INVENTORY MANAGEMENT

Written by :

Prayuda Gusianto Saputra (C1C022090)

Besra Adinda Saputra (C1C022130)

Supporting lecturer :

Lisa Martiah Nila P, SE, M.Si., Ak., CA

BACHELOR'S STUDY PROGRAM IN ACCOUNTING

FACULTY OF ECONOMICS AND BUSINESS

BENGKULU UNIVERSITY

2024
 ACKNOWLEDGEMENT

Praise be to Allah, the Almighty, the Most Gracious and the Most Merciful, who has
granted me the strength, guidance, and patience throughout the process of researching and
completing this academic paper. This paper on Management Accounting: Cost Behaviour and
Forecasting would not have been possible without His blessings.

We extend my deepest gratitude to my parents, family, and friends for their

unwavering support and encouragement. Their words of wisdom and endless motivation have
been instrumental in keeping me focused and motivated during the challenging phases of this
research.

we are also grateful to my professors, mentors, and colleagues for their invaluable
insights, feedback, and guidance, which have enriched my knowledge and understanding of
the subject matter. Their constructive criticism and expertise have contributed significantly to
the quality and depth of this paper.

Lastly, we want to express my appreciation to all the authors, researchers, and

scholars whose works and contributions have informed and inspired this paper. Their
dedication to advancing the field of Management Accounting has been a source of motivation
and inspiration for my research.

This paper is a product of dedication, perseverance, and collaborative effort. I hope it

serves as a valuable contribution to the academic literature on Management Accounting, Cost
Behaviour, and Forecasting.

Thank you

Bengkulu, 06 February 2024

Writer

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 TABLE OF CONTENT

ACKNOWLEDGEMENT……………………………………………………………………………...i
TABLE OF CONTENT………………………………………………………………………………..ii
CHAPTER I INTRODUCTION…………………………………………………………………….....1

1.1 Background……………………………………………………………………………1
1.2 Formulation of the problem……………………………………………………………2

1.3 Purpose………………………………………………………………………………...2

CHAPTER II DISCUSSION………………………………………………………………...3
2.1 Why do firms carry inventory?.......................................... ..........................................3
2.2 What are inventory costs?.............................................................................................4
2.3 What can be done to minimize inventory costs?............... ..........................................5
2.4 How does JIT reduce inventories?................................................... ............................7
2.5 What are the weaknesses of JIT?..................... ......................................... ..................8
2.6 How does using the theory of constraints reduce inventories?......................... ...........9
2.7 Why is effective management of inventory so important?...........................................10

CHAPTER III CONCLUSION………………………………………………………………12

3.1 Conclusion…….……………………………………………………………………...12

3.2 Advice……….………………………………………………………………………..12

REFERENCE LIST…………………………………………………………………………..13

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 CHAPTER I

INTRODUCTION

1.1 BACKGROUND

Inventory management is a crucial component of a company's operations, impacting

everything from customer satisfaction to financial performance. It involves the oversight and
control of the ordering, storage, and use of components that a company uses in the production
of the items it sells, as well as the management of finished products available for sale. The
primary goal of inventory management is to ensure that there is always enough inventory to
meet customer demand without incurring excess cost or waste. This balancing act requires
precise planning, forecasting, and coordination.

One of the key benefits of effective inventory management is the optimization of cash
flow. Inventory represents a significant investment for most companies, tying up capital that
could otherwise be used for growth opportunities or to address short-term operational needs.
By minimizing the amount of money tied up in inventory, a company can improve its
liquidity, reducing the need for external financing and lowering the costs associated with
carrying excess inventory, such as storage, insurance, and risk of obsolescence.

Another critical aspect of inventory management is enhancing customer satisfaction and

loyalty. Having the right products available when customers need them is essential for
maintaining high service levels. Effective inventory management ensures that products are
available to fulfill customer orders promptly, which is particularly crucial in highly
competitive markets where customers can easily switch to competitors if their needs are not
met. By ensuring product availability, companies can avoid stockouts, backorders, and
delays, thereby enhancing the overall customer experience.

Inventory management also plays a vital role in increasing operational efficiency. By

streamlining inventory processes, companies can reduce waste, decrease the time products
spend in the warehouse, and optimize the use of storage space. Techniques such as Just-In-
Time (JIT) inventory management, where materials are ordered and received just as they are
needed in the production process, can significantly reduce inventory levels and associated
costs. Furthermore, effective inventory management can lead to better decision-making

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regarding product pricing, discontinuation of underperforming products, and introduction of
new products based on accurate inventory data.

