by Tony Mock
21 May 2007
Stock control features in the syllabuses of several ACCA examination papers. The areas usually tested in these papers are:
- determining an economic order quantity (EOQ) – calculations to assess how many units of a particular stock item to order at a time
- finding an optimal re-order level (optimal ROL) – providing some idea of the level to which stocks can be allowed to fall before placing an order for more
- discussions of various practical aspects of stock management – often referred to by students with no practical experience as ‘theory’.
Advantages and disadvantages of holding stock
The basis of the theoretical calculations of an EOQ and an optimal ROL is that there are advantages and disadvantages of holding stock (of buying stock in large or small quantities). The advantages include:
- the need to meet customer demand
- taking advantage of bulk discounts
- reducing total annual re-ordering cost
The disadvantages include:
- storage costs
- cost of capital tied up in stock
- deterioration, obsolescence, and theft
The aim behind the calculations of EOQ and ROL is to weigh up these, and other advantages and disadvantages and to find a suitable compromise level.
When determining how much to order at a time, an organisation will recognise that:
- as order quantity rises, average stock rises and the total annual cost of holding stock rises
- as order quantity rises, the number of orders decreases and the total annual re-order costs decrease.
The total of annual holding and re-order costs first decreases, then increases. The point at which cost is minimised is the EOQ. This cost behaviour is illustrated by the graph in Figure 1.