Chapter 8 - Working capital management - Inventory

Question 1

What are some problems with keeping inventory too high?

Answer 1

• the forgone interest that is lost from tying up capital in inventory
• holding costs (storage, stores admin, risk of theft/damage/obsolecence

Question 2

What are some problems with inventory being too low?

Answer 2

• high re-order/set up costs
• stock outs (lost contribution, production stoppages, emergency orders
• lost quantity discounts

Question 3

The objective of good inventory management is therefore to determine what?

Answer 3

• the optimum re-order level (ROL)
• the optimum re-order quantity (EOQ)

Question 4

what is the optimum re-order level (ROL)?

Answer 4

• how many times items should be left in inventory when the next order is placed

Question 5

What is the optimum re-order quantity (EOQ)?

Answer 5

• how many items should be ordered when the order is placed

Question 6

What is the aim of the EOQ model?

Answer 6

to minimise the total cost of holding and ordering inventory

Question 7

What is the calculation for the annual holding costs?

Answer 7

Ch x EOQ/2

Question 8

What is the calculation for the annual ordering costs?

Answer 8

Co x D/EQO

Question 9

What is the calculation for the annual purchasing costs?

Answer 9

P x D
P is the purchase price per unit

Question 10

What does the EOQ tell us?

Answer 10

how many units of inventory to order each time we order from our supplier

Question 11

How does the EOQ qork?

Answer 11

It does so by balancing the holding costs and ordering costs involved

Question 12

What are the steps to calculate the EOQ with quantity discounts?

Answer 12

Step 1: calculate EOQ, ignoring discounts
Step 2: if the EOQ is below the quantity qualifying for a discount, calculate the total annual inventory cost arising from using the EOQ
Step 3: Recalculate the total annual inventory costs using the order size required to just obtain each discount. Take available discount into account within the purchase order.
Step 4: compare the totals from steps 2 and 3 and select lowest option
Step 5: repeat for all discounts

Question 13

What is the reorder level (ROL)?

Answer 13

the quantity of inventory on hand when na order is placed

Question 14

What does ROL equal?

Answer 14

the demand in the lead time. When the demand and lead time are known with certainty the ROL may be calculated

Question 15

When there is uncertainty over demand and or lead time what should be calculated?

Answer 15

an optimum level of buffer inventory must be found, which will depend on such things as variability of demand, cost of holding inventory and cost of stock outs

Question 16

What are periodic review systems?

Answer 16

involves performing a stock take, and ordering more if it is needed

Question 17

What is Just-in-time (JIT)?

Answer 17

the aim is to have inventory reach the business from its suppliers just in time to be used in production, or for sale. This means that very low or even zero units of inventory will be held by the business at any time.