Holding Cost

 Holding costs are those associated with storing inventory that remains unsold. These
costs are one component of total inventory costs, along with ordering and shortage
costs. A firm’s holding costs include the price of goods damaged or spoiled, as well
as that of storage space, labor, and insurance.
 In order to minimize the holding costs and other inventory spending, calculate the
reorder point or the level of inventory that alerts the company to order more
inventories from a supplier.
 Larger order size results in lower order costs because fewer orders need to be
placed to cover the annual demand. This however results in higher holding costs
because of the increase in inventory levels.
 Smaller order size results in lower holding costs because of the decline in average
inventory level. However, as lower quantity of inventory is ordered each time, the
number of orders needed to increase in order to fulfil the annual demand which leads
to higher ordering costs. Reducing the order size may also affect the cost of
purchase due to the loss of trade discounts that are based on the order quantity.

Shortage

 Mismanaged inventory can lead to a surplus of goods, causing financial losses due
to additional storage costs, spoilage, taxes, insurance, and other issues. On the other
hand, inventory shortage can result in an inability to meet customer demand, leading
to reduced sales and profits.

 Economic Order Quantity (EOQ) is one of several lean inventory management

techniques utilized to increase the efficiency with which inventory is handled.

 Since no fluctuation in demand is considered in the EOQ calculation, business losses

due to potential shortage of inventory are ignored.

Order Cost

 Economic Order Quantity helps the company’s cost of ordering to minimize.

 EOQ considers the timing of reordering, the cost incurred to place an order, and
costs to store merchandise. If a company is constantly placing small orders to
maintain a specific inventory level, the ordering costs are higher, along with the need
for additional storage space.
 The costs remain constant and unchanged for the period, irrespective the number of
orders to be placed. As the ordering cost per order is constant, the relationship
between the quantity ordered and number of orders to be placed is negative.
 Higher the quantity ordered (Q) per order, lower the number of orders to be placed;
and lower the quantity ordered (Q) per order, higher the number of orders to be
placed.

Relevance in general Economic Order Quantity in:

Trading

 The EOQ model seeks to ensure that the right amount of inventory is ordered per
batch so a company does not have to make orders too frequently and there is not an
excess of inventory sitting on hand. It assumes that there is a trade-off between
inventory holding costs and inventory setup costs, and total inventory costs are
minimized when both setup costs and holding costs are minimized.

Service

 Most of the service parts especially in the automotive and the engineering industry
have an immediate demand; the service part has to be available on stock. Since
the forecast is always just an estimation of the future demand, it is necessary to
compensate the deviations from the real demand (and the irregularities of the
supply) by safety stock.

Manufacturing Business Decision Making

 Manufacturing industries have to select appropriate manufacturing strategies,

product designs, manufacturing processes, work piece and tool materials, and
machinery and equipment.
 In order to have a successful business, decision making would be a big help in the
production of the business.
 In the businesses, good management of inventory is essential. The management of
inventory requires a number of decisions. Poor decision making regarding inventory
can cause: Loss of sales because of stock outs, Depending on circumstances,
inadequate production for a period of time, Increases in operating expenses due to
unnecessary carrying costs or loss from discarding obsolete inventory and an
increase in the per unit cost of finished goods.
NAME: Mae Carla M. Cornelio

COURSE: BSMAC-1

CASE ANALYSIS:
A CASE STUDY IN AUTOMOTIVE INDUSTRY

1. Definition of the Problem

The Japanese company automotive component in Indonesia is one of the fastest

growing industrial firm among the automotive component companies. The Main
products are copper material used by automotive industry for light, switch, electric
panel components of two-wheeled vehicles and four-wheeled vehicles. The material
is “Cooper A (C2680R-1/2H Sn0.4* 56.5)” hereinafter cal-led “Material XA1” and
“Cooper B (C2600R-1/2H Sn0.8* 108)” hereinafter referred to as “Material XA2”.

The company seeks to meet increasing customer demand but on the other hand
strives for optimal inventory cost, also demanded by the holding company in Japan
for faster turnover of money or in other words known as Inventory Turnover Ratio
(ITR) and that should be in minimal or small numbers. This means that the goods in
the order must be as needed (not excessive and also no shortage).

