I nventory Model

I nventory is the physical stock of items held in any business

for the purpose of future production or sales. In a production
shop the inventory may be in the form of raw materials.
I nventory planning is the determination of the type and
quantity of inventory items that would be required at future
points for maintaining production schedules. Inventory
planning is generally based on information from the past and
also on factors that would arise in future.
I nventory control
The aim is focused to bring down the total inventory cost
per annum as much as possible. Two important questions are
1)how much to stock or how much to buy
2)how often to buy or when to buy.
An answer to the above questions is usually given by certain
mathematical models.
I nventory cost are have four major elements that should be
taken for analysis, such as
1) Item cost
2) Ordering cost
3) Holding cost
4) Shortage cost
I tem Cost is the cost of the item whether it is manufactured
or purchased. If it is manufactured, it includes such items as
direct material and labour, indirect materials and labour and
overhead expenses. When the item is purchased, the item
cost is the purchase price of 1 unit.
Ordering Cost is the administrative and clerical costs are
involved in processing a purchase order, expediting, follow
up, transportation etc., It is also called as Purchasing or
Setup or Acquisition cost. When a unit is manufactured, the
unit set up cost includes the cost of labour and materials
used in the set up and set up testing and training costs.
Component of Ordering Cost
Tender and Bidding Cost
Purchase negotiations
Selection of vendor
Preparation and sending of
order etc.
Component of setup cost are
Cost of cleaning and adjusting
production equipment
Inspection
Bringing required raw materials.
Changing dies etc.
Holding cost. If the item is held in stock, the cost involved
is the item carrying or holding cost. Some of the costs
included in the unit holding cost are
Taxes on inventories,
Insurance costs for inflammable and explosive items,
Obsolescence,
Deterioration of quality, theft, spillage and damage to
times,
Cost of maintaining inventory records.
Shortage Cost is due to the delay in satisfying demand
(due to wrong planning); but the demand is eventually
satisfied after a period of time. Shortage cost is not
considered as the opportunity cost or cost of lost sales. The
unit shortage cost includes such items as,
Overtime requirements due to shortage,
Clerical and administrative expenses.
Cost of expediting.
Loss of goodwill of customers due to delay.
Special handling or packaging costs.
Lost production time.
I nventory models are the different technical methods used to
determine order quantity which minimizes the total costs (i.e.
ordering cost + inventory carrying cost)
E.O.Q model with
shortages
I nventory models
Deterministic probabilistic
Production model
In the deterministic type of inventory control, the parameters like
demand, ordering quantity cost, etc are already known or have
been ascertained and there is no uncertainty. In the probabilistic
inventory control, the uncertain aspects are taken into account.
Model 1: Purchasing model with no shortages
The following assumptions are made in deriving the formula
for economic order quantity.
1. Demand (D) is at a constant rate.
2. Replacement of items is instantaneous (lead time is zero).
3. The cost coefficients C1, C2, and C3 are constant.
4. There is no shortage cost or C4 = 0.
Total cost/period = (Item cost + set up cost +
holding cost/period)

Item cost per period = (Cost of item) X (number of
items ordered/period)
= C
1
Q..(1)

Purchase cost per period = C
2
(only one set up per period)

Holding cost per period = (Holding cost) x (average inventory
per period) x (time per period)
= C
3
(Q/2) x t(2)

Total cost per period (C') = C
1
Q + C
2
+ C
3
(Q/2) x t....(3)

The time for one period t = Q/D..(4)
Therefore the total cost per unit time, C = C'/t