Chapter 4

Business should consider at what level of inventory orders should be made

taking account of demand levels delivery times and any uncertainties

Safety inventory may be held if uncertainties are particularly large

Inventory costs can be conveniently classified into four groups

Holding costs Procuring costs Shortage costs The cost of the inventory itself

Economic order quantity (EOQ) is the most economic inventory replenishment order size, which minimizes the sum of inventory ordering costs and inventory holding costs. EOQ is used in an 'optimizing inventory control system.

EOQ formula may need to be modified if bulk discounts (also called quantity discounts) are available Discount benefits in the form of
1. Total material costs 2. Ordering costs 3. Inventory holding costs

It is used when
replenishment of inventory is gradual rather than

instantaneous when a company is making the items itself rather than ordering them

Re-order level = maximum usage x maximum lead time

It is the measure of inventory at which a replenishment order should be placed By holding a safety inventory, a company can reduce the likelihood that inventories run out during the re-order period

Maximum inventory level =

re-order level + re-order quantity - (minimum usage x minimum lead time)

It is the inventory level set for control purposes which actual inventory holding should never exceed

Minimum inventory level or safety inventory = re-order level - (average usage x average lead time) It is the inventory level set for control purposes below which inventory holding should not fall without being highlighted.

The aim of Just-in-time is to hold as little inventory as possible

Obtaining goods from suppliers at the latest possible time JIT implies a mutually beneficial working relationship with suppliers

Purchasing may be centralized or decentralized

The effectiveness of the purchasing method affects profit in three ways
1) 2) 3)

Effective purchasing ensures the best value for money is obtained by the firm. Effective purchasing assists in meeting quality targets. An effective purchasing strategy minimizes the amount of purchased material held in inventory.

Advantages of centralized purchasing

The firm will be buying in larger quantities and so will be able to negotiate

more substantial discounts. It should be possible to hold lower overall levels of inventory than if inventory was being held at each branch. Only one buying department will be needed, which will save costs.

Advantages of decentralized purchasing

Local branches will be more in control of their production and sales if they

have local control of purchasing. The purchasing requirements of individual branches may vary. For instance, some lines of inventory may sell better in some areas than others. Local branches will be able to form their own relationships with suppliers. A local branch can be made more accountable for its own profitability and cash management if it has control of its own purchasing function.

Advantages of closer relationships with suppliers include:

Sharing of information. Better co-ordination. The security of the relationship enables long-term planning. Discounts for bulk purchases. Preferred customer status and better service agreements.

Disadvantages
Dependence on a supplier inhibits a firm's freedom. It may turn out more expensive. The balance of power might be unequal.