The company is facing the higher cost than to their sales.

2. Supporting Facts

Materials

From the above data it can be concluded that both the purchasing (XA1 and XA2)
materials are greater than the sales, and specifically indicate the XA1 material order
is generally almost evenly distributed on every order, because of the total of 9 orders
only 2 orders of distances below the average in February 2016 (815.5 kg) and
October 2016 (721 kg). While the XA2 ordering material that was well below average
only occurred in May 2016 (657.6 kg) of total purchasing alignment in that month.

Table 1. Two Types of Materials

 Supplier Japan Koyo Company Japan Koyo Company
Materials “Cooper A (C2680R- “Cooper B (C2600R-
1/2HSn0.4*56.5)” 1/2HSn0.8*108)”

Material XA1 Material XA2

Based on the Figure 1 above, XA1 linear material purchase increased signify-cantly
with an average of 2,180.9 kg/order, whereas for XA2 material linearly decreased
with an average of 1,656.6 kg per order.

No. Month Material XA1 Material XA2

Purchase Sales +/– Purchase Sales
[kg] [kg] [kg] [kg] +/–
1 Janu 1,327.50 -1,327.50 1,418.80 -1,418.80
ary
2 Februar 815.50 363.50 452.00 1,291.6 1,768.6 -477.00
y 0 0
3 March 1,544.50 -1,544.50 3,401.80 1,903.60 1,498.20
4 April 2,530.0 1,669.0 861.00 1,380.6 1,069.2 311.40
0 0 0 0
5 May 1,916.5 1,928.0 -11.50 657.60 1,297.0 -639.40
0 0 0
6 June 2,682.5 1,307.0 1,375.5 2,138.4 423.60 1,714.8
0 0 0 0 0
7 July 2,913.00 1,571.00 1,342.00 1,012.40 -1,012.40
8 August 1,929.0 2,296.0 -367.00 1,069.6 1,025.8 43.80
0 0 0 0
9 Septemb 2,398.00 1,761.00 637.00 220.40 -220.40
er
10 October 721.00 1,538.50 -817.50 641.40 -641.40
11 Novembe 3,722.50 1,587.00 2,135.50 450.80 -450.80
r
12 December 2,377.00 -2,377.00 405.00 -405.00
Amount 19,628.0 19,270.0 358.00 9,939.60 11,636.6 -1,697.00
 0 0 0
Frequency 9 12 6 12
Average 2,180.90 1,605.80 1,656.60 969.70
Note: +/– (plus/minus)

Data of Purchasing in 2016

In general, the two materials when viewed from the EOQ side are equally less
optimal, because the order frequency is relatively high, XA1 material orders nine
times a year, and XA2 material has six orders in a year. This is certainly very
influential on the cost of ordering, where the total cost of ordering in one year is high
enough, and the impact on the total cost of inventory.

Type of Cost

Ordering Cost

The cost of material ordering is the cost incurred in connection with material ordering
i.e. the cost of material exemption from customs (customs clearance) including the
cost of transportation. The length of material release is directly pro-portional to the
ordering cost. The availability of original document shipment from the supplier will
have an impact on the booking fee. Because without the original document
shipment, material exemption process can not be done, this is because the company
does not do the material release directly but hire the services of For-warder. In
addition, the size of the container will also impact on the cost of booking earlier. The
ordering cost in 2016 for the purchase of the material was US$633 per kilogram.

Table 3.
No. Month Total of Ordering Cost
XA1 [US Dollar] XA2 [US Dollar]
1 January – –
2 February 516,212.00 817,583.00
3 March – 2,153,339.00
4 April 1,601,490.00 873,920.00
5 May 1,213,145.00 416,261.00
6 June 1,698,023.00 1,353,607.00
7 July 1,843,929.00 –
8 August 1,221,057.00 677,057.00
9 September 1,517,934.00 –
10 October 456,393.00 –
11 November 2,356,343.00 –
12 December – –
Amount 12,424,526.00 6,291,767.00
Frequency 9 6
Average 1,380,503.00 1,048,628.00

Holding Cost

The expense of material storage is the cost incurred in relation to the storage of
materials in the warehouse. In this case the company rents a warehouse from a
storage rental firm. These costs include labor costs, insurance costs, warehouse
leases, electricity consumption, water use, and telephone utility.