Lastly, inventory management is essential for supporting a company's strategic goals,

such as expanding into new markets, introducing new product lines, or improving profit
margins. By providing accurate and timely information on inventory levels, turnover rates,
and product performance, inventory management systems enable companies to make
informed decisions that align with their long-term objectives. Additionally, by reducing
excess inventory and improving inventory turnover, companies can free up resources to
invest in growth opportunities, innovation, and competitiveness in the marketplace.

1.2 FORMULATION OF THE PROBLEM

2. Why do firms carry inventory?

3. What are inventory costs?
4. What can be done to minimize inventory costs?
5. How does JIT reduce inventories?
6. What are the weaknesses of JIT?
7. How does using the theory of constraints reduce inventories?
8. Why is effective management of inventory so important?

1.3 PURPOSE

2. To understand why do firms decide to carry inventory?

3. To understand what is the meaning of inventory costs and what counts as inventory
costs?
4. To know what can be done to minimize inventory costs
5. To know how does Just-in-Time system can reduce inventories
6. To know what are the weaknesses of JIT?
7. To understand how does using the theory of constraints reduce inventories
8. To understand why is effective management of inventory so important

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 CHAPTER II

DISCUSSION

2.1 Why do firms carry inventory?

The traditional reasons for firms to carry inventory is due to intents to maximizing
profits. In order to maximizing the profits, it requires that inventory-related costs to be
minimized. But minimizing carrying costs favours ordering or producing in small lot sizes,
whereas minimizing ordering costs favours large, infrequent orders (minimization of setup
costs favours long, infrequent production runs). Thus, minimizing carrying costs encourages
small or no inventories, and minimizing ordering or setup costs encourages larger inventories.
The need to balance these two sets of costs so that the total cost of carrying and ordering can
be minimized is one reason organizations choose to carry inventory.

Dealing with uncertainty in demand is a second major reason for holding inventory.
Even if the ordering or setup costs were negligible, organizations would still carry inventory
because of stockout costs. If the demand for materials or products is greater than expected,
inventory can serve as a buffer, giving organizations the ability to meet delivery dates (thus
keeping customers satisfied). Although balancing conflicting costs and dealing with
uncertainty are the two most frequently cited reasons for carrying inventories, other reasons
also exist.

Inventories of parts and raw materials are often viewed as necessary because of
supply uncertainties. That is, inventory buffers of parts and materials are needed to keep
production flowing in case of late deliveries or no deliveries (for examples strikes, bad
weather, and bankruptcy). Unreliable production processes may also create a demand for
producing extra inventory. For example, a company may decide to produce more units than
needed to meet demand because the production process usually yields a large number of
nonconforming units. Similarly, buffers of inventories may be required to continue supplying
customers or processes with goods even if a process goes down because of a failed machine.
Finally, organizations may acquire larger inventories than normal to take advantage of
quantity discounts or to avoid anticipated price increases.

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2.2 What are Inventory Costs?

Inventory costs are every expense associated with purchasing, storing and managing
inventory throughout the supply chain. In a world of certainty—a world in which the demand
for a product or material is known with certainty for a given period of time (usually a year)—
two major costs are associated with inventory. If the inventory is a material or good
purchased from an outside source, then these inventory-related costs are known as ordering
costs and carrying costs. If the material or good is produced internally, then the costs are
called setup costs and carrying costs.

Ordering costs are the costs of placing and receiving an order. Examples include the
costs of processing an order (clerical costs and documents), the cost of insurance for
shipment, and unloading costs.

Setup costs are the costs of preparing equipment and facilities so they can be used to
produce a particular product or component. Examples are wages of idled production workers,
the cost of idled production facilities (lost income), and the costs of test runs (labours,
materials, and overhead).

Carrying costs are the costs of carrying inventory. Examples include insurance,
inventory taxes, obsolescence, the opportunity cost of funds tied up in inventory, handling
costs, and storage space.

Ordering costs and setup costs are similar in nature—both represent costs that must be
incurred to acquire inventory. They differ only in the nature of the prerequisite activity
(filling out and placing an order versus configuring equipment and facilities).

