Financial Management Inventory Management PDF

SAINT VINCENT’S COLLEGE INCORPORATED College of accounting education MAIN CAMPUS, PADRE RAMON STREET, BARANGAY ESTAKA DIPOLOG CITY, 7100, ZAMBOANGA DEL NORTE, PHILIPPINES TELEPHONE NO. (0...

SAINT VINCENT’S COLLEGE INCORPORATED College of accounting education MAIN CAMPUS, PADRE RAMON STREET, BARANGAY ESTAKA DIPOLOG CITY, 7100, ZAMBOANGA DEL NORTE, PHILIPPINES TELEPHONE NO. (065)212-6292, TELEFAX (065)908-1133 www.svc.edu.ph FINANCIAL MANAGEMENT 21 INVENTORY MANAGEMENT INVENTORY MANAGEMENT refers to the process of formulation and administration of plans and policies to efficiently and satisfactorily meet the production and merchandising requirements and minimize costs relative to inventories. OBJECTIVE: To maintain inventory at a level that best balances the estimates of actual savings, the cost of carrying additional inventory, and the efficiency of inventory control. INVENTORY MANAGEMENT TECHNIQUES INVENTORY PLANNING involves determination of the quality and quantity and location of inventory, as well as the time of ordering, in order to minimize costs and meet future business requirements. Examples: Economic Order Quantity; Reorder Point; Just-in-Time (JIT) System. INVENTORY CONTROL involves regulation of inventory within predetermined level; adequate stocks should be able to meet business requirements, but the investment in inventory should be at the minimum. SYSTEMS OF INVENTORY CONTROL JUST-IN-TIME PRODUCTION system – a “demand pull” (driven by demand) system in which each component of a finished good is produced when needed by the next production stage. FIXED ORDER QUANTITY system – an order for a fixed quantity is placed when the inventory level reaches the reorder point. This is consistent with EOQ concept. PERIODIC REVIEW OR REPLACEMENT system – orders are made after a review of inventory level has been done at regular intervals. OPTIONAL REPLENISHMENT system – combination of fixed order and replacement systems. MATERIALS REQUIREMENT PLANNING (MRP) MRP (a push through system) is designed to plan and control raw materials used in production based on a computerized system that manufactures finished goods based on demand forecasts. MANUFACTURING RESOURCE PLANNING (MRP – II) A closed loop system that integrates various functional areas of a manufacturing company (e.g., inventories, production, sales and cash flows). It is developed as an extension of MRP. ENTERPRISE RESOURCE PLANNING (ERP) ERP integrates information systems of all functional areas in a company. Every aspect of operations is interconnected as the company is connected with its customers and suppliers. ABC Classification system – inventories are classified for selective control A items – high value requiring highest possible control B items – medium cost items requiring normal control C items – low cost items requiring the simples possible control ORDER CYCLING METHOD OR CYCLE REVIEW METHOD Establishes schedules of periodic or regular review of quantities of inventories (e.g., materials) on hand to determine the number of units to be ordered and bring the stock balance at a desired level. High-value, critical normally require a short review cycle. Low-value, noncritical items, the usual review cycle time is longer because the stockout costs is minimal and procurements are done in large quantities. MIN-MAX METHOD Minimum inventory level serves as the reorder point. It includes the normal quantity to be used from the time an order is placed up to the time the materials are received (i.e., lead time). The safety stock quantity to minimize the occurrence of stockout is also included. The maximum inventory level is the sum of stockout quantity and the order size. TWO-BIN SYSTEM Materials are stored in bins, piles, bundles, or specific stocking area. Two bins are used; one bin contains the quantities to be used from the date the materials are received up to the time an order is to be placed, and the other bin contains the quantities to be used during the waiting time (or lead time) and the safety stock. Once the first bin is consumed, an order for two bins is automatically placed. 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 ▪ Universal Bar Code - Bar code printed on a label that has information about the item to which it is attached ▪ ABC Analysis - Divides inventory into three classes based on annual peso volume o Class A - high annual peso volume o Class B - medium annual peso volume Prepared by: VICENTE M. ORTEGA, JR., CPA-MBA| P a g e 1 of 4 FINANCIAL MANAGEMENT HANDOUT o Class C - low annual peso volume INVENTORY CONTROL SYSTEMS - An inventory control system controls the level of inventory by determining how much (replenishment level) and when to order. - Two basic types of systems -continuous (fixed-order quantity) and periodic (fixed-time). ◼ In a continuous system, an order is placed for the same constant amount when inventory decreases to a specified level. ▪ A continual record of inventory level is maintained. ▪ Whenever inventory decreases to a predetermined level, the reorder point, an order is placed for a fixed amount to replenish the stock. ▪ The fixed amount is termed the economic order quantity, whose magnitude is set at a level that minimizes the total inventory carrying, ordering, and shortage costs. ◼ In a periodic system, an order is placed for a variable amount after a specified period of time. ▪ Inventory on hand is counted at specific time intervals and an order placed that brings inventory up to a specified level. ▪ Inventory not monitored between counts and system is therefore less costly to track