Inventory Management and Financial Goals

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Questions and Answers

What is the primary objective of the Economic Order Quantity (EOQ) model?

To minimize the total costs related to inventory management (correct)

To eliminate the need for inventory tracking

To maximize the total amount of inventory held at all times

To increase the frequency of inventory orders

Which of the following best describes holding or carrying costs in inventory management?

Costs related to the depreciation of product value over time.

Costs arising from waste and spoilage of inventory items.

Costs associated with ordering and processing purchase orders.

Costs incurred due to the storage of unsold goods. (correct)

When is it considered ideal to purchase inventories in advance?

When the demand for products is falling

When there is a potential increase in supplier prices (correct)

When stock levels are at a critical low

When bulk discounts on items are available (correct)

If the annual demand is 10,000 units and the order quantity is 600 units, how many orders will be placed per year?

50 orders Signup and view all the answers

What impact does minimizing carrying costs have on overall inventory management?

It improves profit margin and profitability. Signup and view all the answers

What is the primary purpose of a fixed-order quantity model?

To trigger ordering based on pre-set inventory levels Signup and view all the answers

Which of the following is NOT considered a holding (carrying) cost?

Training costs for staff Signup and view all the answers

Which type of inventory model focuses on time-triggered orders?

Fixed-Time Period Model Signup and view all the answers

Which cost is associated with arranging specific equipment setups?

Setup costs Signup and view all the answers

What happens to the total cost to carry when the order size decreases?

Total cost to carry decreases Signup and view all the answers

What assumption does not hold for the fixed-order quantity model?

Ordering costs are variable Signup and view all the answers

Which inventory replenishment strategy involves placing an order when inventory reaches a specified level?

Reorder point Signup and view all the answers

Which strategy is primarily focused on minimizing costs, expenses, and losses?

Developing strategic plans Signup and view all the answers

What is a consequence of not allowing back orders in the fixed-order quantity model?

Potential for order cancellations Signup and view all the answers

How does an increase in order size affect the total cost per order?

Total cost per order decreases Signup and view all the answers

What is the primary goal when determining the optimal inventory order point?

Minimizing total costs Signup and view all the answers

What does inventory typically consist of in an organization?

Raw materials, finished products, and work-in-process Signup and view all the answers

Which of the following best describes holding/carrying costs?

Costs related to maintaining inventory over time Signup and view all the answers

Study Notes

Inventory System

Inventory is the stock of items or resources used in an organization. This can include raw materials, finished products, component parts, supplies, and work in process.
An inventory system is a set of policies and controls that monitor inventory levels, determine appropriate levels to maintain, when stock should be replenished, and how large orders should be.

Primary Goal in Financial Management

The primary goal in financial management is the maximization of shareholder wealth.
To achieve this, strategic plans and operations should be focused on maximizing revenues and minimizing costs, expenses, and losses.

Inventory Costs

Holding (carrying) costs: Costs associated with storage, handling, and insurance of inventory.
Setup (production change) costs: Costs for arranging specific equipment setups.
Ordering costs: Costs associated with placing an order.
Shortage costs: Costs related to canceling an order, or difficulties in meeting customer demand.

Inventory Systems Models

Single-period inventory model: A one-time purchasing decision, such as a vendor selling t-shirts at a football game. This model aims to balance the costs of overstocking and understocking.
Multi-period inventory models: Models used for situations requiring inventory management over a series of time periods.
- Fixed-order quantity models (EOQ): An inventory control model where the amount requisitioned is fixed, and orders are placed when the inventory level reaches a predetermined point.
- Fixed-time period models: Inventory orders are placed at fixed intervals of time, such as monthly.

Fixed-Order Quantity Model Assumptions

Consistent and uniform product demand throughout the period.
Constant lead time from ordering to receipt.
Constant price per unit of product.
Constant ordering/setup costs.
All demands for the product will be met (no backorders).
Inventory holding cost is based on average inventory.

Fixed-Order Quantity Model Behavior

The system begins by receiving a pre-determined reorder quantity (Q).
Inventory is depleted over time.
When the inventory level reaches the reorder point (R), a new order is placed for Q units.
The cycle repeats.

Cost Minimization Goal

By combining item holding and ordering costs, the total cost curve can be determined.
The optimal order quantity (Qopt) minimizes the total costs.
There is a direct relationship between order size and the total cost to carry. A decrease in order size results in a decrease in the total cost to carry; an increase in order size increases the total cost to carry.
There is an inverse relationship between order size and total cost per order. A decrease in order size results in an increase in the total cost per order; an increase in order size results in a decrease in the total cost per order.

EOQ Model Formula

Total cost (TC) is calculated by summing the annual purchase cost and annual ordering costs, plus annual holding costs.
This formula utilizes variables such as annual demand (D), cost per unit (C), ordering cost per order (S), holding cost per unit (H), and reorder point (R).
The optimal order quantity (Q₂) is a critical element in minimizing total costs.
Lead time (L) is the time from placing an order to receiving it.

Deriving EOQ

Using calculus, the derivative of the total cost function with respect to Q is taken.
Setting this derivative equal to zero determines the optimized (cost-minimized) order quantity (Q_opt), which will be the minimum total cost.
The reorder point (R) is calculated by multiplying the average daily demand (d) and the lead time (L).

Example (1) and Solution

Problem data including annual demand, daily demand (days per year), cost to place an order, holding cost per unit per year, lead time, and cost per unit are given.
The EOQ is calculated using the formula.
The reorder point is calculated based on the daily demand.
The analysis concludes that a specified number of quality units, or 90 units in this case, minimizes costs.

Example (2)

Problem data, including annual demand, daily demand, order cost, holding cost (10% of cost per unit), lead time, and unit cost, is given.
A similar calculation is followed to find the EOQ, and reorder point.
For example, an estimated order, with 366 quality units, minimizes total costs.

Application and Considerations

The cost-minimizing EOQ and reorder point are needed to successfully manage inventory levels for companies.
EOQ and reorder points address questions about optimal order sizes to avoid stockouts and excessive inventory while maintaining low costs.
Advance inventory orders are fine for business considerations.

Problem Solving Quiz

The problem presents relevant data like annual demand, ordering costs, carrying costs, and the current ordering quantity.
Individuals need to compute and determine the following: economic order quantity, number of orders per year, annual ordering cost, annual carrying cost, and total annual cost.

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Description

This quiz covers key concepts in inventory management and financial management, including inventory systems, costs, and the primary goal of maximizing shareholder wealth. Test your understanding of how these elements interact in an organization.