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Fin420 Inventory Management

Chapter 8 covers inventory management, detailing types of inventory (raw materials, work in process, finished goods) and the motives for holding inventories, such as transaction needs and precautionary needs. It emphasizes the importance of determining optimal inventory levels to balance turnover and sufficient stock. Additionally, the chapter introduces calculations like Economic Order Quantity (EOQ) and Total Inventory Costs to optimize inventory management practices.

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27 views15 pages

Fin420 Inventory Management

Chapter 8 covers inventory management, detailing types of inventory (raw materials, work in process, finished goods) and the motives for holding inventories, such as transaction needs and precautionary needs. It emphasizes the importance of determining optimal inventory levels to balance turnover and sufficient stock. Additionally, the chapter introduces calculations like Economic Order Quantity (EOQ) and Total Inventory Costs to optimize inventory management practices.

Uploaded by

RisaYui211
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 8:

INVENTORY
MANAGEMENT
OUTLINES

8.1 Types of inventory

8.2 Motives for holding inventories

8.3 Calculations
INVENTORY MANAGEMENT

 Inventory - goods available for sale and raw materials


used to produce goods available for sale.

 Inventory management - Process of ordering,


storing, and using a company's inventory.
Include the management of raw materials,
components, and finished products, as well as
warehousing and processing such items.
Objectives of
Inventory Management

Maximize Carry
Inventory Sufficient
Turnover Inventories

Therefore, the firm must determine the


“optimal” level of inventories holding to
reconcile both of these conflicting objectives.
8.1 TYPES OF
INVENTORIES

• The purpose of holding inventories is to ensure


that the purchasing, production and marketing
functions are independent from each other.

• Any delays or complications in any of the


process will not interrupt the firm’s capacity to
produce goods and services.

• There are three (3) types of inventories:


1. Raw materials
2. Work in process (WIP)
3. Finished goods (Output)
1) Raw materials (Input)
• Consists of basic raw materials purchased mostly on credit or
accounts payable from suppliers to be used in the operation
process.

• Level of raw materials in a firm depends on the;


i. Anticipated sales
ii. Efficiency of the operations process
iii. Seasonal fluctuations
iv. Reliability of supply

• Ex: Latexes and timbers.


2) Work in process (WIP)
• Consists of partially finished goods requiring additional work before they
become finished goods and can be sold to customers.

• Level of WIP in a firm depends on the;


i. Length of production cycle
ii. Level of current production output

• Ex: Rubber sheets and plywood.

3) Finished goods (Output)


• Represent items of products that are ready for sale.

• Ex: Gloves and furniture.


8.2 MOTIVES FOR
HOLDING INVENTORIES

Firms need to hold cash for five (5) main reasons:

1. Transaction need : To do sales.

2. Need for continued production : Need to have raw materials and WIP in
various stages of production to avoid shortages during operations.

3. Speculative need : Through changes in cost of raw materials or change in


product.

4. Precautionary need : To meet anticipated demand especially for seasonal


products. (level of safety stocks)

5. Contractual agreement : Crucial in international trade that deals with


import and export when most goods are consigned using shipping mode.
8.3 CALCULATIONS

1. Economic Order Quantity (EOQ) Model


 Most common technique used to determine the optimal order size
(how much to order?) after take into consideration various
operating and financial costs – To minimize the overall inventory
cost.
 Basic costs: Order Costs (OC), Carrying Costs (CC), and Total
Inventory Costs (TIC)

𝐄𝐎𝐐 =√(𝟐 𝐒𝐎 )/ 𝐂
S = Usage, demand, or sales in unit per period
O = Order cost in Ringgits per order
C = Carrying (holding) cost per unit in Ringgits per period
Basic costs formula:
2. Total
TOC
Ordering
=O
Costs
 The fixed clerical costs of placing and receiving and ordering (such as
processing, telephoning, typing, mailing, etc.)

3. Total
TCC
Carrying
Costs =c

 The cost of carrying each unit of inventory including cost of storing, handling,
taxes, insuring, physical damage, obsolescence, auditing inventories.
4. Total
TIC
Inventory
= TOC + TCC
Costs
 The sum of total carrying costs and total ordering costs.

Q = Order quantity in units; can be EOQ or other quantity


SS = Safety Stock
Other related formula
(cont.)
ROP (Day) [ x DT in day ] + SS
= units
5. ReOrder
Points
ROP (Week) [ x DT in week ] + SS
= units

 Act as an indicator when the firm should place an order for the new shipments
 To ensure that inventories arrived in time before safety stock is affected.

6. Safety
SS
Stock
 Provide allowance for uncertainty in demand and delivery of inventory

S = Sales, demand or usage in unit per period or year


DT = Delivery time
= Lead-time in days to delivery as a fraction of the period (DT/360)
Other related formula
(cont.)

FO
7. Frequency
of Order *No. of orders =

 Lag time in days between orders.

8. Average AI + SS
Inventory = Units
Example of Calculations:

Arjuna Cold Storage purchases 260,000 boxes of chocolate


bars annually. The ordering cost RM60 per order and it
costs RM0.20 per box for storage. The store maintains
3,000 boxes for safety stock and delivery time is a week.
Order must be placed in round lots of 100 boxes. Using 360
days in a year, Determine the following:

i) EOQ
ii) Number of order in a year
iii) Total inventory cost
iv) Reorder point
Solution:
S = 260,000 boxes, O = RM60, C = RM0.20, SS = 3,000 boxes
i) EOQ @ Q =
= = 12,490 units ≈ 12,500 units
Order must be
placed in round
lots of 100 boxes

ii) Number of order in a year = S/Q


= 260,000/12,500 = 20.8 times ≈ 21 times

iii) TIC = TOC + TCC


iv) ROP = [ x DT in Days ] + SS
TOC = O x (D/Q) = [ x 7 ] + 3,000
= 60 X (260,000/12,500) = RM1,248 = 8,056 units
TCC = C x [(Q/2) + SS]
= RM0.20 x [(12,500/2) + 3,000] = RM1,850

TIC = TOC + TCC


= RM1,248 + RM1,850 = RM 3,098
ANY QUESTIONS

15

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