ELEMENTS OF ORDERING COST

• TENDERING & PROCESSING COST

• STATIONARY & COMMUNICATION COST

• FOLLOW-UP COSTS

• INWARD RECEIPT & HANDLING COST

• INSPECTION & VERIFICATION COST

• SALARIES & WAGES OF PURCHASERS

ELEMENTS OF INVENTORY CARRYING COST

• INTEREST ON CAPITAL

• INSURANCE & TAX

• STORAGE & HANDLING

• MAITENANCE & PRESERVATION

• DETERIORATION & OBSOLESCENCE

• THEFT & PILFERAGE

• WAREHOUSE RENTAL

• SALARIES & WAGES OF STORES STAFF

100

4 MONTHS 4 4

MAX INV. LEVEL

ANNUAL DEMAND=300

QU

AN

TITY

TOTAL ANNUAL COST

INVETORYCARRYING COST

ORDER QUANTITY

COST

EOQ

ORDERING COST

ECONOMIC ORDER QUANTITY(EOQ)

• ANNUAL DEMAND IN QUANTITY : A

• QUANTITY PER ORDER (ECONOMIC ORDER QUANTITY) : Q

• ORDERING COST or BUYING COST ( COST PER ORDER IN RUPEES ) : B

• INV. CARRYING COST IN RUPEES PER UNIT PER YEAR :

• NO. OF ORDERS PER ANNUM: A/Q

• ANNUAL ORDERING COST: (A /Q ) x B

• AVERAGE INV. CARRIED DURING THE YEAR: (MAX + MIN) / 2

(Q + 0 ) / 2 = Q / 2

• COST OF CARRYING INVENTORY PER YEAR : (Q/2) x C

ECONOMIC ORDER QUANTITY(EOQ)

ANNUAL ORDERING COST = ( A/Q ) . B ANNUAL INV. CARRYING COST =( Q/2 ) . C

AT EOQ POINT: • ORDERING COST = INV. CARRYING COST

( A/Q ) . B = ( Q/2 ) . C

Q X Q = 2 X A X B / C

• Q = √ ( 2A . B / C )

• ‘Q’ IS THE ECONOMIC ORDER QUANTITY

PROBLEM

• ZEN BICYCLE LTD. SOURCES 3000 SEAT COVERS FOR ITS BICYCLES FROM OUTSIDE SUPPLIER.

• ORDERING COST IS Rs 10 PER ORDER

• INV. CARRYING COST PER UNIT PER YEAR IS Rs. 6

• COMPANY HAS 300 WORKING DAYS

• FIND:

• EOQ

• NO. OF ORDERS PER YEAR

• TOTAL INVENTORY COST

• NO. OF INVENTORY CYCLES IN A YEAR

• DURATION OF INV. CYCLE

SOLUTION

• EOQ: Q = √( 2A. B / C )

= √( 2 X 3000 X 10 / 6 )

= 100

• Q = 100 UNITS

• NO. OF ORDERS PER YEAR:

• 3000 / 100 = 30

• ANNUAL ORDERING COST = 30 X 10 = Rs 300

• AV. INV. PER CYCLE= ( 100 X 6 ) / 2 = Rs 300

• TOTAL COST = Rs 300 + Rs 300 = Rs 600

• NO OF INV CYCLE PER YEAR (300 WORKING DAYS) =30

• DURATION OF EACH CYCLE = 300 / 30 = 10 DAYS

PROBLEM

• YANTRA INDIA IS A SUPPLIER OF SPEEDOMETERS TO SPEED AUTO LTD. –MANUFACTURERS OF 60 cc TWO-WHEELER.

