Online Custom «Managing Independent Demand» Essay Sample
Table of Contents
Independent demand is the demand for a company’s finished products that has the pattern affected by conditions outside the firm’s operation and control. In light of this, external factors that affect the organization include general market conditions, trends and seasonal patterns. Hence, the goods produced are independent of one another, and the company ought to have the right material in the right quantity. Every organization should ensure effective management of its inventories, thus, the importance of establishing an inventory management system is critical (Blackstone & Cox, 1985).
An inventory management system refers to the set rules and guidelines that a company should develop to manage its inventory efficiently and meet its goals and objectives at the least possible cost. Also, inventory management is essential for a firm in that it helps the company establish the amount and level of stocks that it has in storage. In light of independent inventory management, safety stock is its fundamental part at every stage of a firm’s operation. In case of unexpected change in the size of the order, it also plays the role of a buffer. The task of independent inventory management is ensuring quality customer service (Blackstone & Cox, 1985).
The most significant factors in independent inventory management include reduction in excessive inventory, fast moving stock optimization and appropriate definition of safety stock. Furthermore, for proper delivery of customer service, it is necessary in independent demand’s case to point to ordering point. It can establish a safe deadline for order collection eliminating the possibility of premature inventory depletion. When forecasting demand, proper inventory management ought to focus on appropriate monitoring of current and future demand as well as customer service. Besides, reduction in costs associated with maintenance and replenishment of stock is the task of inventory management. Inventory management is essential for a firm in that it helps the company establish the amount and the level of assets that it has in store (Meyer & Bishop, 2011).
Economic Order Quantity
Economic order quantity (EOQ) is the sum of items that a firm ought to order as to minimize the total costs of inventory. These costs include storage costs, shortage costs, and ordering costs. Application of EOQ can be part of a continuous stock review system. Thus, the level of inventory is observed at all times. Additionally, the order of fixed quantity is done whenever the stock level gets to a particular reorder point (Ghasemi & Nadjafi, 2013).
To ensure instantaneous replenishment of inventory with no shortages, the model offers a basis for calculating a suitable reorder point and optimal reorder quantity. The model is an essential tool for small businesses. The owners of the company can apply this model for decisions about how much inventory to hold and the frequency of ordering in order to incur possible minimal costs (Ghasemi & Nadjafi, 2013).
The EOQ model makes assumptions that demand is constant and that depletion of inventory occurs at a fixed rate until it gets to zero. When this happens, the purchasing of a certain number of items is done to replenish the stock to its starting level. Given that the model assumes instantaneous stock up, inventory costs or associated costs do not result. Therefore, under EOQ model, inventory cost involves a tradeoff between inventory storage costs and order costs. Storage costs include cost of holding as well as costs of tying up capital in stock instead of investing or applying it for other purposes. O the other hand, costs of order are any charges involving order placement, such as delivery fees. Taking large orders at the same time increases a small business’s cost of holding, while frequently ordering items minimize storage costs but increase ordering costs. As a result, EOQ model provides the quantity that reduces the sum of these costs (Ghasemi & Nadjafi, 2013).
In business, application of EOQ model comes as a result of applying the model’s formula. The basic EOQ model is an accounting method that establishes the optimal order range, which reduces the sum of holding and ordering costs. Its derivation results from some underlying assumptions. First, the company knows with certainty the number of stocks it requires and demand of the customers. Secondly, throughout the period, the sales made by the enterprise and the number of inventories utilized remain constant (Ghasemi & Nadjafi, 2013).
Thirdly, the refill order is made immediately the moment stocks get to the zero level. Lastly, the lead-time during receipt of the requested items is constant. The model’s full equation is EOQ=square root (2*Quantity*Cost per Order/Carrying Cost per Order). In light of this formula, it is evident that there are two most essential classes of inventory costs. They include ordering and storage costs. The EOQ model assists with the reduction of the two inventory costs through the application of the formula (Ding & Wang, 2009).
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While this model may not be useful for every stock situation, many companies find it essential to some spheres of their operations. Anytime there is repetitive planning or purchasing of an item, EOQ is the answer. The model has obvious applications such as make to stock manufacturers as well as purchase to stock distributors. However, make to order lot ought to reflect EOQ when many orders are placed or dates for similar items during components planning are given.
