The Effect of Payment Rules on Ordering and Stockholding in Purchasing

The payment conditions for the purchase of raw materials and components have received little attention in the literature on inventory control. A common practice is to require payment by some specific day of the month following the month of delivery rather than a fixed time period after delivery. Alternatively, for convenience, invoices for a particular supplier may always be dealt with on the same day of the month, regardless of the payment conditions. In such circumstances the classical square root E.O.Q. is not the ‘optimal’ size for purchase orders. Under the assumption of a roughly constant demand rate for the final products, as is assumed for lot sizing techniques in most statistical inventory control models, it is shown that orders should be specified as a number of integral months' demands. For those items whose annual purchase bill is over about £500 per year, the minimum cost purchase order should be one month's demand, to be delivered as early in the month as possible or in convenient sub-lots.This new model will not lead to large savings on the use of the E.O.Q. lot size. It is however claimed that this fits the practical situation better and avoids many of the nonsenses of the E.O.Q. of, for example, giving absurdly low order sizes for high priced items, and the need to place lower bounds on order sizes.