12.6 The management of inventories

Question 1

What is the main objective of inventory management?

Answer 1

To achieve maximum profits by maintaining adequate inventory levels for smooth business operations, while minimising the cost of inventory holding.

Question 2

What is the “Re-order level” (ROL) in inventory management?

Answer 2

The level of inventory that must be reached before an order is placed - i.e. it indicates ow much to order and when.

Question 3

Why must a “buffer” level of inventory be held?

Answer 3

Because demand and order lead times vary, and so holding a buffer removes the risk of inventory exhaustion.

Question 4

What are some techniques that help in efficient inventory management?

Answer 4

• economic order quantity (EOQ)
• ABC inventory control
• just-in-time (JIT) systems
• fixing the inventory levels
• vital, essential and desirable (VED) analysis

Question 5

What is the economic order quantity technique (EOQ)?

Answer 5

A technique for balancing the total costs of holding and ordering inventory. (i.e. holding costs vs ordering costs)

Question 6

What are “holding costs” in the economic order quantity technique?

Answer 6

The cost of holding X amount of inventory for one year (i.e. holding cost per unit x average inventory)

Question 7

What are “ordering costs” in the economic order quantity technique?

Answer 7

The fixed costs of placing an order, including transportation, inspections etc.

Question 8

How is What economic order quantity calculated?

Answer 8

EOQ = sq root (2cd/h)

where:
d = annual demand
c = ordering cost per order
h = holding cost per unit

Question 9

When determining the right inventory levels, a business must consider “minimum level”. What is this?

Answer 9

The lowest balance that should be maintained at all times.

Question 10

When determining the right inventory levels, a business must consider “re-order level”. What is this?

Answer 10

The level of inventory at which the business should order new supply.

Question 11

When determining the right inventory levels, a business must consider “maximum level”. What is this?

Answer 11

The maximum inventory level that the company can hold at any point in time.

Question 12

When determining the right inventory levels, a business must consider “danger level”. What is this?

Answer 12

The level below “minimum”, after which immediate action must be taken to increase inventory.

Question 13

What is the just in time (JIT) system of inventory management?

Answer 13

A series of manufacturing and supply chain techniques aiming to reduce inventory to the absolute minimum or reducing it all together.

Question 14

Where, when and by who was the just in time (JIT) system developed?

Answer 14

Toyota, Japan, 1960s

Question 15

What types of waste might just in time (JIT) avoid?

Answer 15

• capital and storage costs
• materials handling
• rejects and reworks
• queues and delays
• long lead times
• unnecessary clerical and accounting procedures.

Question 16

What drawbacks are associated with the just in time (JIT) system?

Answer 16

• price fluctuations of raw materials increase costs (since raw items are not bought in bulk when cheap)
• not helpful in periods of unexpected demand
• production highly reliant on suppliers (no buffer_
• may require heavy technological investment

Question 17

What is ABC inventory control?

Answer 17

An analytical approach for classifying inventory items based on their consumption values. i.e. the most costly items are most closely monitored.

Question 18

What are the three categories of item under the ABC system of inventory control?

Answer 18

A category - items that require high investment but are needed in small quantities (around 20%, i.e. Pareto principle). Quantities are closely monitored.

B category - medium value, representing around 30%. Not as closely monitored as A.

C category - low value items making up the rest of inventory - it is not usually cost effective to deploy inventory controls on these.

Question 19

What is vital, essential and desirable (VED) analysis?

Answer 19

A system to identify the criticality of inventory items that the business cannot operate without.

Question 20

In vital, essential and desirable (VED) analysis, items are classified according to their criticality. What are the three categories?

Answer 20

Vital - without these items production will come to a halt (e.g. difficult to obtain items).

Essential - essential spare parts, but non-availability may not adversely affect production (e.g. lead times may be short).

Desirable - items whose stock-out only causes very minor disruption with minimal cost.