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Operations Research and Production Management: Costs Associated with Inventory Problems #ggsipu #bba #mba #inventorymanagement #operationsreserach

Operations Research and Production Management: Costs Associated with Inventory Problems 

Operations Research and Production Management: Costs Associated with Inventory Problems #ggsipu #bba #mba #inventorymanagement #operationsreserach

What is inventory and explain what are the costs that are involved in inventory problems?

An inventory can be defined as a stock of goods, which must be carried out in order to ensure the smooth and efficient running of affairs of a business.

The stock of goods may be kept in any of the three forms.

Raw materials 

Intermediate stage in production size and 

Prepared goods

Thus inventory problem in operation research is to find an optimum decision that is a solution that minimizes the sum of all costs associated with stock of goods.

Costs Involved In Inventory Problems.

The main costs involved in inventory problems may be generally classified as follows:

Holding cost C₁:

The cost associated with carrying or holding the goods in stock is known as holding or carrying cost, which is usually denoted by C₁ per unit of goods for a unit of time. Holding cost is assumed to vary directly with the size of inventory as well as the time the item is held in stock. 

The following components constitute the holding cost:

⒜ Invested Capital Cost: This is the interest charged over the capital investment. Since this is the most important component, careful investigation is required to determine its rate. 

⒝ Record keeping and Administrative cost: This signifies the need of keeping funds for maintaining the records and necessary administration.

⒞ Handling Costs: These include all costs associated with the movement of stock such as the cost of labour, overhead cranes, gantries and other machinery required for this purpose.

⒟ Storage Costs: These involve the rent of storage space or depreciation and interest if the own space is used.

⒠ Depreciation, Deterioration and Obsolescence Cost: Such costs arise due to the items in stock being out of fashion or items undergoing chemical changes during the storage (for example rusting of steel).

⒡ Taxes and Insurance costs: All these costs require careful study and generally amounts to 1% to 2% of the invested capital.

⒢ The purchase price or Production costs: Purchase price per unit item is affected by the quantity purchased due to quantity discounts or price breaks. Production cost per unit item depends upon the length of the production runs. For long smooth production runs, this cost is lower due to the more efficiency of men and machines.

So the order quantity must be suitably modified to take the advantage of these price discounts.

If P is the purchase price of an item and I is the stock holding cost per unit time expressed as a fraction of stock value (say in rupees), then the holding cost C₁=IP

⒣ Salvage costs or Selling price: When the demand for an item is affected by its quantity in stock. The decision model of the problem depends upon the profit maximization criteria and includes the revenue (i.e. sales tax etc.) from the sale of an item. Generally, salvage costs are combined with storage costs and not considered independently.

② Shortage costs or Stock Out Costs C₂:

The penalty costs are incurred as a result of running out of stock. (i.e. a shortage) are known as shortage or stockout costs. These are denoted by CC₂ per unit of goods for a specified period.

These costs arise due to a shortage of goods sales may be lost, goodwill may be lost either by a delay in meeting the demand or being quite unable to meet the demand at all. In the case where the unfilled demand for the goods can be satisfied at a later date (backlog case), these costs are usually assumed to vary directly with the shortage quantity and the delaying time. On the other hand, if the unfilled demand is lost (no backlog case) shortage cost become proportional to shortage quantity only.

③ Setup cost C₃

These include the fixed costs associated with obtaining goods through placing of an order or purchasing or manufacturing or setting up machinery before starting production. So they include the cost of purchase requisition, follow up receiving the goods quantity, quality control, etc. These are also called order costs or replenishment costs usually denoted by C₃ per production run/cycle. They're assumed to be independent of the quantity ordered or produced.


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