by Economic Order Quantity (EOQ):
The Economic Order Quantity (EOQ) model is a method of determining the optimal inventory level that minimizes the total inventory cost. It is based on the tradeoff between the ordering cost and the holding cost of inventory.
Formula: EOQ = √(2DS/H)
Where,
D = annual demand,
S = ordering cost per order,
H = holding cost per unit per year.
Example: A company sells 10,000 units of a product annually. The ordering cost is $50 per order, and the holding cost per unit per year is $10. What is the EOQ?
EOQ = √(2DS/H) = √(210,00050/10) = 223.6
Therefore, the optimal inventory level is 223 units.
Reorder Point (ROP):
Reorder Point (ROP) is the inventory level at which a new order must be placed to avoid stockouts. It takes into account the lead time for the delivery of the order and the safety stock required to cover any unexpected increase in demand.
ROP = (Average Daily Usage x Lead Time) + Safety Stock
Where
Average Daily Usage = total annual demand / 365 days
Lead Time = time it takes to receive a new order
Safety Stock = extra inventory held to cover unexpected demand.
Example: A company sells 1,000 units of a product per month. The lead time for delivery is 2 weeks, and the safety stock required is 100 units. What is the ROP?
Average Daily Usage = 1,000 x 12 / 365 = 32.88
ROP = (32.88 x 14) + 100 = 561.32
Therefore, the company should place an order when the inventory level reaches 561 units.
ABC Analysis:
ABC analysis is a technique used to categorize inventory items based on their value to the organization. It helps organizations focus their attention on the most important items in their inventory.
Formula: No specific formula, but inventory items are categorized into three groups based on their value – A items (high value, low quantity), B items (moderate value, moderate quantity), and C items (low value, high quantity).
Example: A company has 1,000 inventory items with an annual usage value of $1 million. The top 20% of items account for 80% of the value, the next 30% of items account for 15% of the value, and the remaining 50% of items account for 5% of the value. How should the inventory items be categorized?
A items: Top 20% of items by value = 200 items
B items: Next 30% of items by value = 300 items
C items: Remaining 50% of items by value = 500 items
Just-In-Time (JIT):
Just-In-Time (JIT) is a technique where inventory is ordered and received just in time for use in production or sale. It is based on the idea of reducing inventory holding costs by having inventory available when needed and not before.
Formula: No specific formula, but inventory is ordered and received based on production or sales requirements.
Example: A company produces a custom product based on customer orders. It orders raw materials and components just in time for production and only orders the quantity required for each order.
Safety Stock:
Safety stock is the extra inventory held to cover unexpected demand or delays in the delivery of an order.
Formula:
Safety Stock = Z x σ x √Lead Time
where Z = number of standard deviations required
