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Ordering and Stock: Some Important Calculations

The document discusses key inventory management concepts including economic order quantity (EOQ), safety stock, and probability distributions. It provides formulas and explanations for calculating EOQ, which determines the optimal order quantity to minimize total costs. Safety stock calculations aim to reduce the risk of stockouts by accounting for demand variability. Probability distributions, like the normal distribution, can model demand patterns and are used to determine safety stock levels based on a desired service level and factors like lead time and demand standard deviation.

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392 views8 pages

Ordering and Stock: Some Important Calculations

The document discusses key inventory management concepts including economic order quantity (EOQ), safety stock, and probability distributions. It provides formulas and explanations for calculating EOQ, which determines the optimal order quantity to minimize total costs. Safety stock calculations aim to reduce the risk of stockouts by accounting for demand variability. Probability distributions, like the normal distribution, can model demand patterns and are used to determine safety stock levels based on a desired service level and factors like lead time and demand standard deviation.

Uploaded by

YarlagaddaSandeep
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Ordering and Stock

Some important calculations

Economic Order Quantity


(Q*)

EOQ specifies the amount you should order to minimise


your cost for that item.
Economic Order Quantity (EOQ, or sometimes Q*) is the
cheapest way to buy items and store them in inventory.
EOQ includes the cost per unit of ordering stock plus the
cost per unit of holding stock. Both these must be
considered.
If you know the rate of usage of that item (which you
should), then it also tells you when to purchase.
EOQ is critical to efficient purchasing and inventory.

Check out wikipedia: http://en.wikipedia.org/wiki/Economic_order_quantity

Economic Order Quantity


(Q*)
Using the following formula
calculate the economic order
quantity for a product that has a holding cost of $5 (h), a
fixed purchase cost of $120 (K) and demand of 1500 (D)
units.
Assumes that Lead time = 0, initial inventory = 0, the
planning horizon is long (infinite). These are required
assumptions for EOQ to be valid using this formula.
You will get Q* = 268.33 units per order. This is what you
need to order to minimise your ordering+holding costs

Q*

2 KD
h

Q*= optimal order quantity (ie. Lowest


overall cost to order and hold this stock)
D= annual demand quantity
K= fixed cost per order, setup cost (not
per unit, typically cost of ordering and
shipping and handling. This is not the
cost of goods)
h = annual holding (carrying) cost per
unit,

Safety stock calculations


Calculating safety stock involves
taking a chance on not having the
right amount of stock.
The more safety stock you have, the
less likely it is that you will run out.
So ---- calculating safety stock
requires working out the probability
you will not run out at a given level
of stock.

Probability (very basic)


Consider a sandwich shop you run. You measure the sales daily.
After many days (maybe a year), you take the total number of
sandwiches you sold (S).
You divide by the days (n), and you get the average (av) sandwich sales
per day.
You record each days sales and notice that even though the average is
a fixed number, sales vary from day to day. A few days are very high, a
few days are very low, many days are a bit high and many other days
are a bit low.
You plot this and get the graph on the next page. Its called the Normal
Probability Distribution
There is a lot of maths that can be applied to this curve. You can apply
standard formulae to it, and obtain many useful facts about sample
using it.
Go here to see more about probability and normal distributions:
http://stattrek.com/probability-distributions/normal.aspx

You can look these


areas up using a Z
table
Z can be looked up
in a table if you
know the av and
STD of the sample

This is a generalised normal probability distribution plot.


0 is the average, and then then numbers to the right indicate sales above the average,
and to the left below the average.
The spread (fatness) of this normal curve is indicated by the Standard Deviation (STD).
The bigger the STD, the more your sales stray from the average. The spread of the
curve is measured in multiples of the STD. You can calculate the STD using statistical
formulas (most calculators allow you to calculate Av and STD if you enter a series of
data)
The vertical axis indicates the number of times (frequency) of samples of a particular
size (days with this quantity of sales in this example).
You see that many days have the average, and continuously less and less have more
and more above and below. Only a very few have extereme high and low sales.
If you measure the area under the curve for below-average plus above-average you
show the percentage of samples within that range (you calculate Z and look up the
area)

Applying this to safety stock


Required safety stock =z STD L
L = lead time (usually in days), STD = standard deviation, which
is a measure of variability of demand*, z = measure of the area
under the normal distribution curve*
* You calculate these when entering daily stock levels over many
days. Stats calculators do this.
Note The Required Safety stock is not an absolute number. It
depends on the chance you want to take in not having enough.
This is called the Service Level.
To work out safety stock In this formula you need to consider the
variation in demand and the lead time. You need to assume that
demand is normally distributed.
Go here to see how the Z value for normal distributions works:
http://www.mathsisfun.com/data/standard-normal-distributiontable.html

Calculation of Safety stock


Using the following formula calculate the safety stock for an
organisation that is required to provide a service level of 98%
(you go to this entry in a Z-table and from this Service level, look
up the Z value), has a lead time of 30 days (L) and a standard
deviation in demand of 30 (STD) units.
You should get 336.85 units of safety stock required. That is, you
would calculate your average demand and hold stock for it, then
you would hold an extra 337 units to make sure you had stock in
98%
of future
z STD
days.
L

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