CHAPTER 8 INVENTORY MANAGEMENT

Inventory management is as important as the management for current assets in the firm’s working
capital. Financial manager should take considerable efforts to monitor the progress and to influence
the firm inventory management. Its also reflect on risk and return in the short-term period (lower of
risk and return, higher of liquidity).

There are major types of inventories:

1. Raw materials – basic input or materials for the production (basic features) Example: kuih
bahulu – flour, egg, sugar, margarine, cooking oil etc
2. Semi products or work in progress – 50 percent completion of product and need to next
process. Example: frozen food – need to fry before eating by the consumers.
3. Final or finished goods: complete product and directly can consumed by the customers.
Example: hijab by fareeda

There are two major costing of inventory management.

1. Carrying or storage cost (CC) – cost is associated with the cost of carrying for each unit of
inventory and stated in percent from inventory cost or price per units. Example: coast of
storing, handling, taxes, insuring, physical damage, obsolescence’s and auditing of
inventories. Higher order quantity will result in higher total carrying costs for the period given.

2. Ordering or placing cost (OC)- cost is associated with the fixed clerical cost of placing and
receiving and ordering such as cost of processing, telephone utilities bills, mailing expenses
etc. higher. Higher order quantity will result in lower total ordering costs for the period given.

Formula
i. EOQ
EOQ = √𝟐𝑫𝑶/𝑪 = units

ii. Reorder point (ROP)

ROP = (daily demand x lead time) + SS
= (d x l) + SS
= units

iii. Average inventory

AI = (EOQ/2) + SS
= units

iv. Number of orders

Number of order = D/EOQ = times

v. Total Inventory Cost (TIC)

TIC = Total Ordering Cost + Total Carrying Cost
TIC = TOC + TCC
TIC = [(D/EOQ) x OC] + [(EOQ/2) + SS x CC] = RM
Illustration by Final Examination question June 2019 (pages 163)

Aqeel Construction Berhad

Sales 50,000 units per year
Purchase price RM15 per unit
Ordering cost RM1,500 per order
Storage cost 15 percent from purchasing price
Delivery time 14 days after order is placed
Safety stock 2,000 units
Order should be placed in 100 units and assumed 360 days per year

Calculate EOQ, Number of orders, Reorder point and Total inventory cost.
i. Economic Order Quantity (EOQ) (4 marks)
Data related to the formula of EOQ
EOQ = √2𝐷𝑂 /𝐶 = units

Where,
D – annual demand or sales = 50,000 units
O- ordering cost (OC) = RM1,500 per order
C – carrying costs (CC) = 15 % from purchase price
= 15% x RM15 = RM 2.25

EOQ = √2(50,000)√(𝑅𝑀1,500)√/𝑅𝑀2.25√ = units

= √𝑅𝑀150,000,000/𝑅𝑀2.25 = 8164.9√ units multiples of 100
New EOQ = 8200 units √√√√
(8√/8√ x 4 marks = 4 marks)
ii. Number of orders that will be placed annually (2 marks)
Number of order = D/EOQ = times
= 50,000 units √/ 8,200 units √
= 6.0975 times
= 6.10 times √√
(4√/4√ x 2 marks = 2 marks)
iii. Reorder point
ROP = (daily demand x lead time) + SS
= (d x l) + SS = units
So = [(50,000 units√ /360 days) x 14 days√] + 2,000 units√
= [138.8889 x 14 days) + 2,000 units
= 1,944.44 + 2,000 units
= 3,944.44 units √
= 3,944 units √√√√
(8√/8√ x 2 marks = 2 marks)
iv. Annual inventory costs for the year
TIC = Total Ordering Cost + Total Carrying Cost
TIC = TOC + TCC
TIC = [(D/EOQ) x OC] + [(EOQ/2) + SS x CC] = RM
= [(50,000units√/ 8,200units√) x RM1,500√] + [(8,200unit√ /2) + 2,000units√] x RM2.25√
= [6.0976 x RM1,500] + [ (4,100 units + 2,000 units) x RM2.25 ]
= RM9,146.40 + RM13,725.00
= RM22,871.40 √√
(8√/8√ x 4 marks = 4 marks)
Illustration by Final Examination question June 2018 (pages 165)
a) Jeena Corporation is a supplier of mini microphone and has an annual demand of 300,000 units.
Purchase price is RM25 per unit and the carrying cost is 25 percent from purchase price. The
ordering costs is RM120 per order. The desired safety stock is 4,000 units. The delivery time is
7 days. Assume 360 days a year.

a) Determine the optimal economic order quantity. Order must be places in multiple of
100 units.
b) What are the company’s total inventory cost for the year?
c) If annual demand decreases 15 percent from the current demand, calculate the new
optimal economic order quantity.
i. Determine the optimal economic order quantity. Order must be places in multiple of 100
units.
EOQ = √2𝐷𝑂 /𝐶 = units
Where,
D = 300,000 units
O = RM120 per order
C = 25% from purchase price
= 25% x RM25 = RM6.25
Multiples of 100

EOQ = √2(300,000 𝑢𝑛𝑖𝑡𝑠 ) √(𝑅𝑀120 )√/𝑅𝑀6 .25√

= 3,394.11√ units so multiple of 100
New EOQ = 3,400 units √√
(6√/6√ x3 marks = 3 marks)

ii. What are the company’s total inventory cost for the year?
TIC = Total Ordering Cost + Total Carrying Cost
TIC = TOC + TCC
TIC = [(D/EOQ) x OC] + [(EOQ/2) + SS x CC] = RM
= [(300,000units√/ 3,400units√) x RM120√] + [(3,400unit√ /2) + 4,000units√] x
RM6.25√
= [88.2353 x RM120] + [ (1,700 units + 4,000 units) x RM6.25 ]
= RM10,588.24+ RM35,625.00
= RM46,213.24 √√
(8√/8√ x 4 marks = 4 marks)

iii. If annual demand decreases 15 percent from the current demand, calculate the new
optimal economic order quantity.
Changes decrease in sales 15 percent
So new sales will be = (1.00 – 0.15 ) x 300,000 units = 255,000 units
OR
Changes in sales (decrease) 15% x 300,000 unit = 45,000 units
New sales will be = 300,000 units – 45,000 units = 255,000 units

Where,
D = 255,000 units, O = RM120 per order, C = 25% from purchase price
= 25% x RM25 = RM6.25
Multiples of 100

EOQ = √2(255,000 𝑢𝑛𝑖𝑡𝑠 ) √(𝑅𝑀120 )√/𝑅𝑀6 .25√

= 3,129.22√ units so multiple of 100
New EOQ = 3,200 units √√

(6√/6√ x3 marks = 3 marks)