INVENTORY
MANAGEMENT
BARBETS
|
BSA-2A
TABLE OF CONTENTS
01
02
03
04
INVENTORIES
INTRODUCTION
MANAGING
INVENTORIES
CARRYING
COSTS
EOQ
Classes of
Inventories and
Importance of
Inventory
Management
Ways of Managing
Inventories and
Different Types of
Inventory Costs Order Costs
Its components,
and Trade-off of
the Carrying and
Ordering Costs
Economic Order
Quantity and
Optimal Number of
Orders
TABLE OF CONTENTS
05
06
07
CARRYING/ORDERING
COSTS RELATIONSHIP
DETERMINING
SAFETY STOCK
JIT AND LEAN
PRODUCTION
Carrying and Ordering
Cost Relationship, Reorder Point, and Safety
Stock
Maximum Usage
Basis and Frequency
Distribution Basis
Just-In-Time
Inventory and
Lean Production
01
INVENTORIES
INTRODUCTION
Classes of Inventories
and Importance of
Inventory Management
INVENTORIES
●
Inventories, as defined by PAS 2, are “assets which are held for sale in the
ordinary course of business, in the process of production for such sale, or in
the form of materials or supplies to be consumed in the production process or
in the rendering of services.”
●
Inventory takes as much as 50% of total invested capital. To many firms,
inventory is considered as one of the most expensive and vital assets.
●
In order to minimize costs, firms reduce inventory levels. However, this may
lead to inventory shortages, called stock-outs, which can cause consumers’
dissatisfaction. Thus, firms must keep the equilibrium of low and high inventory
levels.
CLASSES OF INVENTORIES
RAW MATERIALS INVENTORY
WORK-IN-PROCESS INVENTORY
It consists of purchased items or extracted
materials to be used in the production of
goods or products. It avoids delay of
production in the event of a delay in shipment.
It consists of partially finished goods around
the plant that require additional work. The
purpose of this inventory is to uncouple the
various operations in the production process.
FINISHED GOODS INVENTORY
It consists of completely manufactured goods
that are yet to be sold. The purpose of finished
goods inventory is to separate the production
and sales function
SUPPLIES
Theses materials regularly used by the
company but do not form part of the finished
goods sold. Though supplies are part of the
firm’s inventory, this does not meet the
general category of an inventory.
IMPORTANCE OF INVENTORY MGMT
1
2
3
DECOUPLING
FUNCTION
STORING
RESOURCES
IRREGULAR SUPPLY
AND DEMAND
It separates
manufacturing processes
to avoid delays and
inefficiencies. Stored
inventory in between
processes may act as a
buffer in the event of a
delay.
It stores goods
especially those that
can only be gathered
seasonally. This
enables the firm to
meet the demand
regardless of the
season.
It helps firms decide
regarding the quantity
of products to be
produced over a
season.
IMPORTANCE OF INVENTORY MGMT
4
QUANTITY
DISCOUNTS
Taking advantage of the
incentive given by suppliers
wherein the cost per unit of
goods or materials is
decreased when the firm
purchases in bulk orders.
5
AVOIDING STOCK-OUTS
AND SHORTAGES
Enables the firm to consistently
meet the demand of its
customers. This will result to
consumer satisfaction which is
beneficial for the reputation of
the firm.
02
MANAGING
INVENTORIES
Ways of Managing
Inventories and Different
Types of Inventory Costs Order Costs
MANAGING INVENTORIES
Monitoring the inventory level is not sole responsibility
of the finance manager
sdkd
It also requires the concerted efforts of the differing
viewpoints about appropriate inventory levels of a firm’s
finance, marketing, manufacturing, and purchasing
managers.
DIFFERING VIEWPOINTS ABOUT INVENTORY LEVEL
Financial Managers
To ensure that the firm’s money
is not being unwisely invested in
excess resources.
Manufacturing /
Operating Managers
Implement the production plan so
that it results in the desired amount
of finished goods of acceptable
quality available on time at a low
cost.
Marketing Managers
Ensure that all orders could be
filled quickly, eliminating the need
for backorders due to stockouts.
