Inventory Management and Cost Categories

Study Notes

Inventory Management

The objective of inventory management is to maintain a sufficient amount of inventory to ensure smooth operation of production and marketing functions while avoiding excessive and slow-moving inventory.

Major Categories of Inventory Costs

Ordering Costs/Setup Costs: all paperwork needed to place the order and shipping costs.
Carrying Costs: including holding costs, storage costs, risk costs, and capital costs.
Stockout Costs: costs resulting from not having a product available for sale when required, including:
- Disruption of production (added labor and overhead costs)
- Extra costs of uneconomic production runs
- Extra costs of purchasing and transportation
- Foregone quantity discounts
- Loss of customer goodwill

Determining Optimum Inventory Level

To minimize stockout costs, compute the least total cost (stockout cost + carrying cost).
Example: Casino Company determines the amount of safety stock that will result in the lowest cost.

Inventory Control Systems

Min-Max System: inventory levels are kept at pre-determined minimum and maximum levels.
Two-Bin System: inventory is maintained in two bins, signaling the need to reorder when the first bin is fully consumed.
Red-Line Method: similar to the first two systems, inventory reorder point is set once the red-line is breached.
Order-Cycling System: physical count is done at predetermined periodic intervals to determine reorder point.
Statistical Inventory Control System: statistical and mathematic models are used.
Turnover Rates: inventories are kept in stock based on the speed of its movement.
ABC System: goods are classified as types A, B, or C depending on their value and inventory turnover rate.
Just-In-Time Systems: system where zero or minimum level of inventory is kept to reduce cost of money tied up with inventory.

Mathematical and Statistical Models

Economic Order Quantity (EOQ) Model: Total ordering costs = Total carrying costs.
Tabular Method, Graphic Method, and Formula Method: used to calculate EOQ.
Formula Method: EOQ = √(2 x S x OC / CC), where S = annual sales demand or usage, OC = cost per order, and CC = carrying cost.
Optimum Number of Orders: S / EOQ.
Annual Ordering Costs: S x OC / EOQ.
Average Inventory: EOQ / 2.
Annual Carrying Costs: CC x EOQ / 2.

Reorder Point (ROP)

ROP Formula: ROP = Lead Time Usage + Safety Stock.
Alternative Formula: ROP = Average daily sales or usage x Maximum lead time in days.
Components: Lead Time Usage (LTU), Safety Stock, Normal lead time in days, and Average daily sales or usage in units.

Inventory Turnover

Inventory Turnover Formula: Cost of Sales / Average Inventory.
Example: Earth Corporation increases inventory turnover from 9 times per year to 12 times per year, resulting in savings.

Description

This quiz covers the basics of inventory management, including the different categories of inventory costs, such as ordering costs, carrying costs, and stockout costs. It's essential for firms to maintain an optimal level of inventory to ensure smooth production and marketing operations.