Then what If the demand is not known with certainty, a third category of inventory
costs— called stockout costs—exists. Stockout costs are the costs of not having a product
available when demanded by a customer. Examples are lost sales (both current and future),
the costs of expediting (increased transportation charges, overtime, and soon), and the costs
of interrupted production.

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2.3 What can be done to minimize inventory costs?

In order to minimize inventory costs, two basic questions must be addressed:

1. How much should be ordered (or produced)?

2. When should the order be placed (or the setup done)?

Order Quantity and Total Ordering and Carrying Costs

If we Assume that demand is known. In choosing an order quantity or a lot size for
production, managers need to be concerned only with ordering (or setup) and carrying costs.
The total ordering (or setup) and carrying costs can be described by the following equation:

TC = PD/Q + CQ/2

= Ordering cost + Carrying cost

Where, TC = The total ordering (or setup) and carrying costs

P = The cost of placing and receiving an order (or the cost of setting up a
production

run)

D = The known annual demand

Q = The number of units ordered each time an order is placed (or the lot size for

production)

C = The cost of carrying one unit of stock for one year

The objective is to find the order quantity that minimizes the total cost. This order quantity is
called the economic order quantity (EOQ). The EOQ model is an example of a push
inventory system. In a push system, the acquisition of inventory is initiated in anticipation of
future demand—not in reaction to present demand. Fundamental to the analysis is the
assessment of D, the future demand.

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Computing EOQ

Since EOQ is the quantity that minimizes Equation 14.1, a formula for computing this
quantity is easily derived:

Q = EOQ = √2PD/C

Reorder Point

The EOQ answers the question of how much to order (or produce). Knowing when to
place an order (or setup for production) is also an essential part of any inventory policy. The
reorder point is the point in time when a new order should be placed (or setup started). It is a
function of the EOQ, the lead time, and the rate at which inventory is depleted. Lead time is
the time required to receive the economic order quantity once an order is placed or a setup is
initiated.

To avoid stockout costs and to minimize carrying costs, an order should be placed so
that it arrives just as the last item in inventory is used. Knowing the rate of usage and lead
time allows us to compute the reorder point (ROP) that accomplishes these objectives:

ROP = Rate of usage x Lead time

Demand Uncertainty and the Reorder Point

If the demand for the part or product is not known with certainty, the possibility of stockout
exists. To avoid this problem, organizations often choose to carry safety stock. Safety stock is
extra inventory carried to serve as insurance against fluctuations in demand.

Safety stock = (Maximum usage – Minimum usage) x Lead time

With the presence of safety stock, the reorder point is computed as follows:

ROP = (Average rate of usage x Lead time) + Safety stock

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2.4 How does JIT reduce inventories?

Just-in-time manufacturing is a demand-pull system that requires goods to be pulled

through the system by present demand rather than pushed through the system on a fixed
schedule based on anticipated demand. Many fast-food restaurants, like McDonald’s, use a
pull system to control their finished goods inventory. When a customer orders a hamburger, it
is taken from the rack. When the number of hamburgers gets too low, the cooks make new
hamburgers. Customer demand pulls the materials through the system.

This same principle is used in manufacturing settings. Each operation produces only
what is necessary to satisfy the demand of the succeeding operation. The material or
subassembly arrives just in time for production to occur so that demand can be met. Thus,
complementary to and part of the total JIT system is the concept of JIT purchasing. JIT
purchasing requires suppliers to deliver parts and materials just in time for production.
Supplier linkages are vital. Supply of parts must be linked to production, which is linked to
demand.

Just-in-Time (JIT) inventory management has revolutionized production processes by

minimizing inventory levels and minimizing inventory costs that will occur, JIT doesn’t use
the traditional stockpiling practices, Production is solely focused on what is immediately
needed, based on real-time sales data. This eliminates overproduction and its associated
waste, reducing storage needs and freeing up valuable resources.

Every item held in inventory incurs hidden costs such as insurance, security, and
handling (carrying costs). JIT minimizes these burdens by maintaining low inventory levels,
with less inventory to manage, the reliance on large, costly warehouses diminishes
significantly. This translates to substantial cost savings in rent, utilities, and personnel
(carrying costs). This newfound space then can be repurposed for more productive activities,
streamlining operations and fostering a leaner, more efficient working environment.

