(e) The effectiveness of the basic EOQ model is limited by the assumption of a one-product business, and the formula does not allow combining different products in the same order. An organization should keep a more rigorous control on items that are costly while less-expensive items should be given less control effort. JIT inventory management, as its name advocates, means all inventories, including raw materials, work in progress, and finished goods. The FIFO stock control method is when a retailer fulfills an order with the item that has been sitting on the shelf the longest. However, if demand fluctuates, you may run out of inventory sooner than you anticipate. Minimal controls are required for this category of items. This study mainly focuses on ABC analysis. A higher turnover rate indicates that the material in question is a fast-moving one. At what level should the order for replenishment be placed? However, it is necessary to have some control on category ‘C’ items also because some items though very inexpensive may be very critical to whole manufacturing process and non-availability of those items on time may halt the production. D stands for dead stock whose usage rate is negligible because the organization does not foresee any additional demand of such products. For instance, the numerator may be materials consumed, cost of goods sold or net sales. Re-order point is calculated by the following formula: Re-order Level/Point = Lead Time × Average Usage. Helping strike a balance between minimal ordering and carrying costs, while still satisfying demand. The reorder point is that level of inventory at which an order is placed to replenish the inventory. In other words, raw materials are expected just in time to be used to manufacture finished products; and finished products are manufactured in time to be supplied to the consumers. Effective management of inventory plays a decisive role in deciding a firm’s ability to operate with good profit margins. In the context of the EOQ model, the idea with JIT is to reduce setup costs. In fact, in the inventory control of spare parts and components it is advisable for the organization to use a combination of ABC and VED Analysis. Holding costs may include some elements, the costs of which are stepped up with the increase in quantity; for example, if inventory reaches a level where another member of staff is required to control it, there is a stepped increase in costs. Economic Order Quantity (EOQ) Model: Techniques of Inventory Management – Used by the Finance Manager, Techniques of Inventory Management – With Graphs, Formula, Examples and Calculations. The investment incurred in items of group B is moderate, thus, it deserves less attention than A but more attention than C. The ABC analysis divides the total inventory into three classes using their percentage value. On the other hand, items which are quite large in number, say, 55 percent of the total items but carrying little value, say, 10 percent of the total value of inventory are classified under category ‘C’ Category ‘B’ stands midway and consists of items which are 30 percent in number and 20 percent of the total value. B = Buying Cost Per Order EOQ is necessarily used in inventory management, which is the oversight of the ordering, storing, and use of a company's inventory. Slow moving stocks must be evaluated very cautiously before any replenishment orders are placed. Inventory Turnover Ratios 5. The sum of ordering costs and carrying costs represents the total costs of inventory. This approach to managing inventory has become very popular in the early 21st century as suppliers and retailers collaborate to control inventory costs while meeting customer demands. Economic order quantity (EOQ) is the recommended number of units you should add to inventory for each order to minimize total inventory costs. The carrying cost and ordering cost are the only costs incurred on inventory procurement. FSN analysis groups them into three categories as Fast-moving, Slow-moving and Non-moving (or dead) stock respectively. Safety stock size should be determined based on how crucial the item is in production or to the retail business, the item’s purchase cost, and the degree of uncertainty related to both usage and lead time. Below is a list of some of the most popular and effective inventory management techniques you can use to improve your business. Stocks of fast moving items must be taken care of constantly and replenishment orders must be forwarded in time to prevent stock-outs. If the inventory is too little, the organization would face regular stock-outs involving high ordering cost. 3 0 obj Therefore, the other aspect of the inventory management is when to order. The FSN method is considered to be important because of its ability to identify the following types of items: (i) Active items which require reviewing regularly. This involves proficient purchasing, very dependable suppliers, and a well-organized inventory-handling system. It is one of the oldest classical production scheduling models. Aging Schedule of Inventory: Techniques or Methods of Inventory Management – Quality Based Techniques, Classification Based Techniques and Record Based Techniques, Techniques of Inventory Management – EOQ Model, ABC Analysis, Inventory Turnover Ratios and VED Analysis. Despite the equation’s relative simplicity, it is still a core algorithm in the software packages that are sold to the largest firms in the world. Economic order quantity is the lowest amount of inventory you must order to meet peak customer demand without going out of stock and without producing obsolete inventory. The economic order quantity (EOQ) is a model that is used to calculate the optimal quantity that can be purchased or produced to minimize the cost of both the carrying inventory and the processing of purchase orders or production set-ups. The VED Analysis is very useful in categorizing items of spare parts and components. The order is forwarded before the amount of raw material depletes to a minimum stock level. Given the above assumptions, the EOQ model may be presented as follows: Since it is assumed that the inventory falls to zero before it is replenished, the average inventory becomes EOQ/2. (b) Arrange the items in descending order according to the usage value. The ordering cost per order is fixed and is constant over the year. The following inventory management techniques can help an organization in optimizing the cost of inventory and its effective management: Inventory management is a risk process as businesses needs to avoid lost sales due to out of stock merchandise, and reduce the expense of overstocking the wrong product or over-ordering the wrong inventory. Therefore, M/s Raghav & Co. should reorder auto parts when there are 2500 units on hand. ABC analysis can also be presented in the form of a diagram as follows: Certain items of inventory are slow moving. (ii) Surplus items, stocks of which are higher than their rate of consumption. Therefore, the management should give top priority to the acquisition of new stock. Record based techniques organizes ” inventory records ” is a detailed listing, a complete inventory records provides a complete picture of the inventory set up and this picture is very helpful for assessing the needs of business. The B items are similar to the A items except that there is less frequency i.e., about 20% of the inventory item contributes about 20% of value of consumption. The forecasted consumption for the inventory, usually for one year, is known. The economic order quantity (EOQ) is the order quantity that minimizes total holding and ordering costs for the year. Terms of Service 7. Class A items merit a tightly controlled inventory system with constant purchase and store management. The primary objective of inventory management is to minimize the overall cost of inventory so that profitability of firm can be maximized. Lead time is the time period between the date of placing order and the date of receiving delivery. Efforts should be made to place an order at the right time with the right source to acquire the right quantity and quality at the right price. Also, if a spare part is, say, an imported component whose procurement lead time is very high, its non-availability may mean a heavy loss. The following EOQ formula is widely used in practice. In order to calculate the number of orders, the total purchase requirement during the year is divided by the quantity per order. It can be achieved through maintaining the optimum level of inventory all the time. There are several variations of the EOQ model, depending on the assumptions made about the inventory system. Technique # 1. But as the order size increases, the carrying costs also increases. The high value and low volume items are included in category A, items with intermediate value are included in category B and the remaining items are included in category C. The categorisation of items has been explained below: Items having high value and low volume are placed in this category. Before uploading and sharing your knowledge on this site, please read the following pages: 1. 7) JIT (Just-in-Time) 8) Inventory turnover ratio. 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