Describe the three motives for holding inventory.

The transactions motive occurs whenever there is a need to hold inventories to meet production and
sales requirements and it is not possible to meet these requirements instantaneously. A firm might
also decide to hold additional amounts of inventories because of uncertainty relating to demand for
future production and sales requirements, and uncertainty in the supply of raw materials in
manufacturing organizations or purchased goods in merchandising organizations.

a precautionary motive, which applies only when future supply and demand is uncertain. When it is
expected that future input prices may change, a firm might maintain higher or lower inventory levels
to speculate on the expected increase or decrease in future prices

Speculative motive is where a firm is able to predict the demand for its inputs and outputs with
perfect confidence and where it knows with certainty that the prices of inputs will remain constant
for some reasonable length of time, it will have to consider only the transactions motive for holding
inventories.

Apply the economic order quantity (EOQ) to a set of information.

2 × annual demad × O
EOQ = √
H
ASSUMPTIONS OF THE EOQ FORMULA

Holding cost per unit will be constant.

Another assumption that we made in calculating the total holding cost is that the average balance in
inventory was equal to one-half of the order quantity.

DETERMINING WHEN TO PLACE THE ORDER

To determine the point at which the order should be placed to obtain additional inventories (i.e. the
re-order point), we must ascertain the time that will elapse between placing the order and the actual
delivery of the inventories. This time period is referred to as the lead time. In a world of certainty, the
re-order point will be:

Lead time x 3 Daily / weekly usage during the lead time period

Discuss the purpose of implementing a safety stock policy

In practice, demand or usage of stocks (inventories) is not known with certainty. In addition, there is
usually a degree of uncertainty associated with the placement of an order and delivery of the stocks.
To protect itself from conditions of uncertainty, a firm will maintain a level of safety stocks for raw
mate rials, work in progress and finished goods inventories. Thus, safety stocks are the amount of
inventories that are carried in excess of the expected use during the lead time to provide a cushion
against running out of inventories because of fluctuations in demand.

JIT advantages

It was pointed out that JIT philosophy focuses on the elimination of waste by seeking to eliminate
non-value added activities, reducing production batch sizes and minimizing inventories. The JIT
philosophy views inventories as representing waste. Many firms have extended the JIT philosophy to
the purchasing function and as an alternative approach to EOQ models for inventory management.

Disadvantages

Need very reliable supplier

Skilled employees

Need high tech machinery

Require suppliers to supply high quality goods

If suppliers are not reliable this will lead to loss of sales.