Economic Order Quantity includes Economic Production Quantity (EPQ), Planned Shortage with Backorders and Quantity Discount Model (discussed below). EPQ model establishes the quantity of total cost of stocks that a firm or a retailer ought to order to minimize by balancing both storage and average fixed ordering costs. In this model, variable costs are yearly carrying, ordering and backorder costs. Combining the optimal order and backorder quantity, the annual cost of the order is a result of the sum of back ordering and annual carrying costs. Like the basic EOQ model, EPQ model too has some underlying assumptions. They includes only a single item, certain demand, constant usage and production rates, no variation in lead time, and unavailable quantity discounts.
Furthermore, EPQ model hypothetically indicates that the produced items have perfect quality, and the rate of production is constant. However, the quality of production relies on many conditions during the process. Due to the deterioration of the process or other aspects, there may be a shift in the production process that can lead to quality imperfection. To correct the defect of the quality items, repairing and reworking are used. Thus, this leads to an overall reduction in costs of inventory production.
In practice, however, it is obvious that cost and time required for repetitive production decrease whenever the number of units produced increases. Consequently, the cost of production cannot be constant. On the other hand, in the Planned Shortage with Backorders model, refilling orders do not arrive either at or before the stock position drops to the zero level. Instead, shortages arise whenever a predetermined backorder quantity is reached when the refill order arrrives (Ghasemi & Nadjafi, 2013).
Quantity Discount Model
In the traditional batch or large production environments, classification of suppliers’ structure of cost is of two classes. First, fixed costs are autonomous of the produced quantity. Secondly, variable costs are proportional to the delivered quantity. Fixed costs, for example, rent, are general to all manufactured products, while other components, such as set up costs, are specific to a product. Large quantity production reduces the setup cost effect entirely and results in minimized cost per item. It is due to this establishment that the traditional approach encouraged high volume production that is standardized and offers quantity-based economies of scale (Ding & Wang, 2009).
Quantity discount model is an approach that takes into account quantity discounts, and it is a form of Economic Order Quantity. Quantity discounts are reductions in price established to induce placement of large orders. Rationality of the quantity discount model is derived from economic benefits of bigger orders. When there are discounts, buyers must weigh the benefits of minimized price of purchase and reduced orders against an increase in holding costs brought by higher average stocks. Thus, the aim of the buyer is to select the order that will reduce total costs which include the sum of holding, purchase and ordering costs (Ding & Wang, 2009).
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The adequacy of the discount depends on the speed with which the standard cost falls as the amount purchased increments. There is a distinction between cuts, where the average value falls in jerks and those where it fall consistently. Increasingly, the cost will fall if the discount given with a certain size applies just to extra units taken past that point. It will fall in rascals in the event that it applies to the first sums, too. On the off chance that the value falls steadily, the size of the discount relies on how close jerks are to one another (Ding & Wang, 2009).
Quantity discount model comprises of two types of discounts - cumulative and non-cumulative discounts. The cumulative quantity discount application is based on cumulative purchases a buyer makes during a particular period, especially during a year rather than on a single order. The justification for these cuts is not because of cost saved from the large size of an order. The primary aim of the discount is customer retention. In light of this, the buyer ought to buy from the same joint to qualify for the discount. On the other hand, non-cumulative discounts depend on the range of a single purchase, and their basis is on cost saving resulting from taking huge orders as compared to small orders. Intermediaries and manufacturers establish a schedule of discounts on procurement of various sizes with rates of discount directly varying with order size. Hence, the discounts do not change based on a particular size of the order (Ke & Bookbinder, 2012).
Moreover, the two kinds of discounts assist the manufacturers both with cost saving during sales and the cost of production. Non-cumulative discounts aid by reducing the company’s production costs as well as planning major production runs. Cumulative discounts help manufacturers with successful utilization capacity of production despite the small amounts of sales. When comparing both types of quantity discounts, it is evident that non-cumulative discounts result in reductions of costs by avoiding collection costs as well as higher packing and transportation costs. On the other hand, cumulative discount advocates for large purchases and rewarding the customers for their loyalty (Ke & Bookbinder, 2012).
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