Models/Methods of inventory Control: EOQ, Re-order Level
Economic Order Quantity
A problem which always remains in that how much material may be ordered at a time. An industry making bolts will definitely would like to know the length of steel bars to be purchased at any one time.
This length is called “economic order quantity” and an economic order quantity is one which permits lowest cost per unit and is most advantages.
This can be calculated by the following formula:
Q = √2AS/I
Where Q stands for quantity per order
A stands for annual requirements of an item in terms of rupees
S stands for cost of placement of an order in rupees; and
I stand for inventory carrying cost per unit per year in rupees.
Reorder level of stock (also known as reorder point or ordering point) in a business is a preset level of stock or inventory at which the business places a new order with its suppliers to obtain the delivery of raw materials or finished goods inventory.
Every business has to maintain a certain level of raw materials or finished goods in its store. This is done in order to sustain the continuity of production in case of raw materials and the continuity of sales in case of finished goods. For this purpose, the business must set a specific level at which it should place a new order with the suppliers of inventory.
The two formulas used to calculate the re-order level are given below:
- When the business does not need to maintain safety stock:
Maximum demand or usage (in days, weeks or months) × Maximum lead time (in days, weeks or months)
- When the business needs to maintain a safety stock:
[Maximum demand or usage (in days, weeks or months) × Maximum lead time (in days, weeks or months)] + Safety stock
What is lead time?
The timing difference between placing an order with the supplier and arrival of the goods is known as the lead time.
What is safety stock (also known as buffer stock)?
In some scenarios, it may be unlikely that the reorder level could be estimated accurately. This is because the demand and the lead time of the goods could differ than the usual trends and in that case the business may run out of stock. So, a level of safety stock is set to avoid such a condition. It is also known as buffer stock.