Financial Implications of Lot-Size Inventory Models

Abstract

The definition of the cost of resources devoted to inventories which is inherent in the economic-lot-size procedure implies financial conditions which may not exist. This would lead to infeasibility and/or to a misstatement of carrying costs. If carrying costs are incorrectly stated, then in these, as well as all standard inventory models which emobdy the same assumption, the indicated optimum inventory is either too high or too low, and needlessly excessive costs are incurred by firms using such models. These weaknesses can be corrected by reflecting the firm's actual financial arrangements in the model's carrying cost equation and deriving the corresponding optimum lot size. Examples are presented illustrating how this may be done in the face of several different financial circumstances. In each case, the results of our procedure are compared to those that emerge from an application of the standard lot-size model. Worthwhile savings in inventory cost are indicated, especially if the firm is employing the standard, or classical, model for a number of different products or for a single product which involves a large commitment of resources. In sum, the model builder must be prepared to develop models which reflect the conditions of his financial environment if he is to choose both an optimal inventory and an optimal means of financing the inventory.