Inventory Control Techniques
(1) Determining EOQ
(2) Determining other Inventory Levels (e.g. Re-order Point)
(3) ABC System
(4) Perpetual inventory System
(A) Economic Order Quantity (EOQ): Economic order quantity is that quantity ordered at which the total ordering costs and inventory carrying costs will be the minimum. Alternatively, it is also known as “economic lot size’. If orders are placed for a relatively small quantity frequently, the company will have to place orders again and again during a year, consequently, it will have to incur considerable costs in the form of transportation costs and clerical expenses. If, on the other hand, large orders are placed, such costs will be minimized and in addition, the company will be able to enjoy advantages of bulk buying. As a result of it, per unit cost of placing an order will decline considerably. At the same time, bulk buying leads to locking-up of capital and loss of interest to the company. Therefore, a company is required to consider a number of factors before fixing an economic ordering quantity. Of these factors, important ones are inventory carrying costs and ordering cost.
Inventory carrying costs refer to the costs of maintaining inventory of goods. Most important of these costs is the interest cost due to locking up of funds. The money that is locked-up in inventory stock could have been invested elsewhere, earning interest or dividend to the company. But that opportunity is lost. Other items included in inventory carrying costs are cost of storage, cost of transport, insurance premium, loss due to deterioration of the stored materials and their obsolescence, etc. Thus there are two types of costs (1) Costs that arise due to storing the inventory (2) The opportunity cost of funds (e.g. if the funds were not locked in inventory, it would have earned interest in bank deposit etc.) According to the Planning Commission of India, the inventory carrying costs in our country amounts to 15 to 20 per cent of the total cost of inventory. Of course the larger the inventory, the greater is the inventory carrying cost.
Ordering cost includes clerical expenses and time involved in sending enquiry, opening of tenders, preparing schedule of quotations and cost of placing” orders. It also includes cost involved in sending reminders to suppliers, recording goods when received, inspection of quality of goods received, checking invoices, getting them sanctioned by accounts department and making payments thereof, etc. It is found that the larger the order, the lower is the ordering cost.
If the required material is to be manufactured, and not to be ordered, set¬up cost is taken into account instead of ordering cost. The set-up cost includes such expenses as the cost of setting “up goods in machinery, the wastage incurred in the initial period, lower efficiency of labor in the initial stage, etc.
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