Working Capital

Management
Inventory
Intended Learning Outcomes
After the presentation, you should be able to:
• Understand the concept of inventory management
• Apply economic order quantity in inventory management
• Compute for the economic order quantity
• Compute for the safety stock and reorder point
Inventory Management
Inventory management refers to the process of formulating and implementing
plans and policies to efficiently meet production and merchandising requirements
while minimizing costs relative to inventories.
Objective:
To maintain inventory level that balances sales demand, the cost of carrying
additional inventory, and the efficiency of inventory control.
Inventory Management
Inventory management refers to the process of determining and maintaining the required
level of inventory that will ensure that customer orders are properly filled on time.
Inventory management requires that the organization answer three additional questions.
They are:
• What to order (or make)?
• When to order (or make)?
• How much to order (or make)?
Inventory Control
Inventory control (or stock control) refers to the collective activities and procedures that
ensure that the right amount of each item is held in stock. Inventory control requires that
the organization be able to answer three questions.
They are:
• What do we have?
• How much do we have?
• Where is it?
Why Companies Carry Inventory
Inventories are carried to compensate for the variability between the supply of an
item and the demand for it.
Inventory control involves balancing conflicting costs—balancing the cost of holding
sufficient stock to provide a specified level of customer service with the cost of
purchasing the inventory. The point at which those costs intersect provides answers
to many inventory control issues, such as what to keep in stock, when orders
should be placed, how much should be ordered, and so on.
Why Companies Carry Inventory
To some degree, every company holds inventory. But holding inventory is costly because of
storage and handling costs, the danger of inventory obsolescence, and the costs associated
with tied-up capital. When capital is tied up, businesses must forgo other profitable
opportunities for investments. These disadvantages and costs for holding inventory lead to
the question: Why do companies carry inventory?
• Coverage for emergencies
• Coverage for mismatches between supply and demand
• Coverage for delayed or insufficient supplier deliveries
• Maintenance of consistent levels of operation
Ordering Costs
Ordering costs include the marginal costs of placing a purchase or production
order. They are the marginal cost of computer time to prepare orders and the cost
of the supplies used to generate an order. Fixed costs of ordering, such as salaries,
are irrelevant.
Examples: Cost of insurance for shipment, and unloading and receiving costs

Ordering Cost = Number of orders per year x Cost of placing an order

Carrying Costs
Carrying costs (also called storage costs or holding costs) are the costs of having the
inventory. They include storage and handling costs, obsolescence and deterioration
costs, insurance, taxes, and the cost of the funds invested in inventories.
Total carrying costs increase as the order size grows and decrease when items are
ordered in smaller amounts. This is true because a smaller space is needed when
the quantity stored is smaller.

Carrying Cost = Average number of units in inventory x Cost of carrying one unit
Economic Order Quantity
•Economic
  order quantity (EOQ) represents the optimum order size—the quantity
of a regularly ordered item to be purchased at a point in time that results in
minimum total cost (i.e., the sum of ordering costs and carrying costs).
Economic Order Quantity
If the carrying costs decrease, the EOQ increases. If total inventory units demanded
or fixed cost per order decrease, EOQ also decreases. EOQ is based on these
assumptions:
• Lead time is constant and known
• Demand occurs at a relatively stable and known rate
• Operating and storage costs are known
Reorder Point
The EOQ answers the question how much to order. Knowing when to place an order is also
an essential part of any inventory policy.
Reorder point is the point in time when a new order should be placed.
Lead time is the time required to receive the economic order quantity once an order is
placed or a setup is started.
To avoid stockout costs and to minimizer carrying costs, an order should be place 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 that accomplishes these objectives.
Reorder point = Rate of usage x Lead time
Checklist
Understand the concept of inventory management
Apply economic order quantity in inventory management
Compute for the economic order quantity
Compute for the safety stock and reorder point