Chapter 9:

Stock (inventory) control

 Objectives
After completing this lesson, you should:

Know the different costs associated with stock

Understand the methods of stock control including JIT

Be able to calculate the reorder level and reorder quantity

Have an understanding of the basic economic quantity

order (EOQ) model
Have an understanding of the economic batch quantity
(EBQ) model
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 Objectives
After completing this lesson, you should:

Understand the effect of discounts on the total cost of an

order

Use software-generated information to prepare a

spreadsheet to calculate economic order quantities

Understand the implications for supply chain management

of supply chain networks

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 Outline
Objectives of stock Simple methods of
control stock control

Stock (inventory) control

Inventory models

Materials
Supply chain
requirements
networks
planning(MRP)

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 1. OBJECTIVES OF STOCK CONTROL

1.1 Why hold stocks

1.2 Holding costs
1.3 Costs of obtaining stock
1.4 Stockout costs
1.5 Stocks control levels

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 1. OBJECTIVES OF STOCK CONTROL

• The overall objective of stock control is,

therefore, to maintain stock levels so that the
total of holding costs, ordering costs and
stockout costs is minimised.

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 1.5. STOCK CONTROL LEVELS
• Reorder level = maximum usage ´ maximum lead time
• Minimum level = reorder level – (average usage ´
average lead time)
• Maximum level = reorder level + reorder quantity –
(minimum usage ´ minimum lead time)
• Reorder quantity. This is the quantity of stock which is
to be ordered when stock reaches the reorder level. If it
is set so as to minimise the total costs associated with
holding and ordering stock, then it is known as the
economic order quantity.
• Average stock = safety stock + ½ reorder quantity

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 Activity 1:
• A manufacturing firm holds an average of 40,000 items of stock. This
is typically one month's supply. Stock items are bought for an average
of £2.50 each. Further possibly relevant information from last year's
financial and management accounts is as follows.
£
• Warehouse rent 8,000
• Delivery charges (goods in) 24,000
• Purchase department wages 45,400
• Stores department wages 75,600
• Purchase department overheads 31,400
• Stores department overheads 34,800
• Warehouse contents insurance 4,800
(a) What is the average cost of acquiring and holding a single item
of stock?
(b) Would any other information be relevant?
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 2. SIMPLE METHODS OF STOCK
CONTROL
• Simple methods of inventory control are as
follows.
 Demand reorder timing
 Perpetual inventory
 Periodic review

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 PARETO (80/20) ANALYSIS
• Another approach to stock control is Pareto (80/20)
analysis, based on the finding that in many stores 80% of
the value of stock is accounted for by only 20% of the
stock items. In purchasing, 80% of the value of
purchasing expenditure is purchased from only 20% of
suppliers. Stocks of these more expensive items should
be controlled more closely.

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 JUST-IN-TIME (JIT)
• Just-in-time is an approach to operations planning and
control based on the idea that goods and services should
be produced only when they are needed – neither too
early (so that inventories build up) nor too late (so that the
customer has to wait). JIT is also known as 'stockless
production'.
• A consequence of JIT is that if there is no immediate
demand for output, the operation should not produce
goods for inventory.
• JIT is a collection of management techniques. Some of
these relate to basic working practices.

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 Activity 2:
• A firm needs regular supplies of a material that has to be
imported from South America. Lead time for delivery is
typically nine weeks but it can be between five and 13
weeks. The firm uses a minimum of about 2,000 kg per
week and never more than 4,000 kg. It does not expect
any increase or decrease in production levels in the
foreseeable future. There is not room to store more than
60,000 kg at any one time. What re-order level and re-
order quantity would you suggest?

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 3. INVENTORY MODELS

3.1 The purpose of an inventory model

3.2 The basic EOQ formula
3.3 EOQ with spreadsheets
3.4 The economic batch quantity (EBQ) model
3.5 The effect of discounts
3.6 Sensitivity analysis

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 3. INVENTORY MODELS

• The purpose of an inventory model is to help

management to decide how to plan and control
stocks efficiently, so as to minimise costs.
• The economic order quantity (EOQ) or
economic batch quantity (EBQ) is the order
quantity for an item of stock which will minimise
costs.

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 3. INVENTORY MODELS

Some symbols must be introduced.

• Let D = the usage in units for one
time period (demand)
Co = the cost of making one
order (relevant costs only)
Ch = the holding cost per unit of
stock for one time period (relevant costs only)
Q = the re-order quantity

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 3. INVENTORY MODELS

• The formula for the economic order quantity

(EOQ) can be derived from the above using
elementary calculus. For now you should simply
accept that

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 Activity 3

• Placing an order for an item of stock costs £170.

The stock costs £30 a unit, and annual storage
costs are 15% of purchase price. Annual
demand is 600,000 units. What is the economic
order quantity?

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 3. INVENTORY MODELS

• The amended formula is known as the Economic Batch

Quantity or the EBQ formula, and is written as:

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 Activity 4

• A company is able to manufacture its own

components for stock at the rate of 4,000 units a
week. Demand for the component is at the rate
of 2,000 units a week. Set up costs for each
production run are £50. The cost of holding one
unit of stock is £0.001 a week. Calculate the
economic production run.

