The primary function of inventory management is to determine:
(i) When to order?
(ii) How much to order?
When to Order?
This problem of inventory control deals with the point of time when the order for fresh inventory is to be given. The problem of ‘when to order’ is solved by fixing the appropriate re-order level of each type of inventory. It is determines by compromising the cost of maintaining these stocks and the disservice to the customer if this order are not delivered in time.
‘When to order’ is an important query requires a suitable answer.
Buying and issuing the inventories are the foremost tasks of all types of organizations. When the inventories fall below a particular level as decided in advance, they are refilled with fresh procurement. But what should be the quantity of fresh stock is always an important question which requires a suitable answer. In short, the re-order level is the level of inventory at which the order for additional stock should be placed.
Re-order level = Average usage × Lead time
i.e. R = Au × L
How Much to Order?
After solving the problem of ‘when to order’ the next immediate issue is ‘how much to order’. Considering overbuying can lead to unproductive use of working capital and under-buying leads to unwanted emergency orders and ultimately increases the workload of the purchase department, the issue of ‘how much to order’ is of vital significance.
Hence, a balance is achieved by selecting the right quantity for each order. This quantity in short is known as Economic Order Quantity (EOQ).
EOQ is an important technique of inventory management. The EOQ refers to the optimal order size that will result in the lowest total of order and carrying cost for an item of inventory given its expected usage, carrying cost and ordering cost. By calculating an economic order quantity, the firm attempts to determine the order size that will minimize the total inventory cost.
1.Ordering Cost: The cost of placing an order and obtaining the supplies is known as ordering cost. It includes cost related to the clerical work of preparing, calling, issuing, transportation, following and receiving orders, physical handling of goods, inspections and machine set-up cost. This cost does not depend or vary on the number ordered. 2.Carrying Cost:It is the cost which is incurred on account of inventory storage, handling, insurance, etc. from the date of receipt to the date disposal. It includes store-related expenses like salaries of staff, electricity expenses, handling, insurance, pilferage, breakage, obsolescence, depreciation, taxes and opportunity cost of capital.
EOQ Model with Price Discount
Price discount is nothing but reduction in the price offered by a supplier for purchasing a larger volume of an item. This could be in one step or multiple steps. Price discount decreases the unit price as well as Ordering cost. However, inventory carrying cost tends to increase with large order size in spite of reduction in unit cost. As a result of these, total cost may reduce or increase. Thus, the basic decision with Quantity Discount is whether a larger quantity should be ordered to take benefit of a unit price reduction or not.