How to solve Supply Chain Inventory Problems – setup cost | holding cost | analyze
How to solve Supply Chain Inventory Problems
As an Inventory Planning Managers Maintaining proper levels of inventory is essential to the success of every business that sells products. Mastering this knowledge you need to analyze inventory problems effectively will help you make great decisions.
When you place orders to get new inventory you are interested in finding and minimizing your total costs. So what goes into these calculations? Your two cost components are the cost of placing an order, Also holding inventory costs money.
You tend not to think of inventory as a cost. It’s easy to forget that holding onto inventory cost money because the space in your warehouse or store room could be used for something else. So how do you find the lowest total cost?
Well, you can do it graphically by creating a chart or you can do an analytically using formulas in Excel or another spreadsheet.
So let’s take a look calculating total cost and visualizing them on a chart. In this case, I need to know three different pieces of information, the amount it costs for each order, and we’ll say that that’s $100.
That’s the time of the individuals who need to create the order. Next to the inventory holding costs. And we’ll say that’s $20 per item per year. And then our demand is 2,800 units per year. And you can see here that our total costs with only one order are very high and that’s mostly due to inventory costs I’m sure. And the curve decreases rapidly and it looks like it hits the bottom or a minimum somewhere between 16 and 17.
If we want to see what that minimum is we can look at the ordering cost and the inventory holding costs separately. Let’s go ahead and do that now.
You can see here that I have a similar graph except I’ve broken out setup costs and holding costs.
The setup cost is the number of orders multiplied by 100, my ordering cost. So you can see that it increases linearly from $100 to $3,500. And the inventory holding costs again $20 per item per year moves down from a high of about 28,000 and appears to intersect with the setup cost line between 16 and 17. And in fact, that intersection is at about 16.73 orders. So you could choose to play 16 orders a year. You would probably choose to play 17 orders because it’s better to have a little bit more than you need than not enough.
The number of items that you order each time is called the economic order quantity. And for that you need three pieces of information, cost of placing an order, annual demand and the inventory holding costs.
And that’s exactly the same as you need when you’re creating your graphs. But I do want to emphasize that the lowest cost quantity might not be the best policy. If you think you might lose a customer because you don’t have an item that they want in stock then it makes sense to buy more than you need and make sure that you can meet most of your customer demand.