Below is a Table 4 that provides information about the holding cost component

Table 4. Component of Holding Cost

Holding Costs Cost in million [US Dollar]

 Per year
Labor Cost 48.00
Insurance Fee 222.00
Storage Rental Fee 52.00
Electricity Bill 46.00
Water Usage 1.00
Telephone Bill 5.00
Total 374.00

From the data of holding cost in the Table 4 above, the biggest cost component was
insurance that must be paid annually (US$ 222 million per year) or contributed
59.35% of total holding cost (US$ 374 million per year). This should be the com-
pany’s attention that meant it should be more observant to analyze the amount of
material that must be stored because it will directly affect the cost of insurance,
which in turn has an effect on the amount of holding costs.
3. Objective

The objective of Japanese company automobile is to seek many customers demand

from their business that will really benefit and increase their profit. They wanted to
reduce the cost of their materials so that it will lessen to their expenses. They also
wanted to have a faster turnover of money (ITR), it is very important for the
company so that they will determine how fast they sell their products.

4. Alternative Courses of Action

Application of Economic Order Quantity (EOQ) Method

EOQ applies only when demand for a product is constant over the year and each new
order is delivered in full when inventory reaches zero. There is a fixed cost for each
order placed, regardless of the number of units ordered. There is also a cost for each
unit held in storage, commonly known as holding cost, sometimes expres-sed as a
percentage of the purchase cost of the item. Our draft is to determine the optimal
number of units to order so that we minimize the total cost associated with the
purchase, delivery and storage of the product.

The required parameters to the solution are the total demand for the year, the purchase
cost for each item, the fixed cost to place the order and the storage cost for each item
per year. Note that the number of times an order is placed will also affect the total cost,
though this number can be determined from the other parameters.

5. Analysis of Alternatives

Economic Order Quantity (EOQ) Calculation Results

Descriptions Material XA1 Material XA2

Quantity of sales per period 19,270.00 11,637.00

[kilogram per year]

Cost per order [US Dollar] 1,380,503.00 1,048,628.00

Storage cost per kilogram per 374.00 374.00

period [US
Dollar/kilogram/year]

EOQ within kilogram 11,927.00 8,078.00

In the Table above the optimal purchase amount of material each time the message is
XA1 = 11,927 kilograms and XA2 = 8,078 kilograms respectively with the purchase
frequency of each material XA1 = 1.6~2 times (19,270/11,927) orders in one year, and
material XA2 = 1.4~2 times (11,637/8,078) orders in one year.

Taking into account the same storage costs for material XA1 and material XA2 stored in
the storage place or warehouse, material EOQ XA1 was greater than 47.6% or 3,849
kilograms compared to material XA2. This effort was done by the company to avoid the
frequency of reservations that required the cost of US$ 1,380,503 per order.

6. Conclusion

Inventory control and maintenance is a vital issue experienced by almost all sec-tors of
the economy and this issue becomes very important topic because all orga-nizations
handle inventory every day. Ignoring the importance of inventory in any organization
can lead to the closure of the company, especially if the production factor is not properly
managed to meet the needs or desires of the customer, the company will stop. The
inventory issue consists of a sufficient supply of goods when desired by the customer.
The stock of goods must be reasonable, meaning it should not be too much or too little.
Companies must be in a position to meet customer demand in terms of quantity and
quality.

