1. Introduction
1.3 Nuisance
1.3.4. Application
This is the actual purchase price of the material or the direct production cost of the product.
It is represented by ‘p’. i.e. the cost of material is N ‘p’ per unit. This may be constant or variable. Say for example the cost of an item is N 10/- item if we purchase 1 to 10 units. In case we purchase more than 10 units, 10 percent discount is allowed. i.e. the cost of item will be N9/- per unit. The purchase manager can take advantage of discount allowed by purchasing more. But this will increase the inventory carrying charges. As we are purchasing more per order, ordering cost is reduced and because of discount, material cost is reduced. Materials manager has to take into consideration these cost – quantity relationship and decide how much to purchase to keep the inventory cost at low level.
3.7 PURPOSE OF MAINTAINING INVENTORY OR OBJECTIVE OF INVENTORY COST CONTROL
The purpose of maintaining the inventory or controlling the cost of inventory is to use the available capital optimally (efficiently) so that inventory cost per item of material will be as small as possible. For this the materials manager has to strike a balance between the interrelated inventory costs. In the process of balancing the interrelated costs i.e. Inventory carrying cost, ordering cost or set up cost, stock out cost and the actual material cost. Hence we can say that the objective of controlling the inventories is to enable the materials manager to place and order at right time with the right source at right price to purchase right quantity. The benefits derived from efficient inventory control are:
i. It ensures adequate supply of goods to the customer or adequate of quantity of raw materials to the manufacturing department so that the situation of stock out may be reduced or avoided.
ii. By proper inventory cost control, the available capital may be used efficiently or optimally, by avoiding the unnecessary expenditure on inventory.
177
iii. In production models, while estimating the cost of the product the material cost is to be added. The manager has to decide whether he has to take the actual purchase price of the material or the current market price of the material. The current market price may be less than or greater than the purchase price of the material which has been purchased some period back. Proper inventory control reduces such risks.
iv. It ensures smooth and efficient running of an organization and provides safety against late delivery times to the customer due to uncontrollable factors
v. A careful materials manager may take advantage of price discounts and make bulk purchase at the same time he can keep the inventory cost at minimum.
3.8 OTHER FACTORS TO BE CONSIDERED IN INVENTORY CONTROL
There are many factors, which have influence on the inventory, which draws the attention of an inventory manager, they are:
(i) Demand
The demand for raw material or components for production or demand of goods to satisfy the needs of the customer, can be assessed from the past consumption/supply pattern of material or goods. We find that the demand may be deterministic in nature i.e., we can specify that the demand for the item is so many units for example say ‘q’ units per unit of time. Also the demand may be static, i.e. it means constant for each time period (uniform over equal period of times).
The supply of inventory to the stock may deterministic or probabilistic (stochastic) in nature and many a times it is uncontrollable, because, the rate of production depends on the production, which is once again depends on so many factors which are uncontrollable / controllable factors Similarly supply of inventory depends on the type of supplier, mode of supply, mode of transformation etc.
(iii) Lead time or Delivery Lags or Procurement time
Lead-time is the time between placing the order and receipt of material to the stock. In production models, it is the time between the decisions made to take up the order and starting of production. This time in purchase models depends on many uncontrollable factors like transport mode, transport route, agitations etc. It may vary from few days to few months depending on the nature of delay.
(iv) Type of goods
The inventory items may be discrete or continuous. Sometimes the discrete items are to be considered as continuous items for the sake of convenience.
(v) Time horizon
178
The time period for which the optimal policy is to be formulated or the inventory cost is to be optimized is generally termed as the Inventory planning period of Time horizon. This time is represented on X - axis while drawing graphs. This time may be finite or infinite.
In any inventory model, we try to seek answers for the following questions:
(a) When should the inventory be purchased for replenishment? For example, the inventory should be replenished after a period‘t’ or when the level of the inventory is qo.
(b) How much quantity must be purchased or ordered or produced at the time of replenishment so as to minimize the inventory costs? For example, the inventory must be purchased with the supplier who is supplying at a cost of Np/- per unit. In addition to the above depending on the data available, we can also decide from which source we have to purchase and what price we have to purchase? But in general time and quantity are the two variables, we can control separately or in combination.
3.9 INVENTORY CONTROL PROBLEM
The inventory control problem consists of the determination of three basic factors:
1. When to order (produce or purchase)?
2. How much to order?
3. How much safety stock to be kept?
When to order: This is related to lead time (also called delivery lag) of an item. Lead time may interval between the placement of an order for an item and its receipt in stock. It may be replenishment order on an outside or within the firm. There should be enough stock for each item so that customers’ orders can be reasonably met from this stock until replenishment.
How much to order: Each order has an associated ordering cost or cost of acquisition. To keep this cost low, the number of orders has to be as reduced as possible. To achieve limited number of orders, the order size has to be increased. But large order size would imply high inventory cost.
How much should the safety stock be. This is important to avoid overstocking while ensuring that no stock out takes place.
The inventory control policy of an organisation depends upon the demand characteristics.
The demand for an item may be dependent or independent. For instance, the demand for the different models of television sets manufactured by a company does not depend upon the demand for any other item, while the demand for its components will depend upon the demand for the television sets.
3.10 THE CLASSICAL EOQ MODEL (Demand Rate Uniform, Replenishment Rate Infinite)
179
According Gupta and Hira 2012, the EOQ model is one of the simplest inventory models we have. A store keeper has an order to supply goods to customers at a uniform rate R per unit. Hence, the demand is fixed and known. Not shortages are allowed, consequently, the cost of shortage C2is infinity. The store keeper places an order with a manufacturer every t time units, where t is fixed; and the ordering cost per order is C3. Replenishment time is negligible, that is, replenishment rate is infinite so that the replacement is instantaneous (lead time is zero). The holding cost is assumed to be proportional to the amount of inventory as well as the time inventory is held. Hence the time of holding inventory I for time T is C1IT, where C1, C2 and C3 are assumed to be constants. The store keeper’s problem is therefore to the following
i.
How frequently should he place the order?ii.
How many units should he order in each order placed?This model is represented schematically below.
If orders are placed at intervals t, a quantity q = Rtmust be ordered in each order. Since the stock in small time dt is Rtdt the stock in time period t will be