Inventory Management Ratios
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Questions and Answers

What is the denominator of the inventory turnover ratio?

Average inventory at cost

What are the two main categories of inventory costs?

Holding (carrying) costs and Ordering costs

What is an example of a stockout cost in self-service retailing?

The cost of a lost sale (e.g., lost profit)

What is an example of an opportunity cost in holding (carrying) costs?

<p>The cost of capital</p> Signup and view all the answers

What is included in ordering costs?

<p>Expenses incurred in placing and receiving orders from suppliers, including order preparation, order transmittal, order receiving, and accounts payments</p> Signup and view all the answers

What is an example of a stockout cost in manufacturing?

<p>The opportunity cost of having the production line shut down</p> Signup and view all the answers

What are the consequences of stockouts in the supply chain?

<p>Disruptions of materials flows</p> Signup and view all the answers

What is the main goal of the Economic Order Quantity (EOQ) model?

<p>To minimize total annual inventory costs</p> Signup and view all the answers

What happens to annual order costs when the order size is small?

<p>They are high</p> Signup and view all the answers

What is the relationship between order size and average inventory level?

<p>Small order size leads to low average inventory level, and large order size leads to high average inventory level</p> Signup and view all the answers

What is the cost associated with placing an order?

<p>Order cost (set up cost)</p> Signup and view all the answers

What is the cost of holding inventory in storage?

<p>Holding cost (carrying cost)</p> Signup and view all the answers

What is the assumption about demand in the EOQ model?

<p>Demand must be known and constant</p> Signup and view all the answers

What is the assumption about lead time in the EOQ model?

<p>Lead time is known and constant</p> Signup and view all the answers

What is the formula for Total Annual Inventory Cost (TAIC)?

<p>TAIC = APC + AHC + AOC = (R<em>C) + [(Q/2)</em>(k*C)] + [(R/Q)*S]</p> Signup and view all the answers

Why is the annual purchase cost ignored in the EOQ model?

<p>Because the annual purchase cost remains constant regardless of the order size, as long as the same annual quantity is purchased.</p> Signup and view all the answers

What is the total annual inventory cost for the optimal order quantity of 501 units, and how does it relate to the price break points?

<p>The total annual inventory cost for the optimal order quantity of 501 units is minimized, and it qualifies for the deepest discount. The optimal order quantity corresponds to the correct price level of $4 per unit.</p> Signup and view all the answers

What is the method to find the optimum Q (EOQ) using the first derivative of TAIC?

<p>Take the first derivative of TAIC with respect to Q and then set it equal to zero.</p> Signup and view all the answers

What is the formula for Annual Holding Cost (AHC)?

<p>AHC = (Q/2)<em>(k</em>C)</p> Signup and view all the answers

What is the reorder point, and how is it calculated in a situation with probabilistic demand and constant lead time?

<p>The reorder point (ROP) is the lowest inventory level at which a new order must be placed to avoid a stockout. ROP = Average demand during the order's delivery lead time + Safety stock.</p> Signup and view all the answers

What is the formula for Annual Order Cost (AOC)?

<p>AOC = (R/Q)*S</p> Signup and view all the answers

What is the difference between Model 1 and Model 2 in calculating the reorder point?

<p>Model 1 involves probabilistic (unknown) demand and constant lead time, whereas Model 2 has different assumptions.</p> Signup and view all the answers

What is the method to find the optimum Q (EOQ) by making AHC = AOC?

<p>Set (Q/2)<em>(k</em>C) = (R/Q)*S and solve for Q.</p> Signup and view all the answers

How does the annual holding rate affect the total annual inventory cost, and what is the holding rate in this scenario?

<p>The annual holding rate increases the total annual inventory cost. The holding rate in this scenario is 25 percent.</p> Signup and view all the answers

What is the optimal order quantity that minimizes the annual inventory cost?

<p>600 units</p> Signup and view all the answers

What is the relationship between the order quantity and the unit price, and how does it impact the total annual inventory cost?

<p>A higher order quantity qualifies for a lower unit price, reducing the total annual inventory cost.</p> Signup and view all the answers

What is the formula for Economic Order Quantity (EOQ)?

<p>Q = √(2R<em>S/K</em>C)</p> Signup and view all the answers

What is the total annual inventory cost at the EOQ?