and keep account of. EOQ MODEL Where: Total ordering costs = Total carrying costs Total relevant inventory costs equal ordering costs and carrying cost. Total relevant inventory costs are at the lowest. Ordering Costs include those spent in placing an order, waiting for an order, inspection and receiving costs, setup costs, and quantity discounts lost. Cost per order = Total ordering costs / Number of orders Total ordering costs = Cost per order X No. of orders No. of orders = Annual demand / Order Size Annual Demand represents the annual need or requirements of the business. Order size refers to the number of units or amount purchased per order batch. Carrying Costs are those spent in holding, maintaining, or warehousing inventories such as warehousing and storage costs, handling and clerical costs, property taxes and insurance, deterioration and shrinkage of stocks, obsolescence of stocks, interest, and return on investment (e.g., lost return on investment ties up in inventory). Carrying cost per unit = Total carrying costs / Average inventory Total carrying costs = Carrying cost per unit X Average inventory also: Carrying cost per unit = Unit cost X Carrying costs ratio Carrying cost ratio = Carrying cost per unit / Unit cost Average inventory = Order size / 2 𝟐(𝐀𝐧𝐧𝐮𝐚𝐥 𝐃𝐞𝐦𝐚𝐧𝐝)(𝐂𝐨𝐬𝐭 𝐩𝐞𝐫 𝐨𝐫𝐝𝐞𝐫) ( )( ) 𝐄𝐎𝐐 (𝐮𝐧𝐢𝐭𝐬) = √ 𝐄𝐎𝐐 (𝐩𝐞𝐬𝐨𝐬) = √𝟐 𝐀𝐃 𝐢𝐧 𝐏𝐞𝐬𝐨𝐬 𝐂𝐏𝐎 𝐂𝐚𝐫𝐫𝐲𝐢𝐧𝐠 𝐂𝐨𝐬𝐭 𝐩𝐞𝐫 𝐔𝐧𝐢𝐭 𝐂𝐂 𝐑𝐚𝐭𝐢𝐨 THE REORDER POINT..when to place an order? The reorder point (ROP) refers to the inventory level where a purchase order should be placed. Reorder point is the sum of lead time quantity and safety stock quantity. Reorder point = Lead time quantity + Safety stock quantity = LTQ + SSQ where: Lead time quantity = Normal usage x Normal lead time = NU X NLT Safety stock = Safety stock (in usage) + Safety stock (in time) Safety stock (in usage) = (Maximum usage – Normal usage) X Normal lead time Safety stock (in time) = (Maximum lead time – Normal lead time) X Normal usage and; Maximum inventory level = Safety stock quantity + Order size = SSQ + OS Lead time refers to the waiting time from the date the order is placed until the date the delivery is received. Lead time quantity represents the normal usage during the lead time period. Normal usage means the average usage of inventory during a given specific period of time (e.g., days, weeks). Prepared by: VICENTE M. ORTEGA, JR., CPA-MBA| P a g e 2 of 4 FINANCIAL MANAGEMENT HANDOUT Safety stock is established to serve as an allowance in case of variations in normal usage and normal lead time. Hence, there is a safety stock for variation in usage and a safety stock for variations in time. EXERCISES: INVENTORY MANAGEMENT ECONOMIC ORDER QUANTITY 1. Sshhhh Corporation is trying to improve its inventory control system and has installed an online computer at its retail stores. Sshhhh anticipates sales of 126,000 units per year, an ordering cost of P 4 per order, and carrying costs of P 1.008 per unit. It normally takes the company 10 days to make and receive the order. Required: (Note: Use a 360-day year to calculate daily usage). a. Calculate the EOQ. b. Calculate total carrying costs c. Calculate total ordering costs d. Compute the total relevant inventory cost at EOQ. a. Determine the reorder point. 2. Sakuragi Co. has been buying product XXX in lots of 1,250 units which represents a three month’s supply. The cost per unit is 220. The order cost is P900 per order; and the annual inventory carrying cost per one unit is P25. Assume that the units will be required evenly throughout the year. Required: Determine the following: a. Economic order quantity – b. Number of orders in a year – c. Average inventory based on economic order quantity. – d. Total carrying cost, ordering cost, and relevant inventory costs at economic order quantity. e. Total relevant inventory costs for oder sizes of 2,000 units, 1,000 units, 600 units, 250 units, and 100 units. Order Ordering Carrying Total Invty. No. of Orders CPO Ave. Invty. CCPU size Costs Costs Costs 2,000 1,000 600 250 100 3. EOQ IN PESOS, NO. OF MATERIAL ORDERS Akagi Co. determines the manufacturing cost per order of a raw material is P25. The company expects to use P 50,000 of this materials in the coming year. The carrying charge is 10% of inventory. Required: Determine the following: a. Economic order quantity in pesos – b. Number of times the raw materials be ordered in the coming year. – c. Average inventory – d. Total relevant inventory costs at economic order quantity. – 4. REORDER POINT, LEAD TIME QUANTITY, SAFETY STOCK QUANTITY Rukawa Co. makes available the following information relative to its Material G-224: Annual demand 30,000 units Working days in a year 300 days Normal lead time 12 days Maximum lead time 19 days Maximum usage per working day 125 units Economic order size 6,000 units Required: Calculate the following: a. Lead time quantity – b. Safety stock quantity – c. Reorder point – d. Average inventory – e. Maximum inventory – Prepared by: VICENTE M. ORTEGA, JR., CPA-MBA| P a g e 3 of 4 FINANCIAL MANAGEMENT HANDOUT 5. The Tsk Tsk Corporation wishes to determine the amount of safety stock that it should maintain for Product TSK that will result in the lowest cost. The following information is available. Stockout cost P 200 per occurrence Carrying cost of safety stock P 2 per unit Number of purchase orders 12 per year The available options open to Tsk Tsk are as follows: Units of Safety Stock Probability of Running Out of Safety Stock 0 60% 100 50% 200 40% 400 20% 600 10% Determine the optimal safety stock level. Prepared by: VICENTE M. ORTEGA, JR., CPA-MBA| P a g e 4 of 4