Raw Material Inventory Analysis with Economic
Order Quantity Method
Mahlia Muis
Muh. Taufik
ABSTRACT
This study aims to determine the economic order quantity (EOQ), safety stock, reorder point,
and the total cost of raw material inventory (paper) at Harian Tribun Timur Makassar. The
data used in this study consisted of qualitative and quantitative primary and secondary data
related to the supply of paper as the company’s critical raw material. Primary data were
obtained through direct observation and interviews with various stakeholders. Secondary
data obtained from documents and company management reports. Results of this study
indicate that the application of the EOQ method in Harian Tribun Timur Makassar is more
efficient than the simple method currently being used by the company. Application of this
method emphasizes the importance of planning for the company's inventory particularly to
manage their raw materials in the production process.
A. Keywords: economic order quantity (EOQ); safety stock; reorder point; total cost of
inventory INTRODUCTION
In general, the purpose of a company, whether they are a manufacturing or other
organization is to economically produce goods in order to make a profit and be able to carry
out the production process in a timely manner. Furthermore, the company also wants to be
able to sustain its production processes and development in order to ensure continuous
production process. This is becoming necessary for any organization in this modern era, as
the advancement of science and technology is rapidly increasing demands that force a
company to be more competitive in order to compete with other companies as well as
capture the existing market. Therefore, companies must be able to execute its business
strategy in order to maintain their credibility so as not to adversely affect the company.
Furthermore, in order to produce a quality product, the company must pay attention
to every detail in the production process. In relation with this, one of the most important
things that must be managed by the company in the production process is inventory,
because inventory is one of the most expensive assets for many companies as company
could reduce costs by reducing inventory. However, this option could in the other hand force
production to be halted and customers become dissatisfied when the order is not available,
which in turn could cause a reduction in revenue generated by the company. (Lapin, Whisler,
2006) Therefore, companies must be able to adjust the balance between their investment in
inventory and their orientation toward customer service . Large inventory is therefore
inefficient because of a huge cost in maintaining it, while a small inventory could also put
company at a high risk that would halt company production process, this paradox makes
inventory management become critical (Render, Stair Jr. 2000).
One of the inventory model that most widely used is the Economic Order Quantity or
EOQ models . EOQ method trying to achieve a minimum level of inventory , lower costs and
better quality .By employing EOQ method to handle their nventory planning, a company
would be able to minimize the out-of-stock so it does not interfere with the production
process within the company, while at the same time be able to reduce their raw material
cost. Thus, with the implementation of the EOQ, company is expected to reduce storage
costs, reduce space usage in their warehouse and work floor, while at the same time resolve
the problems arising from accumulating too many supplies and thereby reducing the risk that
can be caused due to excess inventory in storage or warehouse space (Chase, Jacobs,
Aquilano, 2004)
EOQ model is one of the earliest inventory control techniques and most widely
known (Render, Heizer , 2005) . By applying this method , at least the company is able to
take into account the amount of production with existing inventory , and when to reorder
(reorder point) to produce in the next production phase to ensure the sustainability of their
production process.
INVENTORY LEVEL
Order Quantity = Q
(maximum inventory
level)
Usage Level
Average
𝑄
Inventory ( )
2
Minimum
Inventory
0
TIME
Figure 1. Inventory Usage Level from Time to Time (Render, 2005)
Harian Tribun Timur Makassar with their main business in the mass media sector
particularly newspaper is using paper as their main raw material. This situation make their
daily operation process is very dependent on the availability of paper so that they could
produce newspaper. Thus, it is necessary for this company to ensure that they conduct good
inventory planning to maintain their production process.
The critical role of paper as the main raw material in producing newspaper in this
company made the management at Harian Timur Makassar should be able to plan the
supply of raw materials as appropriate as possible. And this is becoming more and more
critical in order to keep the production process run as smoothly as possible, as well as to
guarantee the availability of raw materials at the time the newspaper will be produced
according to their schedule or when they experiencing delays from the agreed schedule .
Therefore, the level of raw materials inventory that below the minimum threshold
could hamper the production process and cause operational congestion. Vice versa, when
the level of inventory is becoming too high, then there is a buildup of raw materials that
would increase company’s holding cost. Therefore, it is necessary to ensure that a certain
method is employed by company’s management in order to enable them to control the
supply of raw materials in order to expedite the process of production in a sustainable
manner.
