Chapter 3.3 Managing Inventory

Question 1

EOQ Model

Answer 1

• Optimal ordering quantity for an item of inventory which will minimise inventory related costs
• Links the order qunatity placed to inventory related costs
• Bulk discounts are ignored by the simple EOQ model

Question 2

Inventory related costs

Answer 2

1. Cost of holding - increase as order size increase
2. Cost of ordering - increase if number of order increase
3. Purchasing costs - may decrease if the order size increase (bulk discount)

Question 3

1. Cost of holding

Answer 3

Average inventory = (starting inventory + closing inventory)/2 = Q/2
- if no buffer inventory, then the closing inventory would be zero as inventory has been fully utilised

Average inventory = (buffer inventory + EOQ)/2

Cost of holding = Ch * average inventory

Question 4

2. Cost of ordering

Answer 4

Cost of ordering = Co * (D/Q)
- take note if question stated number of inventory retain in warehouse. (Unlikely, but ACCA is unpredictable sometimes)

Question 5

Drawbacks of EOQ Model

Answer 5

• Assume zero lead times
• No bulk discounts
• Ignore the needs to increase order sizes (possibility of supplier shortages/price rises)
• Ignores fluctuations of demand
• Ignores benefit of holding inventory to customers (shorter lead times)
• Ignores hidden cost of holding inventory

Question 6

Bulk purchase discounts

Answer 6

1. Calculate EOQ in normal way & inventory related costs at EOQ
2. Calculate inventory related costs at lower boundary of each discount above the EOQ
3. Select the order quantity that minimises inventory related costs

Question 7

Buffer inventory

Answer 7

• In reality, company would not wait for inventory to fall to 0 before placing anew order with its suppliers.
• The risk of demand being higher than expected while waiting for new delivery, which create risk of stock-outs.

Buffer inventory (max usage per day * max lead time) - (average usage per day * average lead time)

Question 8

Just-in-time (JIT)

Answer 8

Elimination of inventory
JIT Procurement
- obtain goods from suppliers at the latest possible time
- avoid the need to carry any materials/components as inventory
JIT Production
- manufacturing is triggered to fulfil orders when orders are received
- better product customisation, no risk of obsolescence and few holding costs
- require highly flexible and reliable manufacturing process

Question 9

Benefit of JIT

Answer 9

• Allows firm to compensate for inefficient processes by holding buffer inventory

Question 10

Requirement of JIT

Answer 10

• Very good production planning system
• Suppliers who can respond quickly
• Short physical delivery times
• Guaranteed quality

Question 11

Drawback of JIT

Answer 11

• Not appropriate if production processes and suppliers are unreliable