____________________________________________________________________________________________________

Where,
Raw materials stock = Average cost of materials in stock
WIP stock = Cost of materials + wages + overhead of work-in-progress
Finished goods stock = Cost of materials + wages + overhead of work-in-progress
Creditors for material = Cost of average outstanding creditors
Creditors for wages = Average wages outstanding
Creditors for overhead = Average overheads outstanding

While determining the working capital requirement, following points should be given due
consideration:

1. Depreciation: Depreciation on fixed assets is an important point that needs to be

considered in the estimation of working capital requirement. The depreciation on the
fixed assets, which are used in the production process or other activities, is not considered
in estimation of working capital. The depreciation is a non-cash expense and there are no
funds blocked in depreciation as such and therefore, it is ignored in the valuation of WIP
or in the valuation of finished goods. If working capital is estimated by including the
amount of depreciation, such estimate is known as total basis working capital. If working
capital is estimated by ignoring depreciation, then such estimate is known as cash basis
working capital.
2. Safety margin: Sometimes, a firm may also like to have a safety margin of working
capital in order to meet any contingency. It may be expressed in terms of percentage of
total current assets or total current liabilities or NWC. It is incorporated in the working
capital estimates to calculate the NWC. There is no hard and fast rule for quantum of
margin of safety and depends upon the nature and characteristics of firm as well as of its
current assets and current liabilities.

5. Practical Problems in Estimation of Working Capital

Illustration 1
The cost sheet of ABC Ltd. provides the following data:
Cost per unit (Rs)
Raw materials 50
Direct labor 20
Overheads (including depreciation of Rs 10) 40
Total cost 110
Profit 20
Selling price 130

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
____________________________________________________________________________________________________

Average raw material in stock is for one month. Average materials in work-in-progress are for
half month. Credit allowed by suppliers; one month; credit allowed to debtors; one month.
Average time lag in payment of wages; 10 days; average time lag in payment of overheads; 30
days. 25% of the sales are on cash basis. Cash balance expected to be Rs 1,00,000. Finished
goods lie in the warehouse for one month.
You are required to prepare a statement of the working capital needed to finance a level of the
activity of 54,000 units of output. Production is carried on evenly throughout the year and wages
and overheads accrue similarly. State your assumptions, if any, clearly.

Solution:

As the annual level of activity is given at 54,000 units, it means that the monthly turnover would
be 54,000/12 = 4,500 units. The working capital requirement for this monthly turnover can now
be estimated as follows:

Estimation of Working Capital Requirement

Particulars Amount (Rs) Amount (Rs)

I. Current Assets:
Minimum cash balance 1,00,000
Inventories:
Raw materials (4500×Rs 50) 2,25,000
Work-in-progress:
Materials [(4500×Rs 50)/2] 1,12,500
Wages [50% of (4500×Rs 20)/2] 22,500
Overheads [50% of (4500×Rs 30)/2] 33,750
Finished goods (4500×Rs 100) 4,50,000
Debtors (4500×Rs 100×75%) 3,37,500

Gross working capital 12,81,250 12,81,250

II. Current Liabilities:

Creditors for materials (4500×Rs 50) 2,25,000

Creditors for wages [(4500×Rs 20)/3] 30,000

Creditors for overheads (4500×Rs 30) 1,35,000
Total current liabilities 3,90,000 3,90,000
Net working capital 8,91,250

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
____________________________________________________________________________________________________

Working Notes:
1. The overheads of Rs 40 per unit include a depreciation of Rs 10 per unit, which is a non-
cash item. This depreciation cost has been ignored for valuation of WIP, finished goods
and debtors. The overhead cost, therefore, has been taken only at Rs 30 per unit.
2. In the calculation of WIP, the raw materials have been taken at full requirements for 15
days; but the wages and overheads have been taken only at 50% on the assumption that
on an average all units in WIP are 50% complete.
3. Since, the wages are paid with a time lag of 10 days, the working capital provided by
wages has been taken by dividing the monthly wages by 3 (assuming a month to consist
of 30 days).