In general terms, inventory or stock is considered to be a major theme in mana-ging

materials. Inventory Turnover Ratio (ITR) is a barometer of performance of material
management functions because the ratio should be in minimal or small numbers. In
commonly understood terms, inventory means the inventory of physical goods stored in
the store to meet anticipated demand. However, from a material management
standpoint, the other inventory definition is a usable but idle resource that has some
economic value. This brings forward a paradox in the concept of inventory that is
considered a necessary evil. It is necessary to have a physical stock in the system to
meet anticipated demand because unavailability of materials when required will result in
delays in production or projects or services provided. However, keeping inventory is not
free because there is an opportunity cost to carry or hold the inventory within the
organization. So, the paradox is that we need inventory, but no need to have an
inventory. This is a paradoxical situation that makes inventory management a
challenging area of issues in materials management. It also creates a high inventory
turnover ratio as the desired performance indicator.

In inventory management, Economic Order Quantity (EOQ) is the quantity of orders that
minimize the total cost of containment and booking fees. This is one of the oldest
classical production scheduling models. The EOQ mathematical model has been
established within the scope of operations management to determine optimal inventory
levels. The assumptions made in the EOQ formulation confine the use of formulas. In
practice the cost per unit of item purchase changes over time and lead time is also
uncertain. This is necessary for the application of the EOQ command to keep the
demand constant throughout the year that is not possible. Ordering the cost per order
cannot be constant as it includes transportation costs. The booking fee is the cost to
order and receive the stockpile. This includes determining how much is needed,
preparing invoices, transportation costs and inspection fees. Cost shortcoming occurs
when demand exceeds inventory at hand. Costs include opportunity cost to make a
sale, loss of goodwill of customers, same cost of delay and similar cost.

7. Recommendation

Economic Order Quantity would be a big help to the company of Japanese

automobile. In order to lessen their cost to their product materials, they should use
the Economic Order Quantity and its method so that they would able to predict their
cost and compare it to their sale for the year. It would be big help to maintain a
consistent inventory level of their company.
Case Analysis:

A CASE STUDY OF SHPRESA LTD, ALBANIA

1. Definition of the Problem

"Shpresa” Ltd has started its activity in 1992, in the small town of Permeti, where the
main activity was cleaning and Greening the City, and Maintenance of Public Cemetery.
Further, in 1998 the activity has moved to Tirana. Now "Shpresa” deals with:
Reconstruction, Construction, Cleaning, Greening, Maintenance and Food public
entities, such as hospitals, catering and Urban Design etc. One of the activities of "Hope
Ltd" is the marketing of natural flowers, which supply in the Netherlands and sells in
Albania. It carries out wholesale sales to 80% of retail points in Tirana, and also
distributes in the cities of Shkodra, Lezha, Elbasan and Durres. Apart from wholesale
sales, this company carries out retail sales. Due to the inability of the collection of data
for all activity, inventory analysis have applied only to retail sales.

Current forecasting model used by "Shpresa Ltd" has brought some problems due to
inaccurate
forecasting, which has resulted in the further expected and damaged, and loss of sales.
Forecasting method used is the simple average, ie estimated average requirements
(future)
based on average historical demand, but this has led to inaccurate predictions.

The company "Shpresa" ltd, Albania is facing an ineffective predictive method, which
caused the excess stock in the warehouse, loss of sales, and also loss of earnings.

2. Supporting Facts
The Method of Tabulation
We list the significant annual costs for different order quantities. The purpose of this
method is to find which amounts significant annual total costs are minimal. In the level
of 128orchids vases, the level of total significant costs are lower than for other ordering
quantities, at the value of € 263.84.

Table 1: EOQ through Tabulation Method

The 80 90 100 128 130 150
quantity of
order
Avverage 40 45 50 64 65 75
stock in
 units
No of 15 13.33 12 9.375 9.2308 8
purchase
orders
Annual 82.4 92.7 103 131.84 133.9 154.5
holding
Cost
Annual 211.2 187.733 168.96 132 129.97 112.64
Ordering
Cost
Total 293.6 280.433 271.96 263.84 263.869 267.14
Significant
Cost

Graphical Method
According to the graphical method, economic order quantity is found at the point where
the cost
of holding is equal to the cost of ordering . So EOQ point is found where these curves
intersect
one another. For the orchid flower the curveof holding costs is crossed with the ordering
curve
at the value of € 132 and the amount of 128 units, which is the optimal order quantity.

