10 Working Capital II - Inventory & Short-Term Financing Flashcards
What the the four components of total cost of inventory?
- purchase costs
- carrying costs
- ordering costs
- stockout costs
What are purchase costs?
Actual invoice amounts charged by suppliers. It is the investment in inventory.
What are carrying costs?
Consists of all costs associated with holding inventory.
- storage
- insurance
- security
- depreciation or rent of facilities
- interest
- obsolescence
- spoilage
- opportunity cost of funds invested in inventory (percentage investment in inventory)
What are ordering costs?
The fixed costs of placing an order with a vendor. They are not affected by the number of units ordered. If units are manufactured internally, setup costs for production lines are calculated instead.
If units are manufactured internally, what is calculated as ordering costs?
Setup costs for production lines
What are stockout costs?
The opportunity costs of not being able to fill customer orders. They also include the costs of expediting special shipments required because of insufficient inventory.
What factors contribute to the difficulty of minimization of total inventory costs?
- stockout costs can be minimized by only incurring higher carrying costs
- carrying costs can be minimized by only incurring the high fixed costs of placing many small orders
- ordering costs can be minimized only by incurring the higher carrying costs of larger inventories
What are inventory replenishment factors?
- lead time
- safety stock
- reorder point
What is lead time?
The time between placing an order and receipt of goods from the supplier. When lead time is known and demand is uniform, the goods can be timed to arrive just as inventory is eliminated. This is the basis of the just-in-time model.
What is safety stock?
Inventory held as a hedge against contingencies. Determining the appropriate safety stock requires a probabilistic calculation that balances the variability of demand with the risk of stockouts the firm is willing to accept.
What is reorder point?
The inventory amount indicating that a new order should be placed.
What is the calculation for reorder point?
(average daily demand x lead time in days) + safety stock
What is the economic order quantity model (EOQ)?
The economic order quantity model determines the order quantity that minimizes the sum of ordering costs and carrying costs.
What is the formula for economic order quantity (EOQ)?
EOQ = square root of (2 x ordering cost per purchase order x periodic demand in units (usage of units)) / periodic carrying costs per unit
What are the assumptions underlying the EOQ model?
- demand or production is uniform
- order (setup) costs and carrying costs are constant
- no quantity discounts are allowed
What is a just-in-time inventory system?
It is a pull system that is demand-driven. In a manufacturing environment, production of goods does not begin until an order has been received. In this way, finished goods inventories are also eliminated. The purpose of the JIT system is to minimize the cost associated with inventory control and maintenance by reducing the lag time between inventory’s arrival and use.
What is materials requirement planning (MRP)?
A computerized system for moving materials through a production process according to a predetermined schedule. MRP is a push system. The demand for materials is driven by the forecasted demand for the final product as programmed into the system. MRP, in effect, creates schedules of when items of inventory are needed in the production departments. If an outage of a given item is projected, the system automatically generates a purchase order on the proper date (considering lead times) so that deliveries arrive on time.
What are the 3 essential components of MRP?
- the master production schedule (MPS) - a table of the projected demand for end products along with the dates they are needed.
- the bill of materials (BOM) - a table of every component part required by every end product (and by every assembly).
- perpetual inventory records - must be used to ensure that a true count of every component, subassembly, and finished good is available at all times.
What are demand-dependent (derived demand) goods?
Demand-dependent goods are components of other goods. Their demand is driven by the demand for final goods of which they are a part.
What is the difference between an ERP (enterprise resource planning) and MRP (materials requirements planning) software system?
Although ERP and MRP are similar, they are not interchangeable. ERP includes many functions not included in MRP. Ex - ERP system allows a firm to determine what hiring decisions need to be made or whether it should invest in new capital assets. A firm that only needs to control materials should implement MRP.
What is an MRP II?
MRP II does not replace but extends the scope of an MRP system. MRP is based on programmed demand, regardless of capacity considerations or changes in the market for the end product. MRP II is a closed-loop system that adds a feedback loop to allow analysis of capacity, market changes, and other variables.
