Inventory management

Hi, you are referring to an area of the syllabus that students often can find difficult to understand.

To begin, you need to appreciate that we are ASSUMED to think that the only STOCK costs that matter to a company are the FIXED Order Costs and the VARIABLE Holding Costs (OC and HC) (order costs or holding costs). Thus if OC are fixed and HC are variable then all you have to do in the exam question is identify these ! …. but as always you need an approach or a template (procedure) to do this.

To help you grasp this point here is a fully worked solution to Example 1, Chapter 4 of the OT F9 Lecture Notes … which I hope will then provide you with complete clarity on the specifics of the question you have raised.

Calculating “Total Stock Costs pa”

Based on examination of the Total Order Costs + Total Holding Costs pa
TC = OC + HC + PC
(Include PC only if DISCOUNTS are offered)

=> Compare “Total Annual Stock Costs” for each Order Quantity

– Order Quantity –
Annual Demand 40,000

Order Cost [ OC ]
Order Size – units 500 750 1,000 1,250
No. of Orders * 80 53.33 40 32
* Annual Demand / Order Size
Cost per Order 20 20 20 20
Total Re-Order Cost p.a 1,600 1,067 800 640

Holding Cost [ HC ]
Average Stock Holding * 500/2 750/2 1,000/2 1,250/2
* Order Size / 2
Average Stock Held (units) 250 375 500 625
Purchase Price p.u 25 25 25 25
Average Stock Value 6,250 9,375 12,500 15,625
Total Stock Holding Cost pa 625 938 1,250 1,563_

Purchase Cost [ PC ]
Demand 40,000 40,000 40,000 40,000
Purchase Cost P.U 25 25 25_ 25 __
Total Purchase Cost 1,000,000 1,000,000 1,000,000 1,000,000

Total Stock Costs P.A* [ TC ] 2,225 2,005 2,050 2,203

* as the Total Purchase Costs p.a. are the same for all Order Sizes => ignore

DECISION Choose Option 2 Cheapest Order Size

Hope all this has helped you to give you a clearer approach for dealing with this type of question in the exam. kind regards, Peter