriceof$4per
unit.
Required:
oWhatisthemosteconomicalnumberofunitstoorder?
oHowmanyordersshouldbeplacedinayear?
oHowoftenshouldanorderbeplaced?
1. What is the most economical number of units to
order?

8. 2. How many orders should be placed in a year?
= Annual requirement / EOQ
= 48,000 units / 1,200 units
= 40 orders
3. How often should an order be placed?
Frequency of orders = No. of days in one year / No. of
orders
= 360 days / 40 orders
= 9 days

9. LOGISTICS & SUPPLY CHAIN
SEVEN R s
Right Product
Right Quantity
Right Condition / Quality
Right Place
Right Time
Right Customer
Right Price
Logistics Strategies
Postponement
Consolidation
Standardisation
Differentiation
Customisation
Sorting
Assortment
SCM Flow
Products
Money
Information
Technology
Logistics Process /
Flow
Inbound
In process
Outbound
Reverse
Product Flow –movement within
production / warehouse
Simple Flow
Medium Flow
Complex Flow
Product Rotation –how fast the
product moves out of the warehouse
High Rotation
Medium Rotation
Low Rotation

10. GREEN LOGISTICS & / SUSTAINABLE SCM
Procurement –mishandling, spillage
Transport –re use of outdated containers, use of electric vehicles, avoid rash driving, use drone deliveries
W/H , Storage –regular service of material handling equipment, prior training to operators,
decentralised warehouses, evacuation of unsold goods
Manufacturing –avoid over stocking, mishandling, spillage. Re use scrap, regular service of machines, switch
off all electricals & machines when not in use
Packaging –avoid plastic, stick to consolidation and assortment