Illustration 2

PQR Ltd. is presently operating at 60% capacity level, producing 36,000 units per annum. In view of
favorable market conditions, it has been decided that from 1st January 2000, the company would
operate at 90% capacity. The following information is available:
i. Existing cost-price structure per unit is given below:
Raw materials Rs 4
Wages Rs 2
Overheads (Variable) Rs 2
Overheads (Fixed) Rs 1
Profit Rs 1
ii. It is expected that the cost of raw material, wages, other expenses and sales per unit will
remain unchanged in the year 2000.
iii. Raw materials remain in store for 2 months before these are issued to production. These units
remain in production process for one month.
iv. Finished goods remain in godown for 2 months.
v. Credit allowed to debtors is 2 months. Credit allowed by creditors is 3 months.
vi. Lag in wages and overhead payments is one month. It may be assumed that wages and
overhead accrue evenly throughout the production cycle.

You are required to:

(a) Prepare profit statement at 90% capacity level; and
(b) Calculate the working capital requirements on an estimated basis to sustain the increased
production level.
Assumption made if any, should be clearly indicated.

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
____________________________________________________________________________________________________

Solution:

Statement of Profitability at 90% Capacity

Units (at 90% capacity) 54,000
Sales (54000×Rs 10) (A) 5,40,000
Cost:
Raw materials (54000×Rs 4) 2,16,000

Wages (54000×Rs 2) 1,08,000

Variable overhead (54000×Rs 2) 1,08,000
Fixed overhead (36000×Rs 1) 36,000
Total cost (B) 4,68,000
Net profit (A-B) Rs 72,000

Statement of Working Capital Requirement

Particulars Amount (Rs) Amount (Rs)
I. Current Assets:
Stock of raw materials (4500×Rs 4×2 months) 36,000
Work-in-progress:
Material (4500×Rs 4×1 month) 18,000
Wages [50% of (4500×Rs 2×1 month)] 4,500
Overheads 6,000
Finished goods 78,000
Debtors [(468000/12)×2 months] 78,000
Gross working capital 2,20,500 2,20,500

II. Current Liabiities:

Sundry creditors (4500×Rs 4×3 months) 54,000
Outstanding wages (4500×Rs 2× 1 month) 9,000
Outstanding overhead 12,000
Total current liabilities 75,000 75,000
Net working capital 1,45,500

Working Notes:
1. The WIP period is one month. So, the overheads included in WIP are on an average for
half month because overheads have been taken only at 50% on the assumption that on an
average all units in WIP are 50% complete.
Overheads = [50% of (4500×Rs 2× 1 month) + 50% of (36000÷12)] = Rs 6000
2. The valuation of finished goods can be arrived at as follows:
Finished goods = [(4500×Rs 8× 2 months) + (36000÷12) × 2 months] = Rs 78000
3. Since, the overheads are paid to creditors with a time lag of 1 month. So, valuation of
outstanding overheads can be done in the following way:
Outstanding overheads = [(4500× Rs 2 × 1month) + (36000÷12) × 1 month] = Rs 12000

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
____________________________________________________________________________________________________

Illustration 3

XYZ Ltd. sells goods on a gross profit of 25%. Depreciation is considered as a part of cost of
production. The following are the annual figures given to you:
Sales (2 months credit) Rs 18,00,000
Materials consumed (1 month credit) Rs 4,50,000
Wages paid (1 month lag in payment) Rs 3,60,000
Cash manufacturing expenses (1 month lag in payment) Rs 4,80,000
Administrative expenses (1 month lag in payment) Rs 1,20,000
Sales promotion expenses (paid quarterly in advance) Rs 60,000

The company keeps one month’s stock each of raw materials and finished goods. It also keeps
Rs 1,00,000 in cash. You are required to estimate the working capital requirements of the company
on cash cost basis, assuming 15% safety margin.

