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Inventory Management

Case Study

Aussi Cossi - 20AD

Golden Gate Industries trades in Hydraulic tools for the mining industry.
You are considering ways to improve the inventory management for the company .

Activity Patterns and Formulas

You have chosen an item to demonstrate the improvement that can be achieved.

Inventory movement model

Your role as financial manager is to advise management.

Economic Order Quantity formulas

GGI TO4500 Hydraulic Ram

Safety Stock model

Annual Demand:

D

Case Study

Order quantity:

Oq

Case study details

Unit cost:

Cu

Calculations using current policy

Pattern of demand:
Ordering costs:
Annual holding costs:
Lead time orders:

Co
Ch
Lo

Lead time safety stock:
Working days:

Lss
W

Calculations using EOQ method
Report to Management

Inventory Acquisition and Usage Pattern

18,000 units
1,200 First day of each month
\$15
Uniform over time
\$60
0.25 of the average cost of inventory carried
6 working days
5 working days
250 per year

You need to find out the following:
Option 1 - High Inventory Levels / Fewer orders / Larger orders
1 What is the total relevant cost of the current inventory policy?
2 Calculate the economic order quantity.
3 What would be the total relevant cost (including safety stocks)
if the company used the Economic Order Quantity?
4 What is the re-order point?

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Maximum
600

Inventory
Level

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Average
400

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1

Minimum
0
Order 1

Time

Total relevant cost under current policy
Safety Stock =

Order 3

Order 2

Demand per day x Lead time safety stock
(D/w) x L
360 Units

Option 2 - Lower Inventory Levels / Frequent orders / smaller orders

Average Inventory =

Safety Stock + (Order quantity / 2)
SS + Oq/2

Inventory
Level

960 Units

Annual Holding Costs =
(Cha)

Maximum
300

Average Inventory x Holding cost per unit
Sa + (Ch * Cu)

Average

\$3,600

200
Minimum
0
Order 1

Order 2

Time

Order 3

Order 4

Annual Order Costs =
(Coa)

Order 5

Orders per year x Cost of ordering per unit
Cu x Co
\$900

The question is how much to order and how often in order to achieve
the lowest possible operating costs and investment, while still meeting demand.
Total Relevant Costs
(including safety stock) = Annual Holding Costs + Annual Order Costs

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Cha + Coa
\$4,500
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2

Using the Economic Order Quantity
Economic Prder Quantity
EOQ =

(2 x Co x D)/Ch

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Formulas for the Calculations:

\$576,000

What is the most economic order quantity (EOQ)?:
759 Units per order
EOQ =

2 Co D / Ch

3
EOQ =
Co =

Economic Order Quantity
Ordering Costs per Order

D=
Ch =

Demand per Year
Holding Costs per Unit per Year

Q=

Order Quantity

Total Relevant Costs using EOQ (including Safety Stock)
Total Relevant Cost for EOQ (including safety stocks)
TRC =

(Ch x EOQ) + (Ch x SS)

\$4,196

3

Reorder point (ROP) under EOQ

Total Annual Ordering Costs
Co =

(D / Q) * Co

ROP =

SS + Demand during lead time
SS + (Demand per day x Order lead time))

Total Annual Holding Costs
Ch =

792 Units

(Q / 2) * Ch

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Total Relevant Costs (TRC)
TRC =

Co + Ch

( Related to any inventory ordering quantity )

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Report to management:
Total Relevant Cost - Economic Order Quantity
298784520.xls

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With safety stock \$304 Scroll down Back to Top Inventory Level Maximum 300 Average 200 Minimum 100 Safety Stock 0 Order 1 Order 2 Order 3 Order 4 Order 5 Time Cost of holding safety stock Css = SS x Ch Css SS Cost of safety stock Safety stock (in units) Back to Top 298784520.TRCeoq = 1 Our current policy is generating Total Relevant Cost of inventory management (holding costs and ordering costs) of: \$4.xls Page 2 .500 2 Using a revised inventory policy based on the Economic Order Quantity method the Total Relevant Cost can be reduced to: \$4.196 3 A change to the new policy would cause a cost differential of : 4 The optimum reorder point (under the EOQ model) occurs at: 792 Units 5 The optimum quantity to be ordered is: 759 Units Ch * EOQ (Related to EOQ ordering quantity) Bach to Top Option 3 .