Purchasing Manager
Ensure that he or she must have on
hand, in the correct quantities at the
desired times and at a favorable
price,
WAYS IN MANAGING INVENTORIES:
a. Monitoring inventories ratio
b. Do not invest too much fund in an inventory whose price is volatile.
c. Hedge
d. Examine the degree of spoilage.
e. Examine the quantity of the inventory with respect to sale
f. Eliminate slow-moving inventory
g. Watch out for the inventory risk associated with technology, fashion,
and perishable products
h. Forecast the price of the material needed.
TYPES OF INVENTORY COSTS
ORDERING
COST
CARRYING
COST
By careful analysis of these two variables, the firm can determine
the optimal order size to minimize the total inventory costs.
ORDERING COST
●
Also known as purchase cost or set-up cost
●
Order cost includes requisition price, any approval steps, cost to process
receipt, incoming inspection, invoice processing, vendor payment, and in
some cases, a portion of the inbound freight.
●
It is important to understand that the aforementioned are cost associated
with the frequency of the orders and not the quantities ordered.
The Total Ordering Cost is computed as:
Total ordering cost = Number of orders x OC
*where OC = ordering cost per order
ORDERING COST
Example: Assume that the ordering
cost every time an order is placed is
$80. How much will the total ordering
cost if the firm makes an order based
on the following frequencies:
a.
b.
c.
7 times a year
8 times a year
10 times a year
Answers:
a.
b.
c.
7 x $80 = $560
8 x $80 = $640
10 x $80 = $800
03
CARRYING COST
●
●
Components of Carrying
Cost
Trade-off of the
Carrying Cost and the
Ordering cost
DEFINITION
CARRYING COST FORMULA
Where:
Q= quantity or the EOQ
CC= carrying cost per unit
COMPONENTS OF CARRYING COST
INTEREST
INSURANCE
TAXES
STORAGE COSTS
If the firm has to borrow money to pay
for the inventory, the interest rate will
be part of the carrying cost.
Since insurance cost is directly related to the
total value of the inventory, it is included as
part of the carrying cost.
Any tax imposed in the purchase of
inventory is added to its value.
Mistakes in calculating storage costs are common
in EOQ implementations. For the purpose of EOQ
calculation, carrying costs should only include
variable costs based on inventory levels.
CARRYING COST vs. ORDER SIZE
The graph shows that the carrying cost is directly proportional to the
order size. As the number of units increases, the carrying cost also
increases.
TRADE-OFF OF THE CARRYING COST AND THE ORDERING COST
As mentioned, the two inventory costs —carrying cost
and ordering cost — have an inverse relationship. An
order of large quantity increases the carrying cost but
lowers the ordering cost. On the other hand, an order
of less quantity decreases the carrying cost and
increases the ordering cost.
EOQ
The graph shows
that the point
where the total
carrying cost and
total ordering cost
meet. This is the
point where the
EOQ is located.
04
ECONOMIC ORDER
QUANTITY
Economic Order Quantity
and Optimal Number of
Orders
ECONOMIC ORDER QUANTITY
●
The Economic Order Quantity is the level of inventory that minimizes the total
inventory carrying costs and ordering costs. The result is the most-effective
quantity to order.
●
Most organizations find EOQ beneficial in planning of an item to order and
repetitive purchasing. Obvious application of EOQ are for purchase-to-stock
distribution and make-to-order for manufacturers.
●
Though EOQ is generally recommended in operations where demand is relatively
steady, items with demand variability such as seasonality can still use the model
by going for shorter time periods for the EOQ calculation, making sure that
usage and carrying costs are based on the same time period.
EOQ FORMULA
Where:
S = sales usage
OC = ordering cost per order
CC = carrying cost per unit
EXAMPLE
POQ
Corporation
needs to know
Mercury
is the
closest
planet when placing its
the quantity
to the Sun
orders.