Solution:

Statement of Working Capital Requirement

Particulars Amount (Rs) Amount (Rs)
I. Current Assets:
Minimum cash balance 1,00,000
Debtors (cost of sales i.e. 14,70,000× 2/12) 2,45,000
Prepaid sales promotion expenses 15,000
Inventories:
Raw materials (4,50,000/12) 37,500
Finished goods (12,90,000/12) 1,07,500
Total current assets 5,05,000 5,05,000

II. Current Liabilities:

Sundry creditors (4,50,000/12) 37,500
Outstanding manufacturing expenses (4,80,000/12) 40,000
Outstanding administrative expenses (1,20,000/12) 10,000
Outstanding wages (3,60,000/12) 30,000
Total current liabilities 1,17,500 1,17,500
Excess of CA and CL 3,87,500
Add: 15% for contingencies 58,125
Net working capital 4,45,625

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
____________________________________________________________________________________________________

Working Notes:
1. Cost structure
Sales 18,00,000
Less: Gross profit (25% on sales) 4,50,000
Cost of production 13,50,000
Less: Cost of materials 4,50,000
Less: Wages 3,60,000
Less: Cash manufacturing expenses 4,80,000
Depreciation 60,000

2. Total cash cost

Cost of production 13,50,000

Less: Depreciation 60,000
12,90,000
Add: Administrative expenses 1,20,000
Add: Sales promotion expenses 60,000
Total cash cost 14,70,000

Illustration 4
Gulfam Ltd. is presently operating on single shift basis and has the following cost structure (per
unit):
Selling price Rs 36
Raw materials Rs 12
Wages (60% variable) Rs 10
Overheads (20% variable) Rs 10 Rs 32

For the year ending March 31, 2000; the sales amounted to Rs 8,64,000 and the current asset
position on that day was follows:
Raw material Rs 72,000
Finished goods Rs 1,44,000
Work-in-progress (prime cost) Rs 44,000
Debtors Rs 2,16,000

At present the company receives a credit of 2 months from the supplier of raw materials and
wages & expenses are payable with a time lag of half a month. In order to meet the excess
demand, the company is preparing to work in double shift. The increase production will enable
the firm to get a 10% discount from the supplier of raw materials. There will not be of any change
in fixed cost, credit policy, etc.
Ascertain the effect on requirement for working capital if the proposal of double shift
materializes.

Solution:
In order to calculate the working capital requirement for double shift operations, the existing
parameters should be ascertained as follows:
Present position

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
____________________________________________________________________________________________________

Sales = (8,64,000÷36) = 24,000 units per annum i.e. 2,000 units per month
Debtors = (2,16,000÷8,64,000)×12 = 3 months outstanding
Raw material = (72,000÷12) = 6,000 units or 3 months consumption
Work in progress = (44,000÷22) = 2,000 units or 1 month requirement
Finished goods = (1,44,000÷32) = 4,500 units or 2.25 months requirement
New cost of raw material = Rs 12 – 10% of 12 = Rs 10.80

Statement of Working Capital Requirement (Present Situation)

Particulars Amount (Rs) Amount (Rs)
I. Current Assets:
Raw materials (given) 72,000
Work-in-progress (given) 44,000
Finished goods (given) 1,44,000

Debtors (2,000×Rs 32×3 months) 1,92,000

Total current assets 4,52,000 4,52,000

II. Current Liabilities:

Creditors (2,000×Rs 12×2 months) 48,000
Wages & overheads (2,000×Rs 20×1/2 month) 20,000
Total current liabilities 68,000 68,000
Net working capital 3,84,000

Statement of Working Capital Requirement (Proposed Situation)

Particulars Amount (Rs) Amount (Rs)
I. Current Assets:
Raw materials (4,000×Rs 10.80×3 months) 1,29,600
Work-in-progress (4,000×Rs 20.80×1 month) 83,200
Finished goods (4,000×Rs 30.80×2.25 months) 2,77,200
Debtors (4,000×Rs 30.80×3 months) 3,69,600
Total current assets 8,59,600 8,59,600

II. Current Liabilities:

Creditors (4,000×Rs 10.80×2 months) 86,400
Wages & overheads (4,000×Rs 20× ½ month) 40,000
Total current liabilities 1,26,400 1,26,400
Net working capital 7,33,200

Therefore, working capital requirement will increase by (Rs 7,33,200 – Rs 3,84,000) Rs 3,49,200
due to change from single shift to double shift operations.

6. Summary

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
____________________________________________________________________________________________________

 The most appropriate method of determining working capital needs of the firm is
operating cycle. However, there are some other methods as well for estimating the
working capital needs of the firm.
 Apart from operating cycle method, there are other three methods namely current assets
holding period, ratio of sales and ratio of fixed investment.
 In the operating cycle method, working capital is calculated as the difference between
current assets and current liabilities.
 If depreciation is included in the cost, then such estimate is known is total basis working
capital.
 If depreciation is excluded from cost, then such estimate is known as cash basis working
capital.

