#Finding Optimal Inventory
Inventory is scary. Why risk capital? In fact, money can be saved with inventory planning. Below is a simplified example of optimizing inventory and reducing costs.
##Example:
I sell Star Wars posters. Last year, I sold 1000. I ordered batches of 100.
- Cost each: $10
- Printing: $500
- Ordered on credit card at 18%.
Fixed Costs: The $500 fee is flat. I ordered 10 times (annual demand/order size) last year. Fixed costs were $5,000 last year.
Variable Costs: Star Wars posters cost $10 each, and I ordered 1,000. Variable costs were $10,000.
Holding Costs: I order only when I run out, which means my average inventory is order quantity / 2. Last year, that was 50 posters. On average, I had $500 tied up in inventory (50 posters * $10 each). That multiplied by my annual cost of capital (18% credit card rate) finds my holding costs - $90.
Sum = $15,090 annual cost.
###Can I do better?
Use the below formula for quantity:
(2 * setup cost ($500) * annual demand (1,000)) / (cost of capital (.18) * cost each ($10)). Then, take the square root.
Order 745 posters each time (called the economic order quantity - EOC).
That corresponds to the lowest annual cost, found by:
cost each ($10) * annual demand (1,000) + setup (500) * (demand (1,000) / EOC (745)) + (cost of capital (.18) * cost each ($10)) * (EOC (745) / 2)
The best annual cost is $11,341.64.
That’s almost $4,000 saved! Of course, the real world often requires more complexity. There are ways to handle fluctuating demand, lead times, etc. By collecting the information as you go, you can plan and be more cost-efficient.
You are a clever girl.