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 THE EFFECT OF DISCOUNTS

• A quantity discount is a price discount on an

item if predetermined numbers of units are
ordered. Many manufacturing companies
receive price discounts for ordering materials
and supplies in high volume, and retail stores
receive price discounts for ordering merchandise
in large quantities.

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 Activity 5

• A company uses an item of stock as follows.

Purchase price: £96 per unit
Annual demand: 4,000 units
Ordering cost: £300
Annual holding cost: 10% of purchase price
Economic order quantity: 500 units
Should the company order 1,000 units at a time in
order to secure an 8% discount?

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 4. MATERIALS REQUIREMENTS
PLANNING (MRP I)
4.1 COMPUTERISED PLANNING
Materials requirement planning, or MRP I, is a
computerised system for planning the requirements for raw
materials and components, sub-assemblies and finished
items.

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 4. MATERIALS REQUIREMENTS
PLANNING (MRP I)
4.2 MANUFACTURING RESOURCE PLANNING (MRP II)
Materials requirement planning, or MRP I, is a computerised
system for planning the requirements for raw materials and
components, sub-assemblies and finished items.

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 4. MATERIALS REQUIREMENTS
PLANNING (MRP I)
4.3 MICROSOFT MRP
Microsoft MRP is a database used for the planning of
material requirements in a manufacturing process, based on
inventory, open purchase orders, multiple bills of material
and multiple types of forecast plan. It is developed in the
Microsoft Access database environment and is fairly
straightforward to use.

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 4. MATERIALS REQUIREMENTS
PLANNING (MRP I)
4.3 MICROSOFT MRP
The following diagram gives an overview of the system:

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 4. MATERIALS REQUIREMENTS
PLANNING (MRP I)
4.4 USING A SPREADSHEET AS A DATABASE
• A database is a collection of data which is integrated
and organised so as to provide a single comprehensive
system. The data is governed by rules which define its
structure and determine how it can be accessed.
• The purpose of a database is to provide convenient
access to common data for a wide variety of users and
user needs. The point of storing all the data in a single
place is to avoid the problems that arise when several
similar versions of the same data exist, so that it is not
clear which is the definite version, and also to avoid the
need to have to input the same data more than once.
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 Activity 6:
• Construct the spreadsheet shown on the previous page.
You may have to use the on-line help facility (press the F1
key) if you are unsure of the formulae used.
Use the Data … Filters option to answer the following
questions.
(a) What components does supplier P888 supply?
(b) What components are used in product E?
(c) Which suppliers are due to deliver fresh supplies?

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 5. SUPLLY CHAIN NETWORKS

• A supply chain network is an interconnecting group of

organisations which relate to each other through linkages
between the different processes and activities involved in
producing products/services to the ultimate consumer.
• Supply chain management involves optimising the
activities of companies working together to produce goods
and services. The trend towards closer links with
suppliers and the development of supply chain networks
has implications for supply chain management.

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 Summary

1 The objective of stock control is to maintain stock

levels so that the total of the following costs is minimised.
Holding costs
Ordering costs
Stock out costs

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 Summary
2 The demand reorder timing method of inventory control
involves calculating a level of stock (reorder level) which will
let management know that it is time to order more stock. If
stock outs are to be avoided, a prudent reorder level is
calculated as follows.
• Reorder level = maximum delivery period ´ maximum
usage
• Management should ensure that occasional checks are
performed to check that stock has not fallen to the reorder
level.
• The reorder quantity is the amount of stock that should be
ordered when stock reaches the reorder level. The reorder
quantity is the optimum stock level to be ordered when new
stock is required.
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 Summary
3 A perpetual inventory involves knowing stock levels of all
items at all times. A record is kept of all items showing receipts,
issues and balances of stock.
4 The assumptions of the EOQ model are as follows.
(a) Demand is certain, constant and continuous over time.
(b) Supplier lead time is constant and certain or else there is
instantaneous resupply.
(c) Customers' orders should be held while fresh stocks are
awaited.
(d) No stock outs are permitted.
(e) All prices are constant and certain and there are no bulk
purchase discounts.
(f) The cost of holding stock is proportional to the quantity of
stock held.
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 Summary
5 An amended EOQ formula is sometimes necessary when
resupply is gradual instead of instantaneous.
6 Costs might be minimised at:
(a) The pre-discount for EOQ level, so that a discount is not
worthwhile; or
(b) The minimum order size necessary to earn the discount
7 Sensitivity analysis may be useful if there are doubts
about the accuracy of the estimated ordering costs and holding
costs or if there is uncertainty about the volume of demand.

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 QUICK QUIZ
1 State the objective of stock control.
2 Explain the demand reorder timing method of
inventory control.
3 What is perpetual inventory?
4 What are the assumptions of the EOQ model?
5 Why is an amended EOQ formula (sometimes called
the EBQ formula) necessary?
6 At what order quantity might costs be minimised
when bulk discounts are available?
7 When is sensitivity analysis useful?

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