Inventory Costs
Introduction
Production can be described as a flow concept, which measures the volume of output per unit of time. The efficiency of production refers to the proportion of total resource content that can be transformed into a product that can be sold to the market. There are a number of ways that can be used to improve the efficiency of production techniques that are used by the firm. These strategies are either qualitative or quantitative in nature. They are the subject of discussion in this report.
Raw materials refer to the inputs used in developing the final product. They are the essential ingredients used in creating finished products. Raw materials should be used in such a way that limits wastage. This is because raw materials represent a significant amount of handling, storage and disposal costs. These costs are often passed on to the purchase price of the product. This makes the final products more costly. By reducing wastage of raw materials used in the production of drugs, Smitheford Pharmaceuticals can significantly cut on its cost of production.
Controlling the costs of packaging drugs
The production process is often completed with the packaging of the drugs. For companies operating in the pharmaceutical industry, health and safety of drugs is critical. Packaging can also be used to appeal to customers. Properly packaged drugs are often attractive to buy. However, packaging costs can often increase the cost of production to a great extent. The company should adopt technology that is cost effective and safe at the same time in order to reduce the cost of production.
Managing of the costs of labor
Production plants usually require personnel to facilitate the production of output. However, the pay that manufacturing employees are usually entitled to constitute a significant part of the production cost. In order to curtail such increases in the cost of labor, the company should consider the use of an automated system of production that will require less manpower to operate. This will have the effect of significantly reducing the cost of production.
Implementing continuous improvement programs
In order to improve the efficiency of production, the company should continuously seek to upgrade its production facilities. With time, the machines that are used for production wear out and become less efficient. It is important that the company adopts a replacement mechanism where old machines are replaced with new, modern and more efficient equipment. This will help reduce the machine hours lost when the old machines fail to work due to break down.
Setting of production targets
It is important that the company sets production targets for its plants. These targets act as benchmarks against which production goals and objectives are considered. This ensures that the company can supply products in amounts that meet the demand of the customers. By producing and selling their products in the necessary amounts, the company will be able to realize improved profitability levels.
Adhering to production schedules strictly
One of the major problems that production plants face is to meet their production time lines. This situation is often to poor preparedness and anticipation on the part of production managers. This can lead to significant loss of revenue since the company cannot do business without the products. Managers in charge of production plants should ensure the smooth functioning of all systems so that production remains uninterrupted.
Working calculations
- EOQ= square root of [2RS/CI]
Where R=total demand
S=ordering cost per order
C=cost per order
I=inventory carrying cost
EOQ = square root of [(2*400000+28)/ (48*0.15)] =1763.83units
- Total cost= ordering cost + holding cost
Ordering cost= RS/EOQ= (400000*28)/1763.83
=6349.21
Holding cost= (EOQ*CI)/2
= (1763.83*48*0.15)/2
=6350.4
Total cost at EOQ= 6349.21+ 6350.4
= 12699.61
If quantity is equal to 1000units, then;
Total cost = 400000*0.15+(400000*28)/1000+ (1000*48*0.15)/2
=60000 +11200 +3600
=74800
- How much would the TC increase if the order quantity must be 1,000 units?
Total cost= 400000*0.15+ 400000/1763.83+(1763.83*48*0.15)/2
=60000+6349+6350.9
=72699.9
- How is JIT (just-in-time) ordering methodology different from EOQ methodology?
- The demand for the item is known and is constant for the EOQ methodology whereas for the JIT methodology it is unknown and variable.
- The lead time for EOQ methodology is also known and constant whereas for the JIT methodology it is unknown and variable.
- In EOQ methodology, quantity discounts are not allowed. In JIT methodology, quantity discounts may be allowed.
- The price per item is fixed in EOQ methodology while in JIT methodology, it is variable.
- For EOQ methodology, the cost of managing inventory comprises of the ordering and carrying cost only while in JIT methodology it is made up of carrying cost only.
- Within the range of quantities to be ordered, the per unit holding cost and the ordering cost per order are fixed and independent of the quantity order for EOQ methodology. For JIT methodology, the ordering cost per order is variable and dependent on the quantity order.
Conclusion
Smitheford operates in an industry that is extremely sensitive because its business pertains to the health of its customers. The sensitivity of its business makes it important to make its products affordable to the general population. In order to achieve this, production costs will have to be kept down. This will be done by adopting the measures discussed in the report. In addition, production of output should be maintained at the economic order quantity. This will ensure that the company produces its products at an efficient output level.
References
Frazelle, E. (2002). Supply chain strategy: The logistics of supply chain management. New York: McGraw-Hill.
Muller, M. (2003). Essentials of inventory management. New York: AMACOM.
Zipkin, P. H. (2000). Foundations of inventory management. Boston: McGraw-Hill.
