Inventory Planning and Control. How Much to Order and When to Order. 4 Approaches to Volume-Timing Inventory decision.
Tuesday, July 28th, 2009Why is There a Need for Inventory Planning and Control?
The first need arises because of fluctuations in demand. If there is a sudden surge in demand and you have no inventory, you will not be able to keep up with this demand. Conversely, if there is a drop in demand, you may have more inventory than you can effectively store. In both cases, you are losing revenue because you are either not selling as much as you could or not selling as much as you thought you could.
The second need arises out of the first. Inventory is a cost issue. The following costs are relevant in this regard:
Storage costs-it costs money to store goods, money for lighting, energy, equipment, employees, space and rent (if applicable). The more inventory you have, the more it costs.
Obsolescence costs-most stored goods have a shelf-life. If they are stored too long, they may perish (for example food products) or go out of date (for example fashion items).
Capital costs-these arise because of the lag between buying supplies and selling products. The longer the gap, the more you are living on savings or borrowings.
So, inventory planning and control can improve your revenue and reduce your costs. Organisations need some inventory as a buffer, or safety valve, against sudden surges in demand, but too much can be costly. Judging this fine line is the key to good inventory planning and control.
How Much to Order and When to Order
The crucial planning decision for the stock purchaser is how much to order and when to order-the volume—timing continuum. Order too much and you face inventory costs if you cannot sell. On the other hand, you may get a price discount from the supplier if you order in bulk. Order too little and you lose your price discount and may not have enough supplies to meet demand. Order too early, and you may have too much inventory for a short period. Order too late and you run out of supplies for a short period.
There are a number of approaches to the volume-timing decision such as:
order the same amount on a regular basis
order the same amount on a irregular basis
order different amounts on a regular basis
order different amounts on an irregular basis.
There are advantages and disadvantages to each, but the sophistication of planning and control increases as you go down the list. For example, ordering the same amount on a regular basis is an easy system to implement, but there is a danger of unnecessary, wasteful inventory; ordering different amounts on an irregular basis involves continuous forecasting, detailed organisation and a sophisticated supplier information network, but the potential advantages are an inventory which closely matches supply and demand and eliminates wastage.
Another factor in the volume-timing decision is to balance the costs of holding inventory (storage, obsolescence and capital) against the costs of making an order (price discounts and delivery costs). There are various mathematical models which attempt to do this, such as the economic order quantity (EOQ) formula and the economic batch quantity (EBQ) model.
Generally, the more you buy, the more your holding costs and the less your order costs-and vice versa.
