Minimum cost method

Minimum cost method
See also
Costs of production Cost of production Purchasing in the case of discontinuities in needs Determining the length of the production cycle Cost variance Selection of target markets Differential costing Optimum size of the order Uniformity of production

Method of the minimum is one of the methods used to calculate the optimum size of the production batch. This method uses a graphical or analytical techniques. Both of these techniques use the same assumptions relating to the unit cost of components. Main criterion for calculation is minimal unit cost of production.

The graphics technique uses charts of costs of all components of the unit of production. Increasing the quantity of units in a lot of simple products does not change the unit fixed costs. Level of unit costs is driven by the cost of preparatory and finishing activities.

The optimal batch size of products can also be calculated using analytical techniques and mathematical formulas. To calculate optimal batch size managers can use various formulas and models, the greatest difficulty in the calculation is determining the cost resulting from asset utilization.

Benefits and limitations of minimum cost method

Benefits of the Minimum Cost Method:

• The main benefit of this method is that it helps to determine the optimal batch size that minimizes the unit cost of production. This can lead to significant cost savings for the organization.
• The use of graphical or analytical techniques makes this method easy to understand and apply.
• The method takes into account the costs of all components of the unit of production, including fixed costs, variable costs, and costs resulting from asset utilization.
• By using this method, managers can avoid the problem of overproduction and minimize the inventory costs.

Limitations of the Minimum Cost Method:

• The method is based on the assumption that the unit cost of components does not change with the size of the production batch. This may not always be the case in practice, especially for products with high economies of scale.
• The method does not consider other factors such as customer demand, lead times, and production schedules, which can also affect the optimal batch size.
• The method does not consider the opportunity costs of not producing other products or not producing in other ways.
• The method requires accurate and reliable cost data, which may not always be available or accurate.
• The method is mainly focused on cost minimization, which may not always be the only or most important objective of the organization.

References

• Song, W. T., & Schmeiser, B. W. (1995). Optimal mean-squared-error batch sizes. Management Science, 41(1), 110-123.