COMMERCE PAPER No. : 8 Financial Management

MODULE No. : 34 Estimation of Working Capital
Requirement
 Material Cost
Questions:

Q.1 ZED Company supplies plastic crockery to fast food restaurants in metropolitan city. One of its
products is a special bowl, disposable after initial use, for serving soups to its customers. Bowls
are sold in pack 10 pieces at a price of Rs. 50 per pack.

The demand for plastic bowl has been forecasted at a fairly steady rate of 40,000 packs every
year. The company purchase the bowl direct from manufacturer at Rs. 40 per pack within a
three days lead time. The ordering and related cost is Rs. 8 per order .The storage cost is 10%
per annum of average inventory investment.

Required:

(i) Calculate Economic Order Quantity.

(ii) Calculate number of orders needed every year.
(iii) Calculate the total cost of ordering and storage bowls for the year.
(iv) Determine when should the next order to be placed (Assuming that the company does
maintain a safety stock and that the present inventory level is 333 packs with a year of
360 working days.

Q.2 The following information relating to a type of Raw material is available:

Annual demand 2000 units
Unit price Rs.20.00
Ordering cost per order Rs. 20.00
Storage cost 2% p.a
Interest rate 8% p.a
Lead time Half-month
Calculate economic order quantity and total annual inventory cost on the raw material.

Q.3 KL Limited produces product ‘M’ which has a quarterly demand of 8, 000 units. The product
requires 3 kgs . Quantity of material ‘X’ for every finished unit of product .The other information
are follows:

Cost of material ‘X’ Rs.20 per kg.

Cost of placing an order Rs. 1000 per order
Carrying Cost 15% per annum of average inventory

You are required:

(i) Calculate the Economic Order Quantity for material ‘X’.

(ii) Should the company accept an offer of 2 percent discount by the supplier, if he wants to supply
the annual requirements of material ‘x’ in 4 equal quarterly instalments?

CA Anu Agarwal 9819443564

Q.4 A company manufactures a product from a raw material, which is purchased at Rs. 80 per kg.
The company incurs a handling cost of Rs. 370 plus freight of Rs. 380 per order .The incremental
carrying cost of inventory of raw material is Rs. 0.25 per kg per month .In addition, the cost of
working capital finance on the investment in inventory of raw material is Rs. 12 per kg per
annum .The annual production of the product is 1, 00,000 units and 2.5 units are obtained from
one kg. Of raw material.

Required:

(i) Calculate the economic order quantity of raw materials.

(ii) Advice, how frequently company should order for procurement be placed.
(iii) If the company proposes to rationalize placement of orders on quarterly basis, what
percentage of discount in the price of raw materials should be negotiated?

Assume 360 days in a year.

Q.5 Supreme Limited is a manufacturer of energy saving bulbs .To manufacture the finished
product one unit of component ‘LED’ is required. Annual requirement of component ‘LED’ is
72,000 units, the cost being Rs. 300 per unit .Other relevant details for the year 2015-2016 are:

Cost of placing an order Rs.2,250

Carrying cost of inventory 12% per annum
Lead time -
Maximum 20 days
Minimum 8 days
Average 14 days
Emergency purchase 5 days
Consumption-
Maximum 400 units per day
Minimum 200 units per day
Average 300 units per day
You are required to calculate:

(i) Re –order quantity

(ii) Re –ordering level
(iii) Minimum stock level
(iv) Maximum stock level
(v) Danger level

Q.6 Following details are related to a manufacturing concern:

Re–order Level 160000 units

Economic Order Quantity 90000 units
Minimum Stock Level 100000 units
Maximum Stock Level 190000 units
Average Lead time 6 days
Difference between Minimum lead time and Maximum
lead time 4 days
Calculate:

CA Anu Agarwal 9819443564

 (i) Maximum consumption per day
(ii) Minimum consumption per day

Q.7 Re-order quantity of material ‘X’ is 5,000 kg. ; Maximum level 8,000 kg. ; Minimum usage 50 kg.
Per hour; minimum re-order period 4 days; daily working hours in the factory is 8 hours. You are
required to calculate the re-order level of material ‘X’.

