|
|
|
You must decide upon the average level of raw material inventories in weeks. As this is based upon weeks of production, the actual level in units will vary with the level of production. Raw materials inventories provide a buffer to protect against unreliable suppliers to ensure there is a sufficient materials to cover late deliveries. It is estimated that an average of four weeks raw material inventory will be enough to ensure that the factory loses only 10% of its time due to non-availability of key raw materials.
However, you incur a warehousing and implicit financing cost when you hold raw material inventories. There is an annual holding cost of $47/unit of raw materials inventory. One unit of raw materials is required for each $300 of prime cost in a product, i.e. one unit of raw materials for each SCU. For example, to produce one unit of your original adventurer bike (prime cost = $300, 1 SCU) requires one unit of raw materials. Holding an average of 1000 units of RM inventory will cost $47 x 1000 = $47,000 per annum.
If you improve your relationship with your suppliers, they will be more reliable and you will need to hold less raw material inventory.
