Inventory Control
What is Inventory Control?
The cost associated with storing and maintaining inventory over time, including warehousing, insurance, obsolescence, and capital costs.
Key formula / rule: Economic Order Quantity (EOQ)
Key points
- Understand the objectives and importance of inventory control.
- Identify and analyze different types of inventory costs.
- Apply inventory control models like EOQ.
- Differentiate between various inventory management techniques.
Common exam trap
Overestimating or underestimating demand, leading to excess stock or stockouts.
Definitions
- Term
Holding Cost (Carrying Cost)
- Meaning
The cost associated with storing and maintaining inventory over time, including warehousing, insurance, obsolescence, and capital costs.
- Term
Ordering Cost (Setup Cost)
- Meaning
The costs incurred each time an order is placed or a production run is set up, including administrative costs, transportation, and inspection.
- Term
Stockout Cost
- Meaning
The costs incurred when demand exceeds available inventory, including lost sales, backorder penalties, and loss of customer goodwill.
- Term
Lead Time
- Meaning
The time elapsed between placing an order and receiving the inventory.
- Term
Safety Stock
- Meaning
Extra inventory held to mitigate the risk of stockouts due to uncertainties in demand or lead time.
Learning objectives
Understand the objectives and importance of inventory control.
Identify and analyze different types of inventory costs.
Apply inventory control models like EOQ.
Differentiate between various inventory management techniques.
Formulae
- Name
Economic Order Quantity (EOQ)
- Note
Assumes constant demand, no shortages, fixed lead time, and instantaneous replenishment.
- Expression
Q* = sqrt((2DS)/H)
- Name
Reorder Point (ROP)
- Note
The inventory level at which a new order should be placed.
- Expression
ROP = (Average daily demand * Lead time in days) + Safety Stock
- Name
Total Inventory Cost (TIC)
- Note
Calculated at EOQ, this is the minimum total cost.
- Expression
TIC = Ordering Cost + Holding Cost = (D/Q)S + (Q/2)H
- Name
Safety Stock (SS) - Example (Normal Distribution)
- Note
Where Z is the Z-score for the desired service level, and σL is the standard deviation of demand during lead time.
- Expression
SS = Z * σL
Prerequisites
Basic understanding of cost concepts (fixed, variable).
Familiarity with demand forecasting methods.
Knowledge of basic mathematical operations.
Common mistakes
Overestimating or underestimating demand, leading to excess stock or stockouts.
Ignoring lead × in ordering decisions.
Failing to account for all relevant inventory costs.
Not regularly reviewing and updating inventory policies.
Keywords
Inventory Control
EOQ
Reorder Point
Holding Cost
Ordering Cost
Stockout Cost
Safety Stock
ABC Analysis
JIT
MRP
Practice preview
The Economic Order Quantity (EOQ) model aims to minimize the sum of which two costs?…
easy
A company uses 500 units of a component per day. The lead time for replenishment is 10 days. What is the reorder point (ROP) if no safety stock is maintained?…
medium
A company has an annual demand of 10,000 units, an ordering cost of Rs. 100 per order, and a holding cost of Rs. 2 per unit per year. Calculate the Economic Order Quantity (EOQ).…
medium