The information is as
follows:
Units needed per unit = 500 units
Costs per order
= P40
Carrying cost per order = P4
Jupiter is a gas
giant and the
biggest planet
OPTIMUM NUMBER OF ORDERS
● The optimum number of orders is the required number
of times a firm orders in a given period. This is on the
assumption that the inventory will be used at a constant
rate throughout the period.
● The optimum number of orders is crucial in minimizing
the total inventory cost of any order.
COMPONENTS OF INVENTORY COST
OPTIMUM NO. OF ORDERS
= Usage per period / EOQ
TOTAL INVENTORY COST
= Total Carrying Cost + Total Ordering Cost
TOTAL CARRYING COST
= (EOQ/2) x CC
TOTAL ORDERING COST
= Optimum no. of orders x OC
EXAMPLE
Compute for the optimum number of orders and total
inventory cost. The information is as follows:
Units needed per year
Costs per order
Carrying cost per order
= 500 units
= P40 per order
= P4 per unit
Optimum number of orders
= usage per period/EOQ
= 500 / 100
=5
Total inventory Cost = Total Carrying Cost + Total Ordering Cost
= [(EOQ/2) x CC] + (Optimum number of orders x OC)
= [(100/2) x P4.00] + (5 x P40.00)
= 200 + 200
= P 400.00
05
CARRYING/ORDERING
COSTS RELATIONSHIP
Carrying and Ordering
Cost Relationship, Reorder Point, and Safety
Stock
CARRYING AND ORDERING COSTS
The following table illustrates the inverse relationship between the carrying cost
and ordering cost
No. of times
an order is
placed
Number of units per
order
Total Carrying
Cost
Total Ordering
Cost
Total Inventory
Cost
1
500
1000.00
40.00
1,040.00
2
250
500.00
80.00
580.00
3
167
333.33
120.00
453.33
4
125
250.00
160.00
410.00
5
100
200.00
200.00
400.00
CARRYING AND ORDERING COSTS
No. of times
an order is
placed
Number of units per
order
Total Carrying
Cost
Total Ordering
Cost
Total Inventory
Cost
5
100
200.00
200.00
400.00
6
83
166.67
240.00
406.67
7
71
142.86
280.00
422.86
8
63
125.00
320.00
445.00
9
56
111.11
360.00
471.11
10
50
100.00
400.00
500.00
It is only at the optimum number of orders of 5 that the total carrying cost and total
ordering costs are equal.
INVENTORY REPLENISHMENT
The graph shows
that with an ECQ of
100 units, orders
should be placed
every 2.4 months
(12 months/5
optimum no. of
orders) to fulfill the
usage requirement.
RE-ORDER POINT
The re-order point (ROP) is the inventory level at which an order
should be placed to replenish the inventory. It is computed by
multiplying the lead time by the normal lead time usage. To
determine the re-order point under certainty, the firm must identify
the following:
LEAD TIME
- refers to the time it
normally takes to receive the
delivery of inventory after
the order has been placed.
LEAD TIME USAGE
- refers to the number of
units to be used during the
lead time.
RE-ORDER POINT EXAMPLE
FLT placed an order on December 1. It normally receives the
order after 9 days. If the company has a normal usage of 10
units per day, what is the re-order point:
ANSWER:
ROP = Lead Time x Lead Time Usage
= 9 days x 10 units
= 90 units for 9 days
SAFETY STOCK
To cushion the uncertainties during the lead time and lead time
usage, an additional inventory must be on hand. Maintaining safety
stock depends on the following:
DEMAND
LEAD TIME
The higher the risk
associated with the
perceived demand in
the inventory, the
higher the safety stock
to be required by the
company.
The higher the risk of
not receiving the goods
needed, the higher the
risk of a stock-out. This
case required a higher
level of safety stock.
COST OF
STOCK-OUTS
Stock-outs result in the
inability of the firm to
deliver the goods
required. To avoid
such, a safety stock is
maintained.
SAFETY STOCK EXAMPLE
RE-ORDER POINT = (Lead Time x Usage per Day) + Safety Stock
FLT placed an order to MAI and normally receives an order after 9 days. If
the company has a normal usage of 10 units per day and requires a safety
stock of 10 units, what is the reorder point?
