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Perhaps I am being dim but I am on page 18 of the notes looking at example 1 regarding the management of working capital (2). I am confused. The average stock levels appear to be half of the order quantities. Is is just assumed that you would have half left or am I missing something? Thanks very much.
Yes this is a typical assumption that is made in these types of questions. This assumption is based on even demand for the stock in question. In other words it does not take into account the fact that in reality demand for stock can vary.
Formula used is average inventory=buffer safety inventory + (reorder level/2)
Please ask if you need more detail. I have not yet looked at the example to which you refer but it seems like there is no buffer safety inventory in said example given your statement of the situation.The assumption here is not just an arbitrary assumption. It’s based upon a principle which is explained in the following example:
Suppose we’ve placed an order of 30 units of a given raw materials.
It’s usage is 1 unit per day
And there is no safety inventory
Now,
At the point of delivery there are 30 units in the store
After five days we’d have consumed five units so we’ve 25 units remaining
Ten days from delivery we’ve 20 remaining
15 days later 15 units
……
At the end of the 30th day we’ve no units leftIf we take average of the no of units on each day it’ll give us exactly the half of the order quantity.
I hope it helps.
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