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Sem 5 Prep
← OperationsInventory: types, functions and costs

Formulas for this chapter

Annual holding cost

Annual holding cost = (Q / 2) x H

Whenever stock runs down evenly from Q to zero. Q/2 is the average inventory over the cycle.

Q
Order quantity in units
H
Holding cost per unit per year; convert from a percentage of price first

Annual ordering cost

Annual ordering cost = (D / Q) x S

D/Q is the number of orders placed a year. Ordering cost never depends on how big each order is.

D
Annual demand in units
S
Ordering cost per order, or setup cost per run

Holding cost from a percentage

H = carrying charge % x unit price

The first line of almost every inventory numerical. Do it before touching Q.

carrying charge %
Annual carrying cost as a fraction of inventory value, e.g. 0.09
unit price
Cost of one unit
Step 4 of 20
The real wordsTheory

The six functions

Why hold stock at all? Six answers, and this is a standard five-mark question.

  1. To meet anticipated customer demand
  2. To smooth production requirements
  3. To protect against stockouts
  4. To take advantage of order cycles
  5. To hedge against price increases
  6. To take advantage of quantity discounts

Notice that only one of the six is about the customer. The other five are about protecting the firm's own operations from variability and from price.

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