ANSWER:
ROP = ( Lead Time x Usage per Day ) + Safety Stock
= (9 days x 10 units) + 10 units
= 100 units
06
DETERMINING
SAFETY STOCK
Maximum Usage Basis &
Frequency Distribution Basis
DETERMINING SAFETY STOCK
MAXIMUM USAGE BASIS
FORMULA
Maximum usage during lead time
Less: Normal usage during lead time
Safety Stock
XXX
XXX
XXX
MAXIMUM USAGE BASIS
ILLUSTRATION:
FLT Corp. is frequently losing sales due to stock outs. To avoid this problem, the
owner likes to implement a new system of maintaining an inventory level which
all include a safety stock. After looking into the past records of the company, it
was determined that the normal usage during lead time of 12 days is 120 units
while the maximum usage is 150 units for 15 days. Based on the given
information, what should be the safety stock of FLT Corp.? What is the Re-order
Point (ROP)?
Maximum usage during lead time
Less: Normal usage during lead time
Safety Stock
150
120
30
ROP = (lead time x lead time usage) + safety stock
=120 + 30
= 150
FREQUENCY DISTRIBUTION BASIS
Based on the record of Dot Com, the
normal usage is 100 units during lead
time. The following historical data were
obtained with their corresponding
frequencies of occurrences.
From the given information, determine
the level of safety stock if the company
likes to maintain a level of safety of 94%.
USAGE DURING
LEAD TIME
FREQUENCY
60
7
70
16
80
22
100
24
120
18
140
7
160
4
180
2
RE-ORDER POINT
FREQUENCY
SAFETY%
RISK% (100-SAFETY%)
60
7
7
93
70
16
7 + 16 = 23
77
80
22
23 + 22 = 45
55
100
24
45 + 24 = 69
31
120
18
69 + 18 = 87
13
140
7
87 + 7 = 94
6
160
4
94 + 4 = 98
2
180
2
98 + 2 = 100
0
FREQUENCY DISTRIBUTION BASIS
RE-ORDER POINT
FREQUENCY
SAFETY%
RISK%
60
7
7
93
70
16
23
77
80
22
45
55
100
24
69
31
120
18
87
13
140
7
94
6
160
4
98
2
180
2
100
0
Based on the table, the safety stock is 40 units. It
is obtained by looking at the safety percentage of
94% which corresponds to 140 units under the
ROP less Dot Cm’s normal usage of 100 units.
FREQUENCY DISTRIBUTION BASIS
07
JIT AND LEAN
PRODUCTION
Just-In-Time Inventory
and Lean Production
JUST-IN-TIME INVENTORY
Just-in-Time (JIT)
inventory is a part of
a total production
concept that often
interfaces with a total
quality program.
JUST-IN-TIME INVENTORY
HISTORY
-
-
❖ Ford Motor Company
Henry Ford’s My Life and Work
(1922)
Concept of “dock to factory
floor” in which incoming
materials are not even stored
before going into production
Freight Management System
(FMS) ; Ford’s Today and
Tomorrow (1962)
❖ Toyota Motor Corporation
of Japan
- Economic lot size is the
number of identical products
that should be produced, given
the cost of changing the
production process over to
another product.
- Single Minute Exchange of Die
(SMED)
JUST-IN-TIME INVENTORY
BASIC REQUIREMENTS
1
Quality production that
continually satisfies
customer requirements.
2
Close ties between
suppliers,
manufacturers, and
customers
3
Minimization of the
level of inventory
* Computerized ordering / inventory tracking systems are necessary for JIT to work
LEAN PRODUCTION
➔ Lean production requires close cooperation with the vendors
regarding the quality of the output and design-for-manufacture
(DFM) issues to assure ease in manufacturing, quality, reliability,
and ease of service which are built into the product from the
design stage.
➔ Lean production requires close relationships with suppliers and
customers. This way, they will have an open communication on
their processes, quality levels and ways to reduce cost.
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FINANCIAL MANAGEMENT
Ferdinand L. Timbang, CPA, MSCF