Chapter 17 - Working capital management (inventory control) Flashcards
Why is it expensive to hold inventory?
- Foregone interest lost from tying up capital in inventory
- Holding costs (storage)
What problems do businesses face from keeping low inventory levels?
- Stockouts
- High re-order/set up costs
- Lost quantity discounts
What are the objectives of good inventory management?
- Determine the optimum re-order level
- Determine optimum re-order quantity
- Strike a balance between holding costs and stock out/re-order costs
What is the aim of the economic order quantity (EOQ) model?
Minimise the total cost of holding and ordering inventory
What is the EOQ formula?
EOQ = square root of 2CoD/Ch
Co = cost per order
D = annual demand
Ch = cost of holding one unit for one year
What are the assumptions with the EOQ model?
- Demand and lead time are constant and known
- Purchase price is constant
- No buffer inventory held
How is the annual holding cost calculated when X quantity is ordered?
Annual holding cost = Ch x X/2
How is the annual order cost calculated when D is the annual expected sales demand?
Annual order cost = Co x D/X
What is the method for calculating if the order size should be increased above the ECQ?
- Calculate EOQ (ignore discounts)
- If EOQ below quantity quantifying for a discount, calculate total annual inventory arising from using EOQ
- Recalculate total annual inventory costs
- Compare costs of steps 2 and 3 and select cheapest
- Repeat for all discount levels
What are the criticisms of the EOQ model?
- Based on simplifying assumptions
- Not indicate optimal purchase quantity
- Ignores problem of managing stock-outs
- Inconsistent with philosophy of JIT and total quality nmanagement
What are the 3 main systems used to monitor and control, inventory levels?
- Reorder level
- Periodic review
- Mixed
What is ROL?
Quantity of inventory on hand when an order is placed