In relation with the analysis that would be conducted in this paper, then the research
question of this study can be formulated as follows:
1. What is the optimal order for paper as company’s raw material in Harian Tibur
Makassar?
2. What is the order frequency for paper in Harian Tribun Timur Makassar?
3. What is the amount of safety stock for paper that should be set by Harian Tribun Timur
Makassar?
4. When should Harian Tribun Timur Makassar set the reorder point for their raw materials
(paper)?
5. What is the total cost of their paper inventory that should be issued by this company?
B. RESEARCH METHODOLOGY
The study was designed to employ case study method in which the research was
conducted in an intensive, detailed and depth manner on the object or certain symptoms
associated with this research. Thus, the object of study is relating to the overall supply of raw
materials and its use (paper) in Harian Tribun Timur Makassar.
As for the analysis, we were using secondary data that directly obtained from the
company. In this study, secondary data is in the form of actual usage of raw materials, raw
materials inventory forecasting, inventory of raw materials, EOQ, ordering/setup cost ,
holding cost, Reorder Point (ROP) , safety stock and total cost .
This led us to decide to use some of the techniques of data analysis as follows:
1. Analysis using EOQ method to determine the number of optimal ordering or setup
cost that would give an indication on the amount of EOQ needed (Render, 2005).
2. Ordering/setup frequency analysis is used to count how many times order should
occurred per year with reference to the calculation of EOQ method.
3. Analysis on the total cost of raw material inventory to calculate the costs resulting
from the ordering/setup costs and holding costs.
4.
Reorder Point (ROP) analysis to determine the use of lead-time, which added with
the use of a particular period as a safety stock.
5. Lead time analysis to determine the time lapse between orders (Baroto, 2002).
C. ANALYSIS AND DISCUSSION
Raw Material Inventory Control with Current Non-EOQ Method
The company has their own factory that could ensure the continuity of the newspaper
production process. They also have determines the amount of final inventory and daily
condition of paper stored in their warehouse in the morning and afternoon by employing
what is known in the production process as continuous review. This put the warehouse
operator to make a record on all goods being put or taken from the warehouse that would
then enable warehouse administration to make a daily report in timely manner. However, the
determination on the amount that should be purchased or ordered for paper in their
production plan per month is based on their past experiences and knowledge that herewith
will be referred as the non-EOQ method. The amount of order or setup quantity under this
simple method is presented in Table 1.
Table 1. Paper’s Ordering/Setup Amount in 2012
Month
Order/Setup Amount
Januari
110.090
Februari
114.410
Maret
April
119.027
Mei
125.254
Juni
Juli
115.375
Agustus
179.947
September
Oktober
140.501
November
163.705
Desember
445.152
Total
1.513.461
Rata-rata
126.122
Source: Harian Tribun Timur Makassar, 2012
Moreover, with this non-EOQ method, the company put an order on the 7th day in
each month, as it is expected that the raw materials ordered will arrive at mid-month or about
21st day each month, because of the waiting time (seven days). In 2012, the company only
put as much as nine order as management assume that the initial inventory amount in
March, June and September is sufficient for next month production process. This production
policy put the total order quantity of 1.513.461 kg and made them to bear high holding cost
in order to store paper in their warehouse (Rp.259.595.552).
Order quantity and average inventory levels based on the actual condition of the
company in 2012 are shown in Table 2. At general, we could state that the company’s order
amount is fluctuates as the amount of order is very much depended on the initial inventory
they had. We also note that their biggest paper order amount is occurred in December 2012,
which accounted for as many as 445.152 kg.