<p>$146,400</p> Signup and view all the answers

What is the implication of ignoring the annual purchase cost in the EOQ model?

<p>The order decision is not affected by the annual purchase cost if there is no quantity discount.</p> Signup and view all the answers

What is the significance of the 179-unit order quantity in finding the first feasible EOQ?

<p>The 179-unit order quantity corresponds to the correct price level of $5 per unit, making it the first feasible EOQ.</p> Signup and view all the answers

At what point does the firm place its first order?

<p>When the inventory level reaches 120 units (ROP)</p> Signup and view all the answers

What are the two components of the total annual inventory cost, and how do they relate to the optimal order quantity?

<p>The two components are the order cost and holding cost. The optimal order quantity minimizes the total annual inventory cost.</p> Signup and view all the answers

How does the order cost per order impact the total annual inventory cost, and what is the order cost in this scenario?

<p>The order cost per order increases the total annual inventory cost. The order cost in this scenario is $20 per order.</p> Signup and view all the answers

How many orders will be placed during the year to satisfy the annual requirement?

<p>12 orders</p> Signup and view all the answers

What is the primary goal of the operations manager in this scenario?

<p>To minimize the annual inventory cost</p> Signup and view all the answers

What is the holding rate (k) used in the calculation of the annual holding cost?

<p>20%</p> Signup and view all the answers

How does the Quantity Discount model differ from the EOQ model?

<p>It allows for purchase quantity discounts and considers the trade-off between larger quantities and price discounts</p> Signup and view all the answers

What is the significance of the instantaneous replenishment in the EOQ model?

<p>It represents the arrival of a new order, which replenishes the inventory level</p> Signup and view all the answers

Study Notes

Inventory Management

  • Inventory cost includes:
    • Cost of goods sold (CGS)
    • Inventory holding (carrying) costs
    • Ordering costs
    • Stockout costs
  • Inventory turnover (ratio) = Cost of goods sold / Average inventory at cost
  • Higher inventory turnover ratios are better

Inventory Costs

  • Ordering costs (transaction costs):
    • Direct variable costs for placing an order
    • Includes expenses incurred in placing and receiving orders from suppliers
    • Examples: order preparation, order transmittal, order receiving, and accounts payments
  • Inventory holding (carrying) costs:
    • Costs incurred for holding inventory in storage
    • Opportunity cost (including cost of capital)
    • Storage and warehouse management
    • Taxes and insurance
    • Obsolescence, spoilage, and shrinkage
    • Material handling, tracking, and management
  • Stockout costs:
    • Costs incurred when a company does not have inventory available to meet demand
    • Examples: lost sales, lost profit, and opportunity cost of having the production line shut down

Economic Order Quantity (EOQ)

  • The EOQ model determines the optimal order size to minimize total annual inventory costs
  • The model is based on the trade-off between annual order costs and annual inventory holding costs
  • The order size needs to minimize the sum of the annual order cost and the annual inventory holding cost
  • Order cost (set-up cost) is associated with placing an order
  • Holding cost (carrying cost) is the cost incurred for holding inventory in storage

Assumptions of the EOQ Model

  • Demand must be known and constant
  • Lead time is known and constant
  • The model is a quantitative decision model based on the trade-off between annual inventory holding costs and annual order costs

EOQ Formula

  • Total Annual Inventory Cost (TAIC) = APC + AHC + AOC
  • TAIC = (RC) + [(Q/2)(k*C)] + [(R/Q)*S]

Calculating EOQ

  • The optimum Q (EOQ) can be calculated using the formula: Q = √(2RS / kC)
  • The annual purchase cost does not affect the order decision if there is no quantity discount
  • The annual purchase cost is ignored in the EOQ model

Reorder Point (ROP)

  • The Statistical Reorder Point (ROP) refers to the lowest inventory level at which a new order must be placed to avoid a stockout
  • ROP = Average demand during the order's delivery lead time + Safety stock
  • In-stock probability is commonly referred to as the service level

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Related Documents

Week 9 Inventory Management Handout PDF

Description

This quiz covers inventory management ratios, including the inventory turnover ratio and its components, such as cost of goods sold and average inventory at cost. It also touches on ordering costs and their relation to inventory replenishment.

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