• IT SUPPLIES 20000 SPEEDOMETERS TO SPEED AUTO PER ANNUM.• ORDERING COST PER ORDER FOR SPEED IS Rs 5 AND INV. CARRY. COST IS

2.5% OF THE AV. INV. VALUE.• PRICE PER UNIT IS Rs 200.• THE COMPANY PRESENTLY PLACES 10 ORDERS EVERY YEAR.• ADVISE MGMT. OF SPEED AUTO WHETHER THEY SHOULD CONTINUE

WITH EXISTING PRACTICE OR SWITCH OVER TO THE EOQ MODEL OF PROCUREMENT

SOLUTION

• Annual Demand (A = 20,000 ; Ordering Cost (B) =Rs 5: Price=Rs 200 • Inv Carrying Cost (C) = 2.5% of Inv Value = 0.025X 200 = Rs 5

OPTION I: ( SWITCHING TO EOQ MODEL):

• EOQ: Q = √( 2A.B / C )= √( 2 X 20000 X 5 / 5 ) = 200

• NO. OF ORDERS PER YEAR: 20000 /200 = 100• ANNUAL ORDERING COST = 100 X 5 = Rs 500• AV. INV. CARRYING COST= ( 200 /2 ) X 5 = Rs 500• TOTAL ANNUAL COST = Rs 500 + Rs 500 = Rs 1000

OPTION II: ( CONTINUE WITH EXISTING POLICY):

• ORDERS PER YEAR=10 :ANNUAL ORDERING COST = 10X5 = Rs 50• QUANTITY PER ORDER = 20000 / 10 = 2000• AV. INV. CARRYING COST= ( 2000 /2 ) X 5 = Rs 5000• TOTAL ANNUAL COST = Rs 50 + Rs 5000= Rs 5050

OPTION I BEING MORE ECONOMICAL, MGMT. SHOULD SWITCH TOEOQ MODEL OF PROCUREMENT

PROBLEM

• TRINITY HOSPITAL, BANGLORE SOURCES 20,000 SYRINGES EVERY YEAR FROM A LOCAL SUPPLIER

• ORDERING COST PER ORDER IS Rs 100 AND INV. CARRY COST IS Rs 1 PER UNIT PER YEAR.

• THE PRICE OF A SYRINGE IS Rs 5.

• THE SUPPLIER OFFERS A 5% DISCOUNT IF PURCHASES ARE MADE IN LOTS OF 10,000 SYRINGS OR MORE. DETERMINE WHETHER THE DISCOUNT MODEL IS BETTER THAN THE EOQ MODEL IN THIS SITUATION

SOLUTION

• D=20000; Co= 100; Cc= 1 ; P=5

• EOQ ‘Q’ = √( 2DCo / Cc ) = √( 2.20000.100/ 1)

• = 2000 UNITS

• INV. CARRY COST = (2000/2) X 1=1000

• ORDERING COST = 20000/2000 X 100 =1000

• TOTAL ANNUAL COST:

• = 20000X5 + 1000 + 1000 = 102,000

SOLUTION

• DISCOUNT MODEL:• D=20000; Co= 100; Cc= 1 ; P=5• 2 0RDERS OF 10000 EACH• COST OF MATERIALS= 20000 X 5 = 100000• DISCOUNT= 100000X .05=5000• NET COST OF MATERIAL= 95000• INV. CARRY COST = (10000/2) X 1=5000• ORDERING COST = 2 X 100 =200• TOTAL ANNUAL COST:• = 95000+ 5000 + 200 = 100,200• DISCOUNT OFFER IS PREFERABLE

PROBLEM

• MICROCOSM SOFTWARE SOURCES 16000 BLANK CDs ANNUALY FROM A SUPPLIER IN BANGLORE.

• ORDERING COST PER ORDER IS Rs 10 AND CARRYING COST IS 10% OF CD PRICE OF Rs 20 EACH.

• SUPPLIER OFFERS QUANTITY DISCOUNTS FOR LOT SIZES AS FOLLOWS:• 800 DISCOUNT 2%• 1000 DISCOUNT 4%• 2000 & ABOVE, DISCOUNT 5%• ADVISE MGMT. BEST PURCHASE LOT SIZE EOQ OR PARTICULAR

