Course Code: Financial Management
Student Activity Sheet Module #18
Name: Rachel O. Lanzaderas Section: ACTNG-07 Schedule:
Lesson title: INVENTORY MANAGEMENT
Lesson Objectives:
At the end of this module, I should be able to:
1. explain the importance of having adequate inventories
2. establish control measures to avoid risks of having too
many inventories
3. determine the benefits of having carefully planned
inventories
Class number:
Date:
Materials:
SAS
References:
Brigham, E. and Houston, J.
(2013). Fundamentals of Financial
Management. Pasig City: Cengage
Learning Asia Pte. Ltd.
Timbang, F. L. (2015). Financial
Management, Part 1. Quezon City:
C & E Publishing, Inc.
COC Teacher’s Guide
Productivity Tip: Schedule doing practice drills similar to the ones in this module two more times this
week. Spacing your practice time will help you master the process!
A. LESSON PREVIEW/REVIEW
1) Introduction
In this module, we will learn about the ways of managing inventories, its importance, and the types
of inventory costs.
2) Activity 1: What I Know Chart, part 1 (3 mins)
Do you know anything about inventory management? Try answering the questions below by
writing your ideas under the first column What I Know. It’s okay if you write key words or phrases
that you think are related to the questions.
What I Know
Inventories are those things used
by the business to sell
Questions:
What is an inventory?
Why is important to manage
inventory?
What I Learned (Activity 4)
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.
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Course Code: Financial Management
Student Activity Sheet Module #18
What are the types of inventory
costs?
B. MAIN LESSON
1.) Activity 2: Content Notes
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Course Code: Financial Management
Student Activity Sheet Module #18
Name:
Section:
Schedule:
Class number:
Date:
➢ Defined by the Philippine Accounting Standards (PAS) No.2 as “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.”
Classes of Inventories
Raw
➢ Consists of basic materials purchased from other firms to be used in
materials
the production of goods or products
inventory
Work-in➢ Consist of partially finished goods requiring additional work before they
process
become wholly completed
inventory
Finished
➢ Consists of completely manufactured goods that are not yet sold
goods
inventory
Supplies
➢ Materials that are regularly used by the company but do not form part
of the finished goods sold
Importance of Inventory Management
Decoupling
➢ If the firm does not store up for a good inventory, there can be many
function
delays and inefficiencies.
➢ In a manufacturing process, raw materials can be stored by
Storing
themselves, or included in the work-in-process or the finished goods
resources
inventory.
Irregular
➢ When the supply or demand for an inventory item is irregular, storing
supply and
certain amounts on hand can be important.
demand
Quantity
➢ Purchasing in large quantities can substantially reduce the cost of
discounts
products; however, this may result to higher costs due to spoilage,
damaged stock, theft, insurance, so on, and less availability of cash for
other investments
Avoiding
➢ If a company is repeatedly out-of-stock, customers will likely go
stock-outs
elsewhere to satisfy their needs.
and
shortages
Ways in Managing Inventories
1. Monitor inventory ratios.
2. Maintain inventory at its optimum level.
3. Hedge.
4. Examine the degree of spoilage.
5. Examine the quantity of inventory with respect to sales.
6. Eliminate slow-moving inventories.
7. Watch out for inventory risks.
8. Forecast the price of materials needed.
Inventories
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Course Code: Financial Management
Student Activity Sheet Module #18
Name:
Section:
Schedule:
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Types of Inventory Costs
- There are two basic costs associated with inventory: ordering costs and carrying costs. By
careful analysis of these two variables, the firm can determine the optimum order size to minimize
the total inventory costs (Mejorada, 2000).
a. Order Cost
Also known as purchase cost or set up cost, this is the sum of the fixed costs that are
incurred each time an item is ordered. It is computed as follows:
Total ordering cost = Number of orders x OC
Where: OC = ordering cost per order
b. Carrying Cost
Also called holding cost, associated with having the inventory on hand. It is primarily made
up of costs related to the inventory investment and storage. For the purpose of the
economic order quantity calculation, if the cost does not change based on the quantity of
inventory on hand, it should not be included in the carrying cost. In the EOQ formula, the
carrying cost is the average number of units of inventory for the period, multiplied by the
carrying cost per unit.
Total carrying cost = (Q/2) x CC
Where: Q = quantity or EOQ
CC = carrying cost per unit
Components of the Carrying Cost
1. Interest.
2. Insurance
3. Taxes
4. Storage costs
Trade-off of the Carrying Cost and the Ordering Cost
Carrying cost and ordering cost have 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.
The decision to minimize the inventory cost will depend on the two component cost.
Minimizing the costs means locating the point where the two costs will be equal.
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Course Code: Financial Management
Student Activity Sheet Module #18
Name:
Section:
Class number:
Date:
Schedule:
2.) Activity 3: Skill-building Activities
Let’s practice! After completing each exercise, you may refer to the Key to Corrections for
feedback. Try to complete each exercise before looking at the feedback.
Exercise 1: Provide what is asked.
