Raw material cost
• Raw materials form a major part of a
manufacturing entity’s inventory.
• The opportunity cost of holding too much or
too little inventory is too expensive.
• Raw material inventory requires very close
control over its usage and storage.
Inventory cost minimization requires
• Maintaining a viable inventory list (quantity,
description, price, supplier).
• Knowledge of the requirements for planned
• An indication of the materials which should be
held in stock (quantity, quality)
• Accurate and up-to-date records of the materials
issued and used in production
• Use of bulk purchasing opportunities
• Reduction in order and storage costs
Queries: the decision to obtain inventory
The following questions need to be asked
concerning inventory acquisition and storage.
– What to order? [EOQ]
– When to order? [reorder point]
– How much to keep? [safety stock]
– How it should be valued? [end stock calculated]
Costs of inventory
• Purchases (inventory)
• [quoted price less discount allowed, plus carriage charges]
• [preparing, receiving, and paying for an order of materials]
• [carrying cost of keeping one unit in stock for the period]
Economic Order Quantity
Is an estimate of the number of units per
order (that will be the least costly) that will
bring balance between the costs of ordering
and the costs of holding inventory.
Economic Order Quantity
– K is total demand in units,
– O is ordering cost
– C = carrying cost
Q* = √
Assumptions of EOQ
• Demand rates are known and hardly vary
• The cost of item does not vary with order size
• All of the order is delivered at one time
• The cost to make the order is always the same
• Cost of holding stock is linear
• Is the level of inventory that triggers the
placement of an order for additional units.
Daily usage x lead time
• Usage is the quantity used/sold each day
• Lead time is the period between placement
and arrival of the units ordered
• Is the quantity of inventory kept on hand in
the event of fluctuating usage.
• It impacts the re-order point.
(Daily usage x lead time) + safety stock
• It generally acts as a buffer against stock-outs
Stock valuation methods
• Used to calculate the value of the closing stock
• FIFO [closing units x last price(s)]
• LIFO [closing units x starting price(s)]
• AVCO [closing units x (total spent/total units)]
• SIM* [report of actual physical units sold ]
*Specific Identification Method