DISCOUNT MODEL

Q

T T T

MAX INV. LEVEL

TIME

QU

AN

TITY

RE-ORDER POINT

L L L

MIN. INV. LEVEL

Q

T T T

MAX INV. LEVEL

TIME

QU

AN

TITY

RE-ORDER POINT

L L L

Q

T T T

MAX INV. LEVEL

TIME

QU

AN

TITY

RE-ORDER POINT

L L L

MAX INV. LEVEL = SAFETY STOCK + RE-ORDER QUANTITY

L L L

BUFFER STOCK OR SAFETY STOCK ==

RE-ORDER POINT= SAFETY STOCK + LEADTIME CONSUMPTION

RE-

OR

DER

QU

AN

TITY

= E

OQ

S S MIN. INV. LEVEL

LEVELS FOR INVENTORY CONTROL

• MINIMUM INVENTORY LEVEL: BUFFER / SAFETY STOCK

• RE-ORDER LEVEL:

ROL = LEAD TIME DEMAND ( LTD ) + SAFETY STOCK ( SS )

• RE-ORDER QUANTITY: ROQ = EOQ

• MAX INV. LEVEL = ROQ + SAFETY STOCK

NEED FOR SAFETY STOCK

• STOCKOUT COSTS ARE VERY HIGH

• TO TAKE CARE OF THE UNCERTAINTY OF DEMAND AND SUPPLY DURING THE LEAD TIME SAFETY STOCKS ARE MAINTAINED

• SAFETY STOCK =K X STD. DEVIATION OF LTD X √AVERAGE LEAD TIME

• ‘K’ : IS A FACTOR DEPENDING UPON CRITICALITY OF DEMAND

• ‘LTD’ ; IS AVERAGE DEMAND DURING THE LEAD TIME

• GENERALLY VALUE OF ‘K’ VARRIES FROM 0.1 – 3.0 AS IN FLG. TABLE:

CERTAINTY AND

CRITICALITY

‘K’ SEVICE

LEVEL

%

CERTAIN &

UNCRITICAL

0.1 54.0

CERTAIN &

SEMI CRITICAL

0.2 57.9

UN CERTAIN &

SEMI CRITICAL

0.3 61.8

CERTAIN &

CRITICAL

0.5 69.2

UN CERTAIN &

CRITICAL

1.0 84.1

CERTAIN &

SUPER CRITICAL

2.0 97.7

UNCERTAIN & SUPER

CRITICAL

3.0 99.87

ESTIMATION OF SAFETY STOCK

( BASED ON STANDARD DEVIATION IN LEAD TIME DEMAND)• STANDARD DEVIATION IN DEMAND PER MONTH = 20• LEAD TIME =4 M0NTHS• STANDARD DEVIATION IN LEAD TIME DEMAND

SD LTD = SD OF DEMAND PER UNIT TIME X √ LEAD TIME = 20 X √ 4 = 40

• UNDER SUPER CRITICAL CIRCUM STANCES: • SERVICE LEVEL = 99.9 PERCENT • CORRESPONDING VALUE OF ‘K’ = 3 • SAFETY STOCK = K X SD LTD• SAFETY STOCK = 3 X 40 = 120

PROBLEM :

• AVERAGE WEEKLY DEMAND OF PARLE-G BISCUITS IN BIGBAZAR =2500 PACKS• LEAD TIME = 4 WEEKS• STANDARD DEVIATION IN LEAD TIME DEMAND = 100• BIG BAZAR POLICY IS TO PROVIDE 60% SERVICE LEVEL FOR SUCH NON CRITICAL

PRODUCTS• CORRESPONDING VALUE OF K =0.2• ESTIMATE THE SAFETY STOCK TO BE MAINTAINED FOR 60% SERVICE LEVEL

SOLUTION• STANDARD DEVIATION IN DEMAND PER WEEK = 100• LEAD TIME =4 WEEKS• STANDARD DEVIATION IN LEAD TIME DEMAND

SD LTD = SD OF DEMAND PER UNIT TIME X √ LEAD TIME = 100 X √ 4 = 200

• UNDER NON-CRITICAL CIRCUM STANCES: • SERVICE LEVEL = 60 PERCENT • CORRESPONDING VALUE OF ‘K’ = 0.2 • SAFETY STOCK = K X SD LTD• SAFETY STOCK =0.2 X 200 = 40 PACKS