Assuming that Charlene Corporation has an optimal order quantity of 5,000. The company desires
a safety stock of 250 units. A 7-day lead time is needed for delivery. Annual inventory carrying
costs equal 20% of the average inventory level. The company pays P5 per unit to buy the product,
which it sells for P8. The company pays P100 to place a detailed order, and the monthly demand
for the product is 5,000 units. How much is the total carrying costs?
: Carrying cost per unit is P1 (P5 x 20%) Average order size (5,000/2)
stock 250
2,500 units Safety
Average inventory 2,250 units
X Carrying cost per unit
P1.00
Total carrying costs P2,250
Exercise 2: Using the same information in Exercise 1, how much is the total ordering costs?
The annual demand for the product is 60,000 units (5,000 per month x 12 mos) OC
No. of orders x cost per order
=
(60,000 units/5,000 units0 x P200
=
12 times x P200
=
P2,400
=
Exercise 3: Provide what is asked.
Blonde Company’s budgeted sales and budgeted cost of sales for the coming year are P14.4
million and P9 million, respectively. Short-term interest rates are expected to average at 15%. If
the company can increase the inventory turnover from its current level of 9.0 times per year to
12.0 times per year, its cost savings for the coming year are expected to be how much?
Before
After
Cost of goods sold P9 million
Inventory turnover
P9 million
9 times12 times Inventory bal. (CGS/IIT
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Course Code: Financial Management
Student Activity Sheet Module #18
P1,000,000 P750,000 Decrease in inventory bal
(P1,000,000-P750,000)
P250,000
Savings from decrease of inventory
Cost savings (P250,000 x 15%)
P37,500
3.) Activity 4: What I Know Chart, part 2
It’s time to answer the questions in the What I Know chart in Activity 1. Log in your answers in the
table.
4.) Activity 5: Check for Understanding
Encircle the letter of the best answer.
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Course Code: Financial Management
Student Activity Sheet Module #18
Name:
Section:
Schedule:
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Date:
1. Which of the following statements is most consistent with efficient inventory management? The
firm has a
a. below-average inventory turnover ratio.
b. low incidence of production schedule disruptions.
c. below-average total assets turnover ratio.
d. relatively high current ratio.
e. relatively low DSO.
2. Inventory management is largely self-contained in the sense that very little coordination among
the sales, purchasing, and production personnel is required for successful inventory
management.
a. True
b. False
3. Other things held constant, which of the following will cause an increase in net working capital?
a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
c. Merchandise is sold at a profit, but the sale is on credit.
d. Long-term bonds are retired with the proceeds of a preferred stock issue.
e. Missing inventory is written off against retained earnings.
4. Which of the following actions would be likely to shorten the cash conversion cycle?
a. Adopt a new manufacturing process that speeds up the conversion of raw
materials to finished goods from 20 days to 10 days.
b. Change the credit terms offered to customers from 3/10, net 30 to 1/10, net 50.
c. Begin to take discounts on inventory purchases; we buy on terms of 2/10, net 30.
d. Adopt a new manufacturing process that saves some labor costs but slows down
the conversion of raw materials to finished goods from 10 days to 20 days.
e. Change the credit terms offered to customers from 2/10, net 30 to 1/10, net 60.
5. It is the process of determining the appropriate level of inventory.
a. Economic order quantity
b. Inventory management
c. Economic order point
d. Total cost
6. It is the cost of placing an order and receiving the merchandise. It includes the freight charges
and clerical costs to place an order.
a. ordering costs
b. total inventory costs
c. carrying costs
d. safety sock
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Course Code: Financial Management
Student Activity Sheet Module #18
Name:
Section:
Schedule:
Class number:
Date:
7. It measures the average number of days to sell or consume the average inventory.
a. inventory turnover
b. average age of inventory
c. average age of receivables
d. answer not given
8. Which of the following would cause every average inventory holding to increase, other things
held constant?
a. the purchase price of inventory items increase by 20 percent
b. the sales forecast is revised upward by 15 percent
c. fixed order cost of an item increases as a percentage of purchase price
d. all of the above would cause average inventory holdings to decrease
9. When it comes to inventory, there are different views among managers from finance, marketing
and operations. Which one of the desires below best relates to the financial manager?
a. large safety stock
b. large inventory and keep customers happy
c. inventory arriving just in time
d. small investment in inventory
e. maximize inventory holdings
10. All of the following are components of carrying costs except:
a. insurance
b. storage costs
c. handling costs
d. set-up costs
C. LESSON WRAP-UP
Activity 6: Thinking about Learning
Congratulations for finishing this module! Shade the number of the module that you finished.
Did you have challenges learning the concepts in this module? If none, which parts of the module helped
you learn the concepts?
None, so far.
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Course Code: Financial Management
Student Activity Sheet Module #18
Name:
Section:
Schedule:
Class number:
Date:
Some question/s I want to ask my teacher about this module is/are:
FAQ
1. Whose responsibility the monitoring of inventory level is within the entity?
➢ Monitoring the inventory level is not the sole responsibility of the finance manager. It require she
concerted efforts of the operating units in the organization.
Homework:
Study in advance:
• Inventory Management
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