Figure 2: EOQ through Graphical Method

Reordering Point
The delivery time for “Shpresa” Ltd is 2 weeks. This amount of time is considered as the
most
significant interval and includes the moment when the order is made and the moment
when the
order is delivered.

For Orchids the Economic Order of Quantity is 128 units per order. Since the annual
demand is 1200 units, then the firm should make approximately 9 orders in a year. The
firm
works 52 weeks a year, so the order should be made approximately every 6 weeks.

The weekly usage of orchids is calculated dividing the annual demand with the number
of the weeks the firm works in a year.
1200⁄52 ≅ 23 𝑢𝑛𝑖𝑡𝑠⁄𝑤𝑒𝑒𝑘𝑠.

Reorder Point for Orchids

Figure 3- Reorder Point for Orchids

Since the most significant interval is two weeks then the firm should make an order
when the
stock level is at 92 orchid vases.

3. Objective
The objective of the company of SHPRESA LTD is to have relevant information about
their forecasting that will give to their business a high profit.

4. Alternative Courses of Action

Application of EOQ model to "Shpresa" [Link]

Significant and Irrelevant cost

Significant Costs
Significant Costs affecting the determination of the optimal inventory levels are the
holding costs
and ordering costs. Significant holding costs are only those that differ with respect to
inventory
levels. This includes the opportunity cost of holding funds invested in stocks, which is
reflected
by the lost of wanted return from investing in stocks compared with any other
investment
alternative. For our firm the required return is 25%.
In other holding costs it is included electricity used for lighting of flowers and
refrigerating
equipments. Society pays 20,000 ALL per month for electricity, and taking the exchange
rate
140, the cost of electricity goes to € 1,714 for 12 months.

In ordering costs there are included costs for transportation and telephone , which relate
to the number of units ordered. "Shpresa" Ltd Society makes a supply once every two
months
and the charge is € 15,000. Society pays 10,000 ALL per month for phone expenses,
and
taking the exchange rate 140, the phone costs go to € 857 per year.

Irrelevant costs
Irrelevant costs include those costs that are not affected by changes in the levels of
inventories,
such as employee salaries, depreciation of equipment, fixed rent of equipment and
buildings etc.

5. Analysis of Alternatives
Economic Order of Quantity EOQ can be determined reflecting the total costs for
different amounts of orders via three methods: the formula, tables and graphical
representation. The methods use to see the right forecast and to other cost of
business. It gives relevant information to the business.
So, the economic order for the orchid vases is approximately 128 vases per order.
Since the firm currently orders 88 vases, it should increase the amount of the order for
up to 128 orchids vases, in order to minimize costs.
According to the graphical method, economic order quantity is found at the point where
the cost of holding is equal to the cost of ordering . So EOQ point is found where these
curves intersect one another. For the orchid flower the curveof holding costs is crossed
with the ordering curve at the value of € 132 and the amount of 128 units, which is the
optimal order quantity.
In the method of tabulation, the level of 128orchids vases, the level of total significant
costs are lower than for other ordering quantities, at the value of € 263.84.

6. Conclusion
The use of the EOQ model in inventory management for "Shpresa Ltd" will result in
reduction of the cost of ordering and inventory holding costs, and as a result, the
reduction of the total cost. Although this method cannot be fully adaptable by this
company due to the distance with the place of supply, and limited opportunities for
frequent reorders. As we see, this method requires the Company to make reorders for
orchids every 6 weeks, and the company actually makes an order every 8 weeks due to
the remoteness of the supplier country.

A further limitation to the adoption of this method is the use of incomplete information, in
relation to products, as in the analysis made, we consider only the flower of the orchid,
which is sold in vase, while this firm trades a variety of products for which will result in a
different reorder point for these products. Also other important variables, such as annual
demand for wholesale were left out of the analysis. As a conclusion we can argue that
this model is perfect theoretically, but not very suitable from the practical perspective of
this firm.

7. Recommendation
Economic Order Quantity is very significance in the business to maintain a
consistent inventory level and to reduce costs. It would be really big help to the
business when using the methods of EOQ and the company needs to have an
appropriate data to ensure that the business has no loss and also the methods will give
a profitable business.