S T I C S M A N A G EMEN
G I T
LO
Inventory
Carrying Cost
Presented by: Group 3
Question
At some point, we agreed that inventory is
necessary for the firm's operation. However, there
are costs associated with holding products in
stock. It raises questions about what firms can
do to control the inventory costs?
Outline
1 Definition
2 Planning inventory
When to order
How much to order
PART 1
Costs associated with holding products in stock.
INVENTORY
CARRYING COST
Definition the expense associated with maintaining inventory
Calculation: multiplying annual inventory carrying cost percent by
average inventory value
Capital Taxes Insurance
Financial resources or Financial obligations An expense to mitigate
funds invested in Assessed based on financial losses
inventory or assets by a inventory's value on a Influenced by factors like
company. specific date or its product nature, storage
Assessed at varying average value over a facility characteristics,
rates defined period. and security measures.
The cost associated with Varies in rate and Provides protection
using funds assessment method against risks
OBSOLESCENCE STORAGE
Costs arising from product An expense for holding
deterioration during storage. products, not directly tied to
Examples: products aging inventory value.
beyond recommended Public or contract warehouses,
dates and loss of appeal or when storage charges are
billed on an individual basis
demand.
Total annual occupancy cost .
Estimated based on past
experiences
PART 2
What firms can do to control the inventory costs?
Planning inventory
1. WHEN TO ORDER
THE REORDER POINT (ROP) IS THE MINIMUM STOCK LEVEL A SPECIFIC
PRODUCT CAN REACH BEFORE YOU’RE PROMPTED TO ORDER MORE
INVENTORY
1 THE BASIC REORDER POINT FORMULA IS: R = D X T
R = REORDER POINT IN UNITS;
D= AVERAGE DAILY DEMAND IN UNITS;
T= AVERAGE PERFORMANCE CYCLE LENGTH IN DAYS.
EXAMPLE: SUPPOSE YOU MANAGE A CONVENIENCE STORE
AND SELL PRODUCT A. YOU HAVE COLLECTED DATA AND
FOUND THAT THE AVERAGE DAILY DEMAND (D) FOR PRODUCT
A IS 20 UNITS. ADDITIONALLY, YOU HAVE MONITORED AND
CALCULATED THE AVERAGE TIME IT TAKES TO PLACE A NEW
ORDER (T), WHICH IS 10 DAYS
R = 20 (UNITS/DAY) X 10 (DAYS) = 200 UNITS
2 WHEN SAFETY STOCK IS NECESSARY TO ACCOMMODATE
UNCERTAINTY
THE REORDER POINT FORMULA IS:
R = D X T + SS
WHERE: SS = SAFETY STOCK IN UNITS
CONTINUING WITH THE ABOVE EXAMPLE, THIS TIME YOU
DECIDE TO ADD A SAFETY STOCK OF 20 UNITS OF PRODUCT A
TO DEAL WITH UNCERTAINTY IN DEMAND OR SUPPLY TIMES.
=> R = 20 (UNITS/DAY) X 10 (DAYS) + 20 = 220 UNITS
How much?
Lot sizing ⇒ balance 2 cost ( inventory carrying cost , ordering cost)
Lot quantity calculation
⇒ Identify specific quantities where combined annual total cost of
inventory carrying cost and ordering cost is the lowest
⇒
Goal determine the ordering quantity
⇒ minimizes the total inventory carrying and ordering cost
Economic Order Quantity
Stringent Requirements before applying
EOQ:
1. all demand is satisfied
2. Demand rate is continuous, constant,
known
3. Replenishment performance cycle
time is constant and known
4. the product price remains constant
and is independent of order quantity
and time
5. There is an infinite planning horizon
Where
6. No interaction exists between multiple EOQ = Economic order quantity
inventory items C0 = Cost per order
7. No inventory is in transit Ci = Annual inventory carrying cost
D = Annual sales volumes, units
8. There is no limit on capital available
U = Cost per unit
Other EOQ Adjustment
1 Production lot size 4 Dedicated trucking
2 Multiple-item 5 Unitization
purchase
3 Limited capital
Volume Transportation rates
Transportation cost: paid by supply chain
participants, whether the product is sold on a
delivered basis or ownership
Collaborative efforts are essential to minimize
total cost through optimal order quantity
Greater the weight of an order →lower the cost per
pound of transportation from any origin to
destination
Supply chain arrangements should aim for
quantities that offer maximum transportation
economies
Volume Transportation rates
Example
Ordering in larger quantities increases inventory carrying costs
A decrease in the number of orders required to satisfy annual requirements
EOQ must be tested for sensitivity to transportation costs across a range of
weight breaks
Changes in order size and frequency have a modest effect on total costs
Quantity Discount
Definition
A quantity discount is simply a reduced price
(P) for an item when it is purchased in larger
quantities.
Thank you for listening!
Don't hesitate to ask any questions!
