Inventory

Types of stocks
organizations hold different types of stock. A useful
classification has:
raw materials, which have arrived from suppliers and
are kept until needed for operations;
work in progress, which are units currently being
worked on;
finished goods, which are waiting to be shipped to
customers.
 Inventory modelling
The approach is to build a model of an
idealized inventory system and calculate the
fixed order quantity that minimizes total costs.
This optimal order size is called the economic
order quantity (EOQ).
Typical pattern of stock level over time
 Variables used in the analysis
Unit cost (UC) is the price charged by the suppliers for
one unit of the item, or the total cost to the
organization of acquiring one unit.

Reorder cost (RC) is the cost of placing a routine order

for the item and might include allowances for
drawing-up an order, correspondence, telephone costs,
receiving, use of equipment, expediting, delivery,
quality checks, and so on. If the item is made
internally, this might be a set-up cost.
 Variables used in the analysis
Holding cost (HC) is the cost of holding one unit of the
item in stock for one period of time. The usual period
for calculating stock costs is a year, so a holding cost
might be, say, 10 a unit a year.

Shortage cost (SC) is the cost of having a shortage and

not being able to meet demand from stock. In this
analysis we have said that no shortages are allowed, so
SC does not appear (it is effectively so large that any
shortage would be prohibitively expensive).
Features of one stock cycle
 Other variables
Order quantity (Q) which is the fixed order size that we
always use. The purpose of this analysis is to find an
optimal value for this order quantity.

Cycle time (T) which is the time between two

consecutive replenishments. This depends on the order
quantity, with larger orders leading to longer cycle
times.

Demand (D) which sets the number of units to be

supplied from stock in a given time period (for
example, ten units a week). Here, we assume that the
demand is continuous and constant.
Variation of costs with order quantity
 optimal length of the stock cycle We know
that Q = DT, and if we substitute Qo for Q we
find the optimal cycle length, To.

We can also find the optimal cost per unit

time, TCo, by substituting the value for Qo.
We know that:
 Problem 1
Jaydeep (Trading) Company buys 6,000 units
of an item every year with a unit cost of $30. It
costs $125 to process an order and arrange
delivery, while interest and storage costs
amount to $6 a year for each unit held. What
is the best ordering policy for the item?
 Problem 2
Sarah Brown works for a manufacturer that makes
parts for marine engines. The parts are made in
batches, and every time a new batch is started it costs
1,640 for disruption and lost production and 280 in
wages for the fitters. One item has an annual demand
of 1,250 units with a selling price of 300, 60 per cent of
which is direct material and production costs. If the
company looks for a return of 20 per cent a year on
capital, what is the optimal batch size for the item and
the associated costs?