INVENTORY

MANAGEMENT
 What is Inventory?
Inventory - a stock or store of goods

Types of Inventories
• Raw materials & purchased parts
• Work in process
• Finished-goods inventories
• Replacement parts, tools, & supplies
• Goods-in-transit to warehouses or customers
 Functions of Inventory
• To meet anticipated demand
• To smooth production requirements
• To decouple operations

• To protect against stock-outs

• To help hedge against price increases
Objective of Inventory Control
• To achieve satisfactory levels of
customer service while keeping
inventory costs within reasonable
bounds
–Level of customer service
–Costs of ordering and carrying inventory

Inventory turnover
is the ratio of average cost of goods sold
to average inventory investment.
Effective Inventory Management
• A system to keep track of inventory
• A reliable forecast of demand
• Knowledge of lead times
• Reasonable estimates of
–Holding costs
–Ordering costs
–Shortage costs
• A classification system
 Inventory Counting Systems
• Periodic System
- Physical count of items made at periodic intervals
• Perpetual Inventory System
- System that keeps track of removals
from inventory continuously, thus
monitoring current levels of each item
• Two-Bin System
- Two containers of inventory; reorder when the first is
empty
• Universal Bar Code
- Bar code printed on a label that has information about
the item to which it is attached
 ABC Classification System

Classifying inventory according to some

measure of importance and allocating
control efforts accordingly.
A - very important High
A
B - mod. important Annual
$ value B
C - least important of items

Low C
Low High
Percentage of Items
Other inventory control
system
a.Fixed order quantity system
b.Fixed reorder cycle system
c.Optional replacement sytem
 Key Inventory Terms
• Lead time: time interval between
ordering and receiving the order
• Holding (carrying) costs: cost to carry
an item in inventory for a length of time,
usually a year
• Ordering costs: costs of ordering and
receiving inventory
• Shortage costs: costs when demand
exceeds supply
Economic Order Quantity Model
–The order size that minimizes total annual cost

Assumptions of EOQ Model

• Only one product is involved
• Annual demand requirements known
• Demand is even throughout the year
• Lead time does not vary
• Each order is received in a single delivery
• There are no quantity discounts
 The Inventory Cycle

Profile of Inventory Level Over Time

Q Usage
Quantity rate
on hand

Reorder
point

Time
Receive Place Receive Place Receive
order order order order order
Lead time
 Total Cost
Total cost = Annual Annual
carrying + ordering
cost cost

TC = Q H + D
S
2 Q
Deriving the EOQ

S/a= cost of placing one order (ordering cost)

D= annual demand in units
K= annual costs of carrying one unit inventory for one year
 Behavior of OC,CC and TC

The Total-Cost Curve is U-Shaped

Q D
TC  H  S
Annual Cost

2 Q

Ordering Costs

Order Quantity
Q(Ooptimal order quantity)
(Q)
Example:
Emil traders, inc sells cellphone cases which
it buys from a local manufacturer. Emil
trafers sells P24,000 cases evenly
throughout the year. The cost of carrying one
unit in inventory for one year is P11.52 and
order cost per order is P38.40
Requirement:
a.How much is the EOQ?
b.If emily traders would buy in EOQ, How
much is the total order costs?.
c.If emily traders would buy in economic
order quantities, How muchis the total
inventory carrying cost per year?.
Economic Production Quantity (EPQ)
• Production done in batches or lots
• Capacity to produce a part exceeds the
part’s usage or demand rate
• Assumptions of EPQ are similar to EOQ
except orders are received
incrementally during production
 Economic Lot Size

S= setup cost
D= annual production requirement
H= annual cost of carrying one unit in inventory
for one year
Example:
The following information pertains to Emy manufacturing
Corporation's Product X:
Annual demand 33,750 units
Annual cost to hold one unit of inventory P15
Set-up cost(or cost to initiate production run P500

Beginning inventory of product x is zero.