Table 2. Order Quantity and Average Inventory Level
Initial
Month
Inventory
January
463.897
February
449.059
March
448.826
April
310.934
May
288.798
June
273.215
July
119.432
August
98.446
September
142.580
October
12.191
November
4.022
December
30.743
Total 2.642.143
Average
220.179
Order
Quantity
110.090
114.410
119.027
125.254
115.375
179.947
140.501
163.705
445.152
1.513.461
126.122
Total
Initial
Inventory
573.987
563.469
448.826
429.961
414.052
273.215
234.807
278.393
142.580
152.692
167.727
475.895
4.155.604
346.300
Usage
124.928
114.643
137.892
141.163
140.837
153.783
136.361
135.813
130.389
148.670
136.984
124.880
1.626.343
135.529
Total
Final
Inventory
449.059
448.826
310.934
288.798
273.215
119.432
98.446
142.580
12.191
4.022
30.743
351.015
2.529.261
210.772
Average
Inventory
Level
511.523
506.148
379.880
359.380
343.634
196.324
166.627
210.487
77.386
78.357
99.235
413.455
3.342.433
278.536
Total inventory cost for paper as company’s raw material per year is total ordering
cost plus total holding cost per year. Ordering cost is obtained from the number of orders
multiplied by order cost each time an order being made. Whereas, the holding cost is
obtained by multiplying the holding cost per kilogram per year with average inventory levels
of raw materials per year. Amount of inventory stored in the warehouse is the average
amount of inventory obtained from the sum of beginning inventory and ending inventory
divided by two.
The amount of the total inventory that is based on the actual condition of the
company is presented in Table 3. Total cost of paper inventories amounting to
Rp.290.138.708 per year at a cost of order per year (Rp.30.543.156) for a total of nine order
and holding costs per year amounted to Rp.259.595.552. The greater the amount of
inventory stored in the warehouse, the greater the cost of storage. Similarly, the greater the
frequency of bookings made by firm, the greater the cost of ordering.
Table 3. Total Cost of Raw Materials Based on Actual Conditions in 2012
Raw
Material
Paper
Ordering Cost
per Year (Rp)
[a]
30.543.156
Holding Cost per
Year (Rp)
[b]
259.595.552
Total Inventory
Cost (Rp)
[a + b]
290.138.708
Raw Material Inventory Control with EOQ Method
This section particularly deals with a situation when a company uses EOQ method to
control their raw material inventory. We use EOQ method as the conditions, characteristics
and needs of Harian Tribun Timur Makassar falls perfectly under the assumptions in the
EOQ method as follows: (1) the company has a fixed and independent demand; (2) constant
lead time; (3) immediate inventory receipt; (4) no quantity discount; (5) the component of the
variable cost that related to managing their inventory is related only to ordering cost and
holding cost; and finally (6) order could be fulfilled immediately when the order is put a timely
manner through the use of reorder point.
The EOQ method employed here would allow company to determine the amount of
economic raw material order quantities most that meet the amount of demand and constant
lead-time. Calculation of the optimal order quantity of raw materials in 2012 is presented in
detail in Table 4.
Table 4. Calculation of Optimal Order Quantity of Paper in 2012
Raw
Material
Paper
Demand
[D]
1.626.343
Ordering/Setup
Cost
[S]
3.393.684
Holding
Cost
[H]
932
EOQ (Q*)
[√𝟐𝐱𝐃𝐱𝐒/𝐇]
108.830
Based on the results of the EOQ calculations in Table 4, we found that the optimal
order quantity for paper in 2012 is as many as 108.830 kg per order. Referring to the EOQ
method, this allows us to determine the frequency of new orders. Calculation on the optimal
ordering frequency of paper is presented in Table 5.
Table 5. Calculation on the Optimal Ordering Frequency of Paper in 2012
Raw
Material
Paper
Demand
(D)
[a]
1.626.343
EOQ
(Q*)
[b]
108.830
Frequency
(Times)
[a / b]
15
Frequency of order for paper based on the EOQ methods suggest that Harian Tribun
Timur Makassar should made more frequent order (15 times per year) than compared with
the frequency of ordering that has been done based on the current method being employed
by this company (9 times per year).
We realize that the EOQ method give an emphasis on greater frequency of ordering,
and thus put the company to bear greater ordering cost, nevertheless this would made
Harian Tribun Timur Makassar bear less holding cost. However to provide throughout
analysis on this situation, we must pay attention the total inventory cost to find the most
efficient inventory method. Total cost of inventory under the EOQ method is the sum of the
total cost for the ordering and holding costs per year. Calculation of the total inventory cost is
presented in Table 6.
Table 6. Total Cost of Raw Material Inventory Based on EOQ Method in 2012
Raw
Material
Paper
Ordering Cost
per Year (Rp)
[a]
50.905.260
Holding Cost per
Year (Rp)
[b]
50.714.780
Total Inventory
Cost (Rp)
[a + b]
101.620.040
Inventory control using EOQ method resulted in a total cost of Rp.101.620.040, with
the ordering cost of Rp.50.905.260 and the holding cost of Rp.50.714.780. Presentation of
the cost of raw material inventory using the EOQ method in the form of images is presented
in Figure 2.