The success of JIT based on forging strong relationships with suppliers. Frequent
communication and collaboration ensure timely deliveries and consistent quality, minimizing
disruptions and delays. suppliers become valuable partners in the journey towards efficiency
and reliability.

Instead of infrequent, bulk deliveries, JIT embraces smaller, more frequent deliveries
from suppliers. This ensures a steady flow of fresh materials, minimizes obsolescence risk,

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and allows for adjustments based on fluctuating demand. JIT creates a smooth, uninterrupted
production flow by eliminating wasted time searching for and moving materials, ensuring
optimal production speed and reduces waste.

For a bonus point, In today's dynamic market, adaptability is paramount. With lower
inventory levels, companies can swiftly adjust production to new trends or unexpected
demand surges. This agility allows businesses to stay ahead of the curve and capitalize on
emerging opportunities. Just-in-Time inventory management achieves dramatic inventory
reduction, unlocking a world of efficiency, flexibility, and improved financial health.

2.5 What are the weaknesses of JIT?

Answer :

Just-In-Time (JIT) inventory management is a strategy that aims to increase efficiency and
reduce waste by receiving goods only when they are needed in the production process. While
JIT offers several advantages, including reduced inventory holding costs and improved cash
flow, it also has several disadvantages, as follows:

1. Implementation Takes Time: JIT is not a system that can be bought and
implemented with instant results. It requires an evolutionary process and patience in
its implementation. Building good relationships with suppliers does not happen
overnight.
2. Supplier Relationships: Changing the relationship with suppliers unilaterally, by
demanding sudden changes in delivery time and quality, can create tension. A
partnership-based approach is more advisable than coercion.
3. Impact on Employees: Drastic inventory stock drops can lead to over-organized
workflows and increased stress among workers. Too rapid and forced inventory
reduction can lead to more problems, such as lost sales and worker stress.
4. Risk of Lost Sales: The absence of inventory as a buffer means that current sales are
always threatened by unexpected production disruptions. Retailers using JIT tactics
also face the possibility of stock shortages.
5. Long-term Risk with Suppliers: Actions that are too oriented toward quickly
reducing costs may cause suppliers to look for new markets, increase prices, or seek
regulatory solutions. This can eliminate many of the benefits JIT is trying to gain.

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 6. Lost Sales are a Real Cost: Losing sales due to not being able to fulfill demand in a
timely manner is a real cost of implementing a JIT system.

Just-In-Time (JIT) systems face significant challenges in implementation that require time
and patience, including relationship building with suppliers, and the potential for increased
stress on employees due to drastic inventory stock reductions. This approach also puts current
sales at risk due to the absence of inventory buffers that can lead to production disruptions
and lost sales. In addition, unilaterally changing relationships with suppliers can have adverse
long-term consequences. While JIT offers several benefits, companies should be aware of and
prepared for the real costs of lost sales and potential conflicts with suppliers when
implementing this system.

2.6 How does using the theory of constraints reduce inventories?

Answer :

Using Theory of Constraints (TOC) reduces inventory through several key mechanisms
aimed at optimizing production flow and improving operational efficiency. Here is how TOC
reduces inventory:

1. Identification and Exploitation of Constraints: TOC starts by identifying

constraints or bottlenecks that limit throughput (the rate at which an organization
makes money through sales). By focusing on exploiting these constraints,
organizations can maximize their usage without increasing inventory unnecessarily.
This is done by ensuring that such constraints operate as efficiently as possible,
reducing lead times and improving production flow.
2. Subordination of Everything Else to the Constraint: Once the constraint is
identified, all other processes in production are subordinated to support the operation
of the constraint. This means that other production activities are organized to ensure
that they do not produce more output than the constraint can process. This approach
prevents the accumulation of excessive work-in-process inventory and finished goods
inventory.
3. Reducing Lead Time: By optimizing operations around constraints, organizations
can reduce production lead time. This lead time reduction allows the company to be

