Inventory control is the system used by a business to control its investment in stock.
Inventory control follows the process of:
- Recording and monitoring of stock levels,
- Forecasting future demands and,
- Determining the time and volume to order.
What is the major objective of inventory control?
The major objective of inventory control is to keep total costs associated with inventory or stock, to the barest minimum.
What are these costs?
These costs are;
1. Costs of obtaining stock,
2. Carrying costs and,
3. Stockout costs.
- Costs of obtaining stock, also known as ordering costs are transport costs and administrative costs associated with purchasing, goods reception and accounting.
For a business which produces its goods internally, the costs of obtaining stock include the planning and production costs.
2. Carrying costs include storage administrative costs and overheads. These may be material handling costs, equipment maintenance and operation costs, rent, lighting, stock taking and so on.
3. Stockout costs also known as costs of being without stock include lost sale caused by the stockout, loss of future sales and the possibility of extra costs in the event of urgent replenishment orders. A business which produces its stock internally may incur the cost of production stoppages as a result of stockout of raw materials and work–in-progress.
A good inventory control system must meet at least two basic requirements. These are;
- It must record accurately, the stock movement between receipt and issue.
2. It must show associated various control levels of reorder level, minimum and maximum.
What is the reorder level?
The reorder level is usually the level of free stock at which a replenishment order should be placed.
The reorder level depends on the lead or procurement time (the period of time between ordering and when the goods are available) and on the rate of demand during the procurement time.
What is minimum level?
This is a necessary buffer or safety stock to cover errors which might have occurred in forecasting either the lead time or the demand during the procurement time.
What is maximum level?
The maximum level is set by management as the maximum desirable. The objective is to indicate when stocks rise too high.
An Example of how to calculate control levels
A business has the following data:
A lead time of 30 – 35 days, a minimum usage of 80 units per day, a maximum usage of 180 units per day, a calculated reorder quantity (EOQ) of 5,000 units and an average usage of 120 units per day.
The reorder level is equal to (=) maximum lead time x maximum usage
= 35 x 180 = 6,300 units.
Minimum level = (reorder level) – (average usage in average lead time)
= 6,300 – (120 x 32.5) ; (Note: Average lead time = 30 + 35/2 = 32.5) = 6,300 – 3,900 = 2,400 units.
Maximum level = (Reorder level + EOQ) – (minimum usage in minimum lead time)
= (6,300 + 5,000) – (80 x 30). = 11,300 – 2,400 = 8,900 units.
Economic Order Quantity (EOQ) also known as Economic Batch Quantity (EBQ) is the reorder quantity calculated to minimize the balance of cost between carrying costs and ordering costs
EOQ is calculated on the basis of the following assumptions;
- There is a known stockholding cost which is constant,
2. There is a known ordering cost which is constant,
3. There is a known price per unit which is constant,
4. Rates of demand are constant and,
5. The whole batch (replenishment) is delivered at once.
The EOQ is calculated by using the following formula;
EOQ = √2CoD/Cc
Co = Ordering cost
D = Demand per annum
Cc = Carrying cost per item per annum.