Total Cost
Total Cost
Ordering Cost
Rp. 101.620.040
Holding Cost
Frequency (times)
15
Figure 2. Raw Material Inventory Cost with EOQ Method
Comparison of Raw Materials Inventory Cost
The current simple method (non-EOQ method) that has been done by the company
could be compared with the EOQ method obtained from this analysis. It is hope by
comparing the results, the company in the better position to determine which method will
yield the minimum cost and to ensure them to employ a more effective inventory method in
the future. The comparison is presented in Table 7.
Table 7. Comparison between the Inventory Cost of Paper between
Non-EOQ Method and EOQ Method
Description
Paper
Total
(Rp/Tahun)
(Rp/Tahun)
I. NON-EOQ METHOD EMPLOYED BY COMPANY
1. Ordering/Setup Cost
30.543.156
2. Holding Cost
259.595.552
3. Inventory Cost (1+2)
290.138.708
290.138.708
Total Biaya Persediaan
II. EOQ METHOD
4. Ordering/Setup Cost
50.905.260
5. Holding Cost
50.714.780
6. Inventory Cost (4+5)
101.620.040
101.620.040
Total Biaya Persediaan
III. SAVINGS
7. Ordering/Setup Cost
-20.362.104
8. Holding Cost
208.880.772
9. Inventory Cost (7+8)
188.518.668
188.518.668
Total Penghematan
In Table 7 we know that by using the EOQ method, companies could save as much
as Rp.188.518.668 per year. Even though the EOQ method suggest higher ordering costs
(Rp.50.905.260) than the non-EOQ method (Rp.30.543.156). This is mainly due to the
frequency of order being made for paper with the EOQ method that would made the
company set an order more frequently than the current non-EOQ method. Nevertheless the
EOQ method would lead the company to have less holding cost (Rp.50.714.780) and less
overall inventory cost (Rp.101.620.040) than the non-EOQ method.
Thus by using the EOQ, the company should place an order 15 times more than the
current method (9 times) during the year. From our interview with the manager at Harian
Tribun Timur Makassar, the rationality to use the current method is caused by the reason
that the company did not want to risk running out of supplies of raw materials and to
maintain high inventory levels in order to ensure the continuity of the production process. In
this case, the rationality to maintain the non-EOQ method is weak as the risk of
obsolescence of raw materials does not really affect the company because of the nature of
the paper as their main raw materials that are not easily damaged or relatively durable.
Furthermore, the shelf life for paper could reach one year or more if the raw material is
maintained from disorders such as exposure to water or insects.
Compared with the non-EOQ method being used currently by the company, we could
state that the EOQ method gives lower balanced inventory costs. This balances is triggered
by the fact that ordering cost and holding cost suggested by the EOQ method does not lie in
the extreme highs and lows, or in other words the cost of inventory is well-balanced and
meet the exact demand at the time a company must placed an order. This is combined the
optimal order frequency and optimal order quantity that pose less cost and efficient. This put
Harian Tribun Timur Makassar being able to save funds spent on inventory costs, so that the
surplus funds could be used or invested into other areas that need it and would ultimately
improve the bottom line or the profit for the company.
Reorder Point and Safety Stock
Reorder Point (ROP) could determine the limit of the amount of inventory that stored
in the warehouse when the reorder has to be placed. It is intended so that the company
could pinpoint the exact time when to place an order. ROP calculations based on the EOQ
method are presented in Table 8. Average usage per day is determined by dividing the total
requirement per year by the number of days in a year or the number of working days per
year. In this study, it is assumed that the working day and the number of days in a year is the
same (360 days). Thus, the average usage per day is the amount of usage per year is
1.626.343 kg divided by the number of working days in a year (360 days) that accounted for
4.518 kg. Furthermore, this would enable us to determine that the ROP for this company is
at 31.626 kg (7 kg x 4.518 kg).
Table 8. Calculations on the Reorder Point (ROP) based on EOQ Method
Raw
Material
Paper
Lead Time
(Day)
[a]
7
Average Usage per
Day (Kg)
[b]
4.518
Reorder Point
(Kg)
[a x b]
31.626
According to Table 8, the company must immediately make a reservation for an order as
the inventory level reached 31.626 kg. This would ensure the availability of their raw
materials as their order that have been placed 7 days before had already arrived at the
warehouse. At general, this means that the production process does not need to be stopped
because the unavailability of their raw material.
