INVENTORY MANAGEMENT

-refers to the process of formulation and administration of plans and policies to

efficiently and satisfactorily meet 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 is a push through system that is designed to plan and control 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 simplest possible control
 SHORT-TERM CREDIT FINANCING

WORKING CAPITAL FINANCE- refers to optimal level, mix and use of current assets and
current liabilities

WORKING CAPITAL FINANCING POLICIES

A) AGGRESSIVE FINANCING STRATEGY- operations are conducted with a minimum
amount of working capital. This is also known as restricted policy.

B) CONSERVATIVE FINANCING STRATEGY- A company seeks to minimize liquidity

risk by increasing working capital. This is also known as relaxed policy.

C) MODERATE FINANCING STRATEGY- also known as semi-aggressive or semi-

conservative financing strategy. Under this strategy, working capital maintained
is relatively not too high (conservative) nor too low (aggressive). This is also
known as a balanced policy.

D) MATCHING POLICY- This is achieved by matching the maturity of financing

source with an asset’s useful life. This is also known as self-liquidating policy orw
hedging policy.

• Short-term assets are financed with short-term liabilities

• Long-term assets are funded by long-term financing sources
HEDGING- financing assets with liabilities of similar maturity.

TOTAL FINANCING REQUIREMENT

A. PERMANENT financing requirement (Minimum operation requirement)
- Fixed and long-term assets
- Permanent Current Assets

B. TEMPORARY financing requirement (Seasonal operation requirement)

FACTORS OF CONSIDERATIONS IN SELECTING SOURCES OF SHORT-TERM FUNDS

• COST: The effective costs of various credit sources
• AVAILABILITY: The readiness of credit as to when needed and how much is
needed.
• INFLUENCE: The influence of use of one credit source and availability of other
sources of financing.
• REQUIREMENT: The additional covenants unique to various sources of financing
(e.g., loans)

SOURCES OF SHORT-TERM FUNDS

• UNSECURED CREDITS (Accruals, trade credit and commercial papers)
• SECURED LOANS ( Receivable financing- pledging and factoring)
• BANKING CREDITS (Loan, line of credit, revolving credit agreement)

COSTS OF SHORT-TERM CREDIT

• Cost of TRADE CREDIT with supplier
COST= [Discount rate/ (100%- Discount Rate)] x [360 days/ (Credit period –
Discount period)]
*This type of financing cost is caused by foregoing cash discounts (opportunity
costs)

• Cost of BANK LOANS (EFFECTIVE ANNUAL RATE)

o
o Without compensating balance:
If not discounted (cash proceeds normally is equal to face value)
COST= Interest/Amount Received (Face)
 If discounted (Cash proceeds is net of interest/deducted in advance)
COST= Interest/(Face Value- Interest)

o With compensating balance:

If not discounted:
COST= Interest/ (Face Value – CB) or COST= Nominal%/(100%-CB%)

If discounted:
COST= Interest/ (Face Value- Interest- CB) or COST= N%/(100%--N%-CB%)

• Cost of COMMERCIAL PAPERS

COST= ([Interest + Issue costs)/(Face Value- Int.- Issue Cost)] x (360 days/Term)