Big Picture in Focus: ULOd. Determine the optimal inventory level
and reorder point.
Metalanguage
For you to demonstrate ULOd, you will need to have an operational understanding of
the following terms below.
1. Inventory Management. A set of guidelines in monitoring inventory.
2. Re-order Point. Refers to the level of inventory that signals replenishment.
3. Safety Stock. Refers to the number of stocks maintained which waiting for the
purchase to arrive.
Essential Knowledge
To perform the aforesaid big picture (unit learning outcomes) for the weeks 4-5 of the
course, you need to fully understand the following essential knowledge laid down in
the succeeding pages. Please note that you are not limited to exclusively refer to
these resources. Thus, you are expected to utilize other books, research articles and
other resources that are available in the university’s library e.g. ebrary,
search.proquest.com etc., and even online tutorial websites.
1. Inventory Management
Classification of inventories
Manufacturing:
Raw Materials
Goods in process
Finished Goods
Factory Supplies
Merchandising:
Merchandise inventory
2. Objective of Inventory Management
Its objective is to ensure the smooth operation of the firm’s production and marketing
functions and at the same time avoid tying up funds in excessive and slow-moving
inventory.
3. Inventory Management Techniques
1. Economic Order Quantity (EOQ)
AD = Annual Demand
CPO = Cost Per Order
CCPU = Carrying Cost per Order
Total Inventory Cost
= Ordering Costs + Carrying Costs
Ordering Cost
Carrying Cost
Average Inventory
= (AD (units) / EOQ ) x CPO
= Average Inventory x CPO
= EOQ or Order size / 2
2. Reorder Point
RP
=
Lead Time Usage + Safety Stocks
Illustration:
Assume that a local gift shop is attempting to determine how many sets of wine glass
to order. The store feel it will sell approximately 800 sets in the next year at a price of
P18 per set. The wholesale price that the store pays per set is P12. Cost of carrying
one set of wine glass are estimated at P1.50 per year while ordering costs are
estimated at P25.
a. Determine the EOQ for the sets of wine glasses.
Solution:
= 163 units per order
b. Determine the annual inventory costs for the firm if it orders in this quantity.
Total Inventory Costs
= [(800/163) + (25) + (163/2) + (1.5)
=P 244.95
Illustration: (Safety Stock)
HHI Operates a chain of hardware stores in Metro Manila. The Controller wants to
determine the optimum safety stock levels for an air purifier unit. The inventory
manager has complied the following date.
The annual carrying cost of inventory approximates 20% of the investment in
inventory.
The inventory investment per unit average P50.
The stockout cost is estimated to be P5 per unit.
The company orders inventory on the average of ten times per year.
Total costs = carrying costs + expected stockout costs
The probabilities of a stockout per order cycle with varying levels of safety stock are
as follows:
Units
Safety Stock
Stockout
Probability (%)
200
0
0
100
100
15
0
100
15
0
200
12
What is the total safety stock on an annual basis with safety stock level of 100 units?
Solution:
Annual Carrying Costs (100 x P10)
Annual Stockout costs (100 x 15% x 5 x 10)
Total
P1,000
750
P1,750
Self-Help: You can also refer to the sources below to help you
further
*Cabrera, E. B. (2016). Financial management: Principles and application (Vol. 1).
Manila: GIC Enterprises & Co., Inc.
*Brigham, E., & Houston, J.(2013). Fundamentals of financial management (13th ed.).
Singapore: Cengage Learning Asia Pte Ltd.
*Agamata, F. T. (2012). Reviewer in management advisory services (2013 Ed.).
Manila: GIC Enterprises & Co., Inc.
Let’s Check
Questions:
1
1. What are the different types of inventories? How do types differ?
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________.
2. What is the importance of having a good inventory management?
_________________________________________________________________
__
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________.
Let’s Analyze Questions:
1. Which condition justifies accepting a low inventory turnover ratio?
A.
High carrying costs.
C.
Low inventory order costs.
B.
High stock-out costs.
D.
Short
inventory order
times.
lead
2. If one optimizes the inventory turnover ratio, which costs will not increase?
A.
Carrying costs
C. Total reorder costs
B.
Stock-out cost
D. Unit reorder costs
3 The underlying philosophy of “just-in-time” inventory system is that
A.
The quantities of most stock items are subject to definable limits.
B.
It is a quest toward continuous improvement in the environmental
conditions that necessitates inventories.
C.
It is impractical to give equal attention to all stock items, hence the need
to classify and rank them according to their cost significance.
D.
The status of quantities on hand must be periodically reviewed where
high-value items or critical items are examined more frequently than low
cost or non-critical items.
4.
Which one of the following items is not directly reflected in the basic economic
order quantity (EOQ) model?
A.
Inventory obsolescence.
B.
Interest on invested capital.
C.
Public warehouse rental charges.
D.
Quantity discounts lost on inventory purchases.
5.
The optimal safety stock level is the quantity of safety stock that minimizes the
sum of the annual relevant
A.
ordering costs and carrying costs.
C.
ordering
costs
and
stockout
costs.
B.
ordering costs and purchasing costs. D.
stockout costs and
carrying
costs.
6.
The following data refer to various annual costs relating to the inventory of a
singleproduct company:
Unit transportation-in on purchases
$0.20
Storage per unit
0.12
Insurance per unit
0.10
Annual interest foregone from alternate investment of funds
Annual number of units required
10,000
What is the annual carrying cost per unit?
A. $0.30
C. $0.42
B. $0.32
D. $0.50
$800
7. The following information are given:
Optimal production run in units
2,000
Average inventory in units
1,000
Number of production runs
5
Cost per unit producedP75Desired annual return on inventory investment
18%
Set-up costs per production run
P5,000
If the units will be required evenly throughout the year, the total annual relevant
costs using the economic-order-quantity approach is
A.
P5,000
C. P75,000
B.
P38,500
D. P150,000
8. Cost of placing an order
P10
Annual demand
20,000 units
Purchasing price per unit
P0.50
The cost of holding the stock items amounts to 20% of the stock value per annum.
What annual cost saving would result if RODENSTOCK used the economic order
quantity for order sizes instead of their current policy?
A.
P 80
C. P150
B.
P 90
D. P240
9. M&L Co. has the following information on inventory:
Sales
20,000 units per year
Order quantity
4,000 units
Safety stock
2,600 units
Lead time
4 weeks
What is the re-order point? (For calculation purposes, use 50-week year)
A.
1,600 units.
C.
4,200 units.
B.
2,600 units.
D.
5,600 units.
Order quantity
1,500 units
Normal use per day
500 units
Maximum use per day
600 units
Minimum use per day
100 units
10. If the lead time is five days, the order point is
A. 500 units
C. 2,500 units
B. 1,500 units
D. 3,000 units
In a Nutshell
Based on the concepts on financial forecasting presented, write the three remarkable
lessons you learned.
1.
_________________________________________________________
__________________________________________________________
__________________________________________________________
2.
_________________________________________________________
__________________________________________________________
__________________________________________________________
3.
__________________________________________________________
__________________________________________________________
__________________________________________________________