Relevant Costs
Relevant costs refer to the costs that will be directly affected by a specific decision. In the context of inventory management, these costs are important because they help in making decisions about purchasing, storing, or ordering inventory. They typically include costs such as the purchasing cost, ordering cost, holding or carrying cost, and stockout costs. Relevant costs help businesses in determining the optimal quantity to order and the timing of orders to minimize overall expenses. For instance, when deciding whether to place a new order, relevant costs include the ordering cost and the carrying cost of holding that inventory. Costs that do not change regardless of the decision (sunk costs) are excluded from this analysis.
Economic Lot Size
Economic Lot Size (ELS), also known as Economic Order Quantity (EOQ), is a formula used to determine the optimal order quantity that minimizes the total cost of inventory management. The formula balances the ordering costs (costs associated with placing and receiving orders) and holding costs (costs of storing and managing inventory). The goal is to find the quantity that minimizes both these costs over time. A business that orders in the correct economic lot size reduces the frequency of orders while avoiding overstocking. The EOQ model helps businesses strike a balance between efficiency and cost-effectiveness in their inventory management.
Reordering Point
The reordering point is the inventory level at which a new order should be placed to replenish stock before it runs out. This point is crucial for maintaining smooth operations and preventing stockouts. The reordering point is calculated based on the lead time (the time it takes for an order to be delivered) and the average usage rate of the inventory during that lead time. For example, if a product is consumed at 100 units per day and the lead time is 5 days, the reordering point would be 500 units. By maintaining the correct reordering point, businesses can ensure they have the right amount of stock available without overstocking or running out.
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