Inventory management

By Dr. Sharon K Jose

Inventory Consist of

•  Inventory includes raw materials inventory work in progress

inventory and finished goods inventory
Purpose of inventory management

•  The main purpose of inventory management is to effectively

minimize the cost both direct and indirect cost which are
associated with holding inventory
Need for inventory

• To avoid lost sales

• To gain a quantity discount
• To reduce the ordering cost
• To achieve efficient production run
• Reducing the risk of production shortage
The cost associated with inventory

•  Material cost: these are the cost of purchasing the goods including
transportation and holding cost.
• Ordering cost:
• Carrying cost
• Opportunity cost
• Cost of running out of stock
Ordering cost

• Annual usage ‘U’

• U=200000
• Q=10000
• F=Rs.5000 cost pre-order 
• Calculate the ordering cost?
Ordering cost =U/Q*F
How to Find the Right Economic Order Quantity

• Economic order quantity (EOQ) is the order quantity that

minimizes total inventory holding costs and ordering costs. EOQ
typically applies only when demand for a product is constant over
a given period of time and each new order is delivered in full
when inventory reaches zero.
Economic order quantity (EOQ)
EOQ refers to the optimal order size that will result in the lowest total cost of the order and carrying cost or (holding cost)

• Total inventory cost = Ordering Cost + Carrying cost or (holding cost)

• Where  U= annual usage
• Q=quantity ordered
• F= fixed cost per order
• Total inventory cost = U/Q*F + Q/2*P*C

• P=Purchase price for units

• C= carrying cost as a percentage of inventory
Total inventory cost = UF/Q + QPC/2

• At EOQ
• The Ordering cost = Carrying Cost
• EOQ=√2UF/PC
Practice problem 1

• U=12000
• F=45000
• SP=6000
• C=2.5% on Selling price
2.Practice problem on EOQ & Discount

• Alpha and Omega is considering a trade discount of 1% Offering by

one of its suppliers if the order is 5000 liters. The annual usage is
12000 liter and the cost per order is rupees 50000 which is fixed
the cost of each litter is 5000 and the cost of carrying is 5 % of the
inventory value.
• What is the company's Q prior to the introduction of the discount?
•  Should the company of for availing the discount?
•  What would be the optimal order size if the company of for
availing itself of the discount?
Solution EOQ

• U=12000
• F=50000
• P=5000/liter
• C=5%
• EOQ=√2UF/PC
• =√(2*12000*500000)/5000*0.05=2190 liters
Discount =U*D

• =12000*0.01*5000=600000

• Incremental Benefit of reduction in Ordering cost

• =Ordering Cost of EOQ –Ordering Cost of discount
=UF/Q - UF/Q’
=(12000/2190)*50000 – (12000/5000)*50000
=273972.6-120000=153975.60
Incremental Carrying cost

• Carrying cost of discount – Carrying cost of EOQ

• Q’/2*(price-Discount)*C – Q/2*P*C
• =5000/2(5000-50)*0.05 -2190/2*5000*.05
• =618750-273750 =345000
Incremental total benefit

• Discount +Decrease in ordering cost –Increase in carrying cost

• = 600000+153975.60 -345000=408975.6
• =U*D+(U/Q#-U/Q’)*F – (Q’(P-D)*C-Q*P*C)/2
• =Q# =EOQ
• Q’=Discount Quantity
EOQ Assumptions

• constant or uniform demand

•  constant unit price
•  constant carrying cost
•  constant ordering cost
•  instantaneous delivery
Optimal production quantity

•
 setup cost
•  inventory carrying cost
•  Optimal production quantity= √2UP/S

• U=Annual (monthly) output

• P= setup cost for each production
• S= cost of carrying inventory per unit per year 
OPR

• U monthly usage =96000/12 =8000

• Selling price =Rs.3000
• S=set up cost per unit =Rs.5
• Find optimal production run = √(2*8000*3000)/5 =3098.38