At present, the comlany produces 2,250 units of product x

per production run, for a total of 15 production runs per
year. The comoany is considering to use EOQ model to
determine the economuc lot size and number of production
runs that will minimize the total inventory carrying cost and
set-up cost for produc X.
Requirements:
a.At present the company's how much is
the total annual inventory costs?
b.If EOQ model is used, How much is the
ELS?
c.If EOQ model is used, How much
should the number of priduction runs?
 When to Reorder with EOQ
Ordering
• Reorder Point - When the quantity on
hand of an item drops to this amount,
the item is reordered
• Safety Stock - Stock that is held in
excess of expected demand due to
variable demand rate and/or lead time.
• Service Level - Probability that demand
will not exceed supply during lead time.
Reorder point = lead time quantity + safety stock
quantity
Where:
Lead time quantity = normal usage × normal lead
time
Safety stock = safety stock( in usage) + safety stock (
in time)
Safety stock in usage= (maximum usage - normal
usage) × normal lead time
Safety stock(in time) = (maximum lead time - normal
lead time) × normal usage
Maximum inventory level= safety stock quantity +
order size
 Example:
Linda Corporation has the following
production data: 40,000 units
Annual requirement 320 days
Number of working days 10 days
Normal lead time 16 days
Maximum lead time 150 units
Maximum usage 5000 units
EOQ
Requirements:
Determine the lead time quantity, safety stock
quantities, reorder point and maximum inventory
leves
 Modern inventory Management
-often applied in context of
manufacturing

a. Materials Requirement planning

(MRP)
b. Manufacturing resource planning
(MRP 11)
c. Enterprise resource planning
(ERP)
Short term financing
 Short term financing
- a debt originally scheduled for
repayment within one year.
- used to finance all or part of the firm's
working capital requirements and
sometimes to meet permanent
financing need
- it is often less expensive and more
flexible than the long-term financing
Factors to be considered in selecting the
sources of short-term financing:

1. Cost
2. Availability of short-term funds when needed
3. Risk
4. Flexibility
5. Restrictions
6. Effect on credit rating
7.expected money-market conditions
8. Inflation
9. The company's profitability and liquidity position,
as well as the stability of its operation
What are the sources of fund?
1) Spontaneous sources
a.Accruals
b.Trade credit

2) Non- spontaneous sources

a.Short-term bank loans
b.Line of credit
c.Commercial papers
d.Pledging/assignment of accounts receivable
e.Factoring of accounts receivable
f.Invenyory loan:
 cost of trade credit
- usually bears no interest, but it is not costless.
Its costs is implicit in terms of credit agreed
upon( discount policy and credit period)

annual Rate =
Discount % × number of days in a year
100%-Discount % net period- Discount
period
Example:
A company purchases merchandise inform
its supplier on credit terms of 3/10, net 30.
What is the equivalent annual interest rate if
company forgoes the discount and pays on
the 40th day,( use 360 days)?
 Cost of bank loans
Interest in bank loans are calculated in five
ways:
1. Simple interest
Effective annual rate= Interest
Face value

2. Discount Interest interest

Effective annual rate= Face value -
interest
3. Add-on Interest
2× annual no. Of payments × interest
Approx. Annual rate=(Total no. Of payments+1)× principal

interest_______
(1+(1/no.ofpayments))/2
Example1: Discount interest
You plan to borrow P10,000 from your bank, which
offers to lend you money at a 10% nominal or
stated rate on a one year loan, What is the Effective
interest rate if the loan is a discount loan?

Example2.: add-on interest

Perlas company borrowed from bank an amount of 1
million. The bank charged a 12% sated rate in an
add on arrangement, payable in 12 equal monthly
installment, what is the effective interest rate?
4. Simple interest w/ compensating balance

Effective annual rate= Interest Or

Nominal rate(%)
Face value-CB 100% -CB

5. Discount interest w/
CB
Nominal rate(%)
Effective annual rate100%-
= nominal interest -CB

Or Borrowing cost/Net proceeds

Example 3: what is the effective interest rate if
the company borrows P200,000 on a 6%
discounted loan w/ 10% compensating balance
for 3 months?
 Cost of Commercial paper

Effective annual rate =

Interest cost per period × no. Of days in a year
Face value of the notes-interest-issue cost No. Of days funds are
borrowed
Example:
Giant corporation plans to issue P500 million in
commercial paper for 180 days at stated,
discounted interest rate of 10%, Dealers of the
commercial paper usually charge P200,000 in
place ment fees and floatation costs. (Use 360
days). What is the effective annual interest rate.