Answer

Q.1 Ans:

(i) Computation of EOQ

U = Annual requirement = 40,000

B = Buying Cost = 40√2,50,000

O = Ordering Cost = Rs. 8

PC = Carrying cost permit × % cost of cost price

= Rs. 40 × 10% = Rs. 4

2UO
EOQ = √ PC

2×40,000×8
=√ 4
= 400

Therefore, EOQ = 400 units

40,000
(ii) No. of orders needed = 400
= 100 orders

(iii) Total Cost of Ordering

At EOQ level
Carrying cost = ordering cost
Ordering cost = 100 × 8 = 800
Carrying cost = 800
Total cost = 1600

Alternatively : Total Cost = √2UOPC

= √2 × 40,000 × 8 × 4 = 1,600

CA Anu Agarwal 9819443564

 (iv) Timing of next order

(a) Day’s requirement served by each order.

No.of working days 360
Number of days requirements =No.of order in year
= 100
= 3.6 days

Supply

This implies that each order of 400 packs supplies for requirements of 3.6 days only.

(b) Days requirement covered by inventory

Unit in inventory
Economic order quantity
× (Day’s requirement served by an order)

333 packs
400 packs
× 3.6 days = 3 days requirement

(c) Time interval for placing next order

Inventory left for day’s requirement - Lead time of delivery

3 days – 3 days = 0 days

This means that next order for the replenishment of supplies has to be placed
immediately.

Q.2 Ans:

2×Annual Consumption×Buying Cost per order

EOQ = √ Storage Cost per unit

2×2,000×20 80,000
= √Rs.20×(2+8 = √ 2
= 200 units
100 )

Total Annual Inventory Cost

Cost of 2,000 Units @ Rs. 20 (2,000× 20) = Rs. 40,000

2,000
No. of Order 200
= Rs. 10

Ordering Cost 10 × 20 = Rs. 200

200 10
Carrying cost of average inventory × 20 × = Rs. 200
2 100

= Rs. 40,400

Q.3 Ans:

Annual demand of material ‘X’

CA Anu Agarwal 9819443564

= 8000 units (per quarter) × 4 (No. of Quarter in a year) × 3 kgs. (For every finished product) = 96,000
kgs.

(i) Calculation of Economic Order Quantity (EOQ) for material ‘X’

2 ×Annual demand ×Oredring cost

EOQ = √ Carrying cost per unit per annum

2×96,000×1000
= √ 20×15%

= 8,000 kg.

(ii) Analysis of Cost under different options of ‘order quantity’.

Particulars When EOQ is ordered When discount of 2% is accepted

and supply is in equal installments
Order size 8000 kgs. 96,000
4
= 24,000 kgs
No. of order 96,000 Kgs 96,000 Kgs
8,000 Kgs
= 12 24,000 Kgs
=4
Purchase Cost per Kg. =Rs. 20 (20 – 2% Rs. 20) = Rs. 19.60
Total Purchase Cost (A) (96,000 kgs. × Rs.20) (96,000 Kgs. × 19.6)
= Rs. 19,20,000 = Rs. 18,81,600
Ordering Cost ( B) 12 orders × Rs. 1,000 4 orders × Rs. 1000
= Rs. 12,000 = Rs. 4,000
Carrying Cost ( c) 8,000 Kgs 24,000 Kgs
× 15% × 20 × 15% × 19.6
2 2
= Rs. 12,000 = Rs. 35,280
Total Cost ( A+B+C) = Rs. 19,44,000 Rs. 19,20,880

Advice: The total Cost is lower if Company accept an offer of 2% discount by the supplier , when
supply of the annual requirement of material ‘X’ is made in 4 equal instalments . Hence, the
company should accept the offer of 2% discount.

Q. 4 Ans:

(i) Economic Order Quantity:

2Aca
EOQ =√ Ci

2 ×40,000∗ ×750∗∗
=√ 15∗∗∗

= 2,000 Kg

*A = Annual Units required

1,00,000
= 2.5

CA Anu Agarwal 9819443564

 = 40,000 Kg.

**Ordering Cost = Ca = 370 + 380 = Rs. 750

***Carrying Cost = Ci = 12 + 3 = 15

(incremental carrying cost = 0.25 p.m. / per Kg.)

