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#HNEW AVERAGE INVENTORY FORMULA TRIAL#
#HNEW AVERAGE INVENTORY FORMULA PROFESSIONAL#

The EOQ formula requires that demand (and lead-time) for a inventory item be constant. Note: This aspect of inventory control produces a few problems. Taking the previous example of the demand in lead-time being 150 units, we’re considering the possibility of demand being more than 150 or less than that. If demand in lead-time varied, it could be described by means of some form of probability distribution. So, if lead-time for a particular inventory item is five days and daily demand is 30 units, the re-order level would be five days at 30 units per day, 150 units. Re-order level (ROL) = Demand in lead-time Specifically, the order should be placed when there is still sufficient inventory to last five days, ie: If the lead-time is, say, five days, an order has to be placed before inventories have been exhausted.

Figure 4 illustrates the problem and its solution. If suppliers take some time to provide goods, orders need to be placed in advance of running out. The assumption of constant demand is consistent with the assumptions underlying the EOQ formula. An organisation could simply wait until it ran out of inventory, click its corporate fingers, and inventory would arrive instantaneously.

If it were possible, a re-order level of zero could be adopted. It is unlikely that this could be reduced to zero – it would require astonishingly co-operative and efficient suppliers. ‘Lead-time’ is the interval between placing an order with a supplier and that order arriving. When it comes to calculating re-order levels, three sets of circumstances can be envisaged. The re-order level as explained below should not be confused with the inventory control levels referred to in textbooks – this article ignores these. If orders are placed too soon, when there are still substantial supplies in inventory, then inventory levels and holding costs will be unnecessarily high. If an order is placed too late, when inventories have been allowed to run too low, a ‘stock-out’ will occur, resulting in either a loss of production or loss of sales, or possibly both. This involves finding the total annual cost (holding cost, re-ordering cost and purchasing cost) at the level indicated by the EOQ and at the level(s) where discount first becomes available.įigure 3 shows total costs (now including cost of purchasing the inventory) plotted against order quantity with discount incorporated.Īs important as how much to order at a time is the question of when to order more inventory.

#HNEW AVERAGE INVENTORY FORMULA TRIAL#

The common approach is one of trial and error. While prices reduce, total annual holding costs will increase if more inventory is ordered at a time, so the matter needs a little thought. Both holding costs and re-ordering costs should be in $, or both in cents.Ī common twist to exam questions is to ask students to evaluate whether bulk discounts are worth taking. Annual demand and cost of holding a unit for a year.

Consistent units – ensure that figures inserted have consistent units.

(Thus, fixed salaries to storekeepers or buying department staff will be excluded.) Only include those holding costs which (in total in a year) will double if you order twice as much at a time.

Relevant costs – only include those costs affected by order quantity.

The areas to beware of fall into two categories: You need to take care over which figures you put into the formula, particularly in multiple-choice questions. This cost behaviour is illustrated by the graph in Figure 1. The point at which cost is minimised is the EOQ. The total of annual holding and re-order costs first decreases, then increases.

as order quantity rises, the number of orders decreases and the total annual re-order costs decrease.

as order quantity rises, average inventory rises and the total annual cost of holding inventory rises.

When determining how much to order at a time, an organisation will recognise that: The aim behind the calculations of EOQ and ROL is to weigh up these and other advantages and disadvantages and to find a suitable compromise level. The basis of the theoretical calculations of an EOQ and an optimal ROL is that there are advantages and disadvantages of holding inventory (of buying inventory in large or small quantities).

discussions of various practical aspects of inventory management – often referred to by students with no practical experience as ‘theory’.Īdvantages and disadvantages of holding inventory.

finding an optimal re-order level (optimal ROL) – providing some idea of the level to which inventories can be allowed to fall before placing an order for more.

determining an economic order quantity (EOQ) – calculations to assess how many units of a particular inventory item to order at a time.

The areas usually tested in these exams are: Inventory control features in the syllabuses of several ACCA exams.

#HNEW AVERAGE INVENTORY FORMULA PROFESSIONAL#

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