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 more responsive to market demand, reducing the need for finished goods inventory as
a buffer against demand uncertainty.
4. More Effective Inventory Management: TOC promotes more effective inventory
management by minimizing the amount of inventory required to support constraint
operations. This includes the reduction of inventory of raw materials and components
required for production, as well as the reduction of in-process and finished goods
inventory. By reducing the amount of inventory, companies can reduce storage costs
and the risk of damage or expiration.
5. Continuous Improvement: TOC is an iterative process that continuously seeks ways
to identify and overcome new constraints that arise as a result of changes in the
process or market demand. By continuously improving processes and reducing
constraints, organizations can continuously reduce unnecessary inventory levels while
maintaining or improving service levels to customers.
6. Drum-Buffer-Rope (DBR): The DBR system in TOC helps in matching the
production flow to the speed of the constraint (drum), using buffers to manage
variability and ensure the constraint continues to operate, and ropes to control the
release of materials into the production process. This approach ensures that inventory
is kept at the minimum level required to support throughput without compromising
customer satisfaction.

As such, TOC helps organizations reduce inventory through identifying and effectively
managing constraints, ensuring that production is aligned with market demand, and
optimizing resource usage, all of which contribute to unnecessary inventory reduction and
improved financial performance.

2.7 Why is effective management of inventory so important?

Answer :

Effective inventory management is critical as it has a direct and significant impact on a

company's financial and operational performance. Based on the theory of constraints (TOC)
and the concepts described, here are some reasons why effective inventory management is
essential:

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 1. Improves Cash Flow: Effective inventory reduces money tied up in stock, which
improves a company's liquidity and cash flow. This allows the company to be more
responsive to market changes and investment opportunities.
2. Reduces Costs: Effective inventory management reduces the costs of storage,
insurance, and damage or obsolescence. By minimizing inventory, companies can
reduce operating costs, which directly increases profit margins.
3. Improving Customer Satisfaction: By focusing on decreasing lead times and
increasing responsiveness to customer demand, effective inventory management can
improve customer satisfaction. On-time delivery and the ability to fulfill demand
quickly are important factors in retaining and attracting customers.
4. Improving Productivity and Efficiency: Identifying and managing production
constraints allows companies to maximize throughput while minimizing unnecessary
inventory and operational costs. This helps improve the overall efficiency of
operations.
5. Support Continuous Improvement: TOC emphasizes the importance of continuous
evaluation and improvement of the constraints that limit performance. By reducing
inventory, companies can more easily identify problems in the production process and
implement improvements, which supports innovation and long-term growth.
6. Improving Pricing Decisions and Product Margins: By reducing inventory and
operational costs, companies have greater flexibility in pricing decisions, which can
help in competitively positioning products in the market without sacrificing margins.
7. Improved Ability to Respond to Market Changes: Lower inventory means
companies can more quickly adjust to changes in customer demand or preferences.
This is especially important in fast-paced industries where product cycles are short
and innovation is constant.

Overall, effective inventory management is a critical component of a company's operational

and financial strategy. Through the application of TOC principles and prudent inventory
management, a company can improve its financial performance, increase operational
efficiency, and strengthen its competitive position in the market.

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 CHAPTER III

CONCLUSION

A. CONCLUSION
Inventory management is a multifaceted discipline that affects many aspects of a
company's operations. From improving cash flow and customer satisfaction to
increasing operational efficiency and supporting strategic goals, effective inventory
management is critical for maintaining a competitive edge and achieving long-term
success. By adopting advanced inventory management techniques and technologies,
companies can optimize their inventory levels, reduce costs, and respond more
effectively to market demands.

B. ADVICE
Based on the discussion, here are some suggestions:
1. Try to understand more about what is the meaning of inventory cost and know
every cost that count as inventory costs
2. Search more about how to reduce inventory costs and when to order
3. Try to understand more about what is Just-in-Time system and how it can help to
reduce inventories and what is its weakness?
4. Forecasting provides projections for future scenarios which helps decision-makers
to make informed decisions based on historical data trends analysis (if available).
5. Try to understand more about how does using some theories can help to reduce
inventories and why is it important?

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 REFERENCE LIST

McGraw.2018. Managerial Accounting,Sixteenth Edition . USA.

Hansen, Don. R. Maryanne M. Mowen, dan Dan I. Heitger .2017 Publishing

McGraw.2015. Managerial Accounting, Tenth canadian edition. USA.

Carter, William K.2009. Cost Accounting Buku 1 Edisi 14. Jakarta : Salemba Empat.

Garrison, Ray H dan Noreen, Eric W. 2000. Akuntansi Manajerial. Jakarta : Penerbit
Salemba Empat.

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