(ii) Computation of days of placing Next Order

For 40,000 units → 360 days

For 2,000 units →? days

2,000 ×360
Days required = 40,000

= 18 days.

Alternative Solution
Frequency of placing orders for procurement:

Annual consumption (A) = 40,000 Kg.

Quantity per order (E.O.Q) = 2,000 Kg.

A 40,000Kg.
No. of orders per annum (E.O.Q))= = 20 orders
2,000 Kg.

360 days
Frequency of placing orders (in days) = 20 orders = 18 days

(ii) Percentage of discount in the price of raw materials to be negotiated

Particulars On Quarterly Basis On E.O.Q Basis
1. Annual Usage (in Kg.) 40,000 Kg. 40,000 kg.
2. Size of the order 10,000 Kg. 2,000 Kg.
3. No.of orders ( 1 ÷ 2 ) 4 20
4. Cost of placing orders or Rs. 3,000 Rs. 15,000
ordering cost ( 4 orders × Rs. 750) ( 20 orders × Rs. 750 )
( No. of orders × Cost per
order )
5. Inventory carrying cost ( Rs. 75,000 Rs. 15,000
Average inventory × Carrying ( 10,000 Kg. × ½ × Rs. 15 ) ( 2,000 Kg. × ½ × Rs. 15 )
cost per unit )
6. Total Cost ( 4 + 5 ) Rs. 78,000 Rs. 30,000

When order is placed on quarterly basis the ordering cost and carrying cost increased by Rs.
48,000 (Rs. 78,000 – Rs. 30,000)

So, discount required = Rs. 48,000

Total annual purchase = 40,000 Kg. × Rs. 80 = Rs. 32, 00,000

Therefore, Percentage of discount to be negotiated

CA Anu Agarwal 9819443564

 Rs.48,000
= Rs.32,00,000 × 100 = 1.5 %

Q.5 Ans:

(i) Calculation of Re-order quantity:

2ACa
EOQ = √ Ci

2 ×72,000 ×2,250
=√
300 ×12%

32,40,00,000
=√ 36

= √90,00,000

= 3,000 units.

(ii) Calculation of Re- ordering level :

ROL = Maximum Re-order period × Maximum usage

= 20 days × 400 units per day

= 8,000 units.

(iii) Calculation of Minimum stock level:

Average Average
Minimum stock level = ROL - [ ]
Consumption × leas time
= 8,000 – (300 × 14)

= 8,000 – 4,200

= 3,800 units.

(iv) Calculation of Maximum stock level:

Minimum Minimum
Maximum stock level = ROL - [ ] + ROQ
Consumption × leas time
= 8,000 – (200 × 8) + 3,000

= 8,000 – 1,600 + 3,000

= 9,400 units

(v) Calculation of Danger level:

Danger level = Minimum consumption × Emergency delivery time

= 200 units × 5 days

CA Anu Agarwal 9819443564

 = 1,000 units

Q.6 Ans:

Difference between Minimum lead time and Maximum lead time = 4 days

Max. lead time – Min. lead time = 4 days

Or, Max. lead time = Min. lead time + 4 days …………………………………………….(i)

Average lead time is given as 6 days i.e.

Max.lead time +Min.lead time
= 6 days…………………………………………………………….(ii)
2

Putting the value of (i) in (ii)

Min.lead time +4 days+ Min.lead time
2
= 6 days

Or, Min.lead time + 4 days + Min. lead time = 12 days

Or, 2 Min. lead time = 8 days

8 days
Or, Minimum lead time = 2
= 4 days

Putting this Minimum lead time in (i), we get

Maximum lead time = 4 days + 4 days = 8 days

(i) Maximum consumption per day:

Re-order level = Max. Re-order period × Maximum Consumption per day 1, 60,000 units = 8 days
× Maximum Consumption per day
1,60,000 units
Or, maximum Consumption per day = = 20,000 units
8 days

(ii) Minimum Consumption per day:

Maximum Stock level = Re-order level + Re- order Quantity – (Min. lead time × Min. Consumption
per day)

Or, 1, 90,000 units = 1, 60,000 units + 90,000 units – (4 days × Min. Consumption per day)

Or, 4 days × min. Consumption per day = 2, 50,000 units – 1, 90, 000 units
60,000 units
Or, Minimum Consumption per day = 4 days
= 15,000 units.