In fact, the amount of raw material usage per month is not really constant. As an
example, usage rate could increase to meet the production process, and this called for an
availability of safety stock in their warehouse. Thus additional safety stock is held in order to
cope with the possibility of a shortage in raw material. Determination of a safety stock that a
company must held could be generated by dividing the standard deviation (10.714) with the
number of time usage in month (12), resulting in a safety stock of 893 kg. This can be seen
in Table 9 below.
Table 9. Calculation of Safety Stock
Standard
Deviation
[a]
10.714
Time Usage
(Month)
[b]
12
Safety Stock
(kg)
[a / b]
893
Lead Time between Orders
Lead-time between the times of order is the time difference between reservations for
an order is placed and the next order. By calculating the lead-time between orders, company
could estimate the availability of their supplies in this case paper that stored in the
warehouse. This become critically important to prevent a decline in the quantity of raw
materials due to the delay that could occurred in any ordering phase.
Lead-time between orders is calculated by multiplying the number of working days in
a year with the optimal order quantity obtained from previous EOQ method and then dividing
them by the number of demand during the year. In this study, it is assumed that the number
of days in a year is 360 days.
Table 10. Calculation on the Lead Time between Orders
Raw
Material
Paper
Work Days
per Year
[W]
360
Optimal Order
Quantity
[Q*]
108.830
Demand
per Year
[D]
1.626.343
Lead
Time
[T=WQ*/D]
24
In Table 10, it is shown that the lead-time between orders is 24 days. This means
that the raw materials could still meet the production process as they have safety stock at
hand, even though the delivery of their order is more than 7 days according to the lead-time
of previous ROP. Furthermore, this is in accordance with the nature of the paper as their
main raw materials that are not easily damaged or relatively durable
The results showed that the company could make savings by determining the
combination of the quantity of optimal order quantity and optimal order frequency for their
raw materials. This in turn would allow the company to be able to use the extra funds owned
to invest in other areas, for example to increase the scope of their market and thus increase
their production. This is recommendable given the large space that a company had in their
warehouse to accommodate greater number of raw materials.
D. CONCLUSION AND RECOMMENDATION
Based on the research that has been done, we could state some conclusions as follows:
1. Purchase of the raw materials to ensure that newspaper is produce in optimal manner
according to the EOQ method in 2012 at Harian Tribun Timur Makassar per order is
108.830 kg .
2. Safety stock quantity according to the EOQ method in 2012 is 893 kg, while the nonEOQ method or simple method being used right now didn’t provide any safety stock to
ensure the continuity of the production process.
3. According to the EOQ method in 2012, Harian Tribun Timur Makassar should put 15
orders, whilst this being higher than the non-EOQ method currently being used by the
company (9 orders), however at general the EOQ method would ensure that the
company gain benefit from the production savings at Rp.188.518.668.
4. The EOQ method suggest that the total inventory cost for paper in 2012 is
Rp.101.620.040. This is less than the current total cost incurred by the company by
using the non-EOQ method at Rp.290.138.708.
5. The current simple method being used by Harian Tribun Timur Makassar do not suggest
any reorder point, whereas by using the EOQ method, the reorder point should be set
when the availability of paper at inventory is at 31.626 kg .
Furthermore, we could also give some suggestions as a consideration for the company.
First, management should consider implementing EOQ method that have been empirically
proven in this paper to optimize their inventory costs in order so that they could incurred a
greater profit that can be used to increase the company's investment in other areas. Second,
company should strive to optimize their production facilities by increasing employee
productivity so as to produce a greater amount of revenue.
E. REFERENCES
Chase, Richard B., Jacobs, F Robert, Aquilano, Nicholas J., 2004., Operations Management
for Competitive Advantage., tenth edition., The McGrawHill Company.
Heizer, Jay., Render Barry., 2005 Operations Management., Prentice Hall International (UK)
Limited, London
Lapin, Whisler., 2006., Quantitative Decision Making., seventh edition Prentice Hall
International (UK) Limited, London
Render, Barry., Stair, Ralph M Jr., 2000., Quantitative Analysis for Management. Seventh
edition. Prentice Hall International (UK) Limited, London.