Inventory Management

Inventory Management

Inventories are held for a variety of reasons.   Usually, large amounts are invested in them and, therefore, a proper control over them is necessary.   In context of inventory management, there are three questions that need to be addressed.   These are:
    • What quantity should be ordered?
    • When should the order be placed?
    • How much safety stock should be kept?
The decisions are taken broadly in the context of two inventory management systems, known as Fixed Order Quantity System and Periodic Review System, having reference to the total cost.   The total cost comprises of purchase cost, ordering/set-up cost, carrying cost, and stock-out cost.
It may be noted that in situations where the demand is known with certainty and the lead-time is also fixed, no safety stock is required.   It is only the presence of uncertainty in demand and/or lead-time that necessitates keeping safety stock since high demand rate/lead time may cause the stocks to run out.
Under the fixed order quantity system, the orders are placed for a fixed quantity.   The time interval between different orders may vary because an order is placed as and when the stock level reaches a predetermined level, called reorder level or reorder point.   On the other hand, in the periodic review system of inventory management, the ordering intervals are fixed but the order size may vary.   When demand is uniform and no variations are found in the lead time, there is virtually no difference in the operation of the two systems.
Inventory Models
With uniform demand and known lead time, the order quantity is determined so as to minimize the total cost.   Specifically, there are different models used for determining the quantity for which order may be placed.   Each one of them is based on a set of assumptions.
Model 1:   Classical EOQ Model
For the classical EOQ model, the ordering and carrying costs are the relevant costs and the least-cost order quantity (the economic order... [continues]

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