Q. 7 Ans:

Re- order Level = Maximum Level – [Re- order quantity – (Minimum usage per day × Minimum Re-
order period)

CA Anu Agarwal 9819443564

= 8000 kg. - [5000 kg. – (400 kg,* × 4)

= 8000 kg. – 3400 kg. = 4600 kg.

Hence, Re-order level is 4600 K.

*Minimum usage per day = 50 kg. × 8 = 400 kg.

CA Anu Agarwal 9819443564

Given the above assumptions, the following formula can be used to determine EOQ.

EOQ = √2AO/C
Where A= Annual consumption/usage of input (in units)
O= ordering costs per order
C= Carrying costs per unit p.a.

1. No. of orders per year = Total annual consumption in units ÷ Order size (EOQ)
2. Frequency of orders = 365 days ÷ No. of orders per year
3. Total Annual ordering and carrying cost at EOQ = √2AOC

Illustration 1:

Let us assume the following data for a firm:

Annual requirements 800 units
Ordering cost (per order) Rs. 50
Carrying cost (per unit) Rs. 2
Purchasing cost (per unit) Rs. 100
Now, using the EOQ formula, EOQ quantity will be as follows:
EOQ = √2 x 800 x 50/2
= √80,000/2
= √40,000
= 200 Units

Illustration 2:

H.Co Ltd produces a product which has a monthly demand 2200 units. Carrying Cost per unit Rs.1.50 p.a.
The ordering cost is Rs.70 per order, you are required to find EOQ and no of orders p.a.
Solution :-

A = Annual Consumption

EOQ = 2AO 2200x12 = 26400 units

C O = Ordering Cost Rs.70 per order

C = Carrying cost Rs. 1.50

 = 2x26400x70

1.50

= 3695000

1.5

= 2464000 = 1569.7 units

EOQ = 1570 Units

No .of order p.a. = Annual consumption

EOQ
= 26400 = 16.8 orders
1570

 No.of orders p.a. = 17

Illustration 3:
Find out EOQ from the following information
Annual consumption 17500 units
Ordering Cost Rs 18 per order
Carrying cost 20% on cost per Unit

Cost per Unit Rs.5

EOQ = 2 AO A = 17500 units

C O = Rs.18
C= 5x20% = 1
 EOQ = 2x 17500x 18

= 630000 = 793.7 units

1

EOQ = 794 Units

Illustration 4:
From the following information find out stock levels of material x.
Reorder quantity 250 units
Re-ordering period 4 to 6 weeks
Maximum usage/consumption 100 units

Minimum usage 50 units

Normal usage 70 units
Emergency delivery time = 1 week

Solution :-
(I) Re-order level = (Max.consumption x Max.Re-order period)
= 100x6 = 600 Units

(ii) Min stock level = ROL - ( NU x NROP)

= 600 – (70 x 5)
= 600-350
= 250 units
Normal Re order period = Max.ROP + Min ROP
2

= 6+4 = 10 = 5 weeks
2 2
(iii) Max. Stock level = ROL + ROQ - (Min. Usage x Min.ROP)
= 600 + 250 - (50x4)
= 850 - 200 = 650 Units

Max.stock level 650 units

(iv) Danger level = Avg. Rate of Consumption x Emg delivery period

= 70 units x 1 week

Danger level = 70 units

(v) Average stock level = Min. stock level + ½ of reorder quantity

= 250 units + ½ (250)
= 250 units+ 125
= 375 units

TECHNIQUES BASED ON THE CLASSIFICATION OF INVENTORIES

A-B-C analysis
It is the inventory management techniques that divide inventory into three categories
based on the value and volume of the inventories; 10% of the inventory’s item
contributes to 70% of value of consumption and this category is known as A category.
About 20% of the inventory item contributes about 20% of value of consumption and
this category is called category B and 70% of inventory item contributes only 10% of
value of consumption and this category is called C category.
Inventory Breakdown Between Value and Volume

Category Volume Value

(%) (%)
A 10 70
B 20 20
C 70 10
Total 100 100