Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html

Inventory Management

Inventory is the stock of any item or resource used in an organization

raw materials

finished products

work-in-process

An inventory system is the set of policies and controls that monitor levels of inventory and determines

what levels should be maintained, when stock should be replenished, and how large orders should be.

Purpose of holding inventory

To maintain independence of operations

To meet variations in product demand

To allow flexibility in production scheduling

To provide a safeguard for variation in raw material delivery time

To take advantage of economic purchase-order size and discounts

To take advantage of currency flections(trends)

Important to control the processes of purchasing, storing and issuing.

Questions in inventory system

What to order?

How many to order?

When to order?

Timing is a critical issue!

Inventory Cost

Ordering costs.

o Costs of someone placing an order, etc.

Setup (or production change) costs.

o Costs for arranging specific equipment setups, etc.

Holding (or carrying) costs.

o Costs for storage, handling, insurance, etc.

Shortage costs.

o Costs of lost sales, emergency procurement, etc.

Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html

Different stock levels

To avoid holding unnecessary stocks, thus avoiding the loss of profits due to increased holdings

costs

To avoid the risk of a stock out by storing enough material to facilitate the smooth flow of

production

To achieve theses ends, various stock levels are calculated,

Re-order level - Level of inventory at which the next order should be placed

Inventory should be sufficient to cover the usage of material during the time lag from the day

the order is placed to the day when goods arrive at warehouse.

However the actual re-order level will depend on the past experience of the organization and

their attitude to risk

𝑅𝑒 − 𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙

= 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑 ∗ (𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑟𝑒 − 𝑜𝑟𝑑𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑)

Minimum stock level/ Buffer stocks - Level below which inventories should not fall

This is held to prevent the risk of a “stock out”

May be used in emergencies.

𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑠𝑡𝑜𝑐𝑘 𝑙𝑒𝑣𝑒𝑙

= 𝑅𝑒 − 𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 – (𝑛𝑜𝑟𝑚𝑎𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛) ∗ (𝑛𝑜𝑟𝑚𝑎𝑙 𝑟𝑒 − 𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙)

Maximum Stock level

𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑠𝑡𝑜𝑐𝑘 𝑙𝑒𝑣𝑒𝑙 = 𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑙𝑒𝑣𝑒𝑙 – 𝑚𝑖𝑛𝑖𝑚𝑢𝑚 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑑𝑢𝑟𝑖𝑛𝑔 𝑝𝑒𝑟𝑖𝑜𝑑 ∗

𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑟𝑒𝑜𝑟𝑑𝑒𝑟 𝑝𝑒𝑟𝑖𝑜𝑑 + 𝐸𝑂𝑄 𝑬𝒄𝒐𝒏𝒐𝒎𝒊𝒄 𝒐𝒓𝒅𝒆𝒓 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚

Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html

EOQ Model

Assumptions

Demand for the product is constant and uniform throughout the period

Lead time (time from ordering to receipt) is constant

Price per unit of product is constant

Inventory holding cost is based on average inventory.

Ordering or setup costs are constant.

All demands for the product will be satisfied (No back orders are allowed)

Formula

Cost Minimization Goal(T-total)

Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html

Deriving the EOQ

Using calculus, we take the first derivative of the total cost function with respect to Q, and set the

derivative (slope) equal to zero, solving for the optimized (cost minimized) value of QOPT

𝑄𝑂𝑃𝑇 = 2𝐷𝑆

𝐻=

2 𝑥 𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑 𝑥 𝑂𝑟𝑑𝑒𝑟 𝑜𝑟 𝑆𝑒𝑡𝑢𝑝 𝐶𝑜𝑠𝑡

𝐴𝑛𝑛𝑢𝑎𝑙 𝐻𝑜𝑙𝑖𝑛𝑔 𝐶𝑜𝑠𝑡

Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html

EOQ with consumption during production

Here is some questions with answers on EOQ Model

Valuation of inventory

FIFO (First In First Out method)

Material issues are priced in strict chronological order of the purchase prices.

This follows the physical flow of goods. Actual cost of material is used to price issues.

LIFO (Last In First Out method)

Issues are made at the prices of the last receipts, until all the material received at the price has

been issued. The next issue is made at the next last price, and so on

This Example show how it happens

Full note set with Examples and Questions: http://www.executioncycle.lkblog.com/2012/06/my-business-economics-and-financial.html

External Reporting

FIFO

o In an inflationary situation, this method will lead to lower cost of sales and thus a higher

profit figure.

o The value of stocks will reflect the latest market prices. Because of this, stocks are valued at

higher prices.

LIFO

o LIFO will charge the latest and highest prices to the cost of sales, thus lowering the profit

figure.

o The stock values will reflect earlier prices and therefore will be lower.