A Summary of INVENTORY MANAGEMENT

Inventory Management
-is the management of a company’s inventory and stock. It includes aspects
such as controlling, ordering inventory, storage inventory, and controlling the
amount of finished goods.

Traditional Inventory Management

-based on old production processes
(eg. purchase of materials, receipt of materials, materials warehousing,
materials issuances to production)
-focuses on warehousing functions

Materials purchased are warehoused as well as the finished goods.

Warehousing materials is very costly. Therefore, there are models that are developed in
order to minimize cost. These are the following:
1. Economic Order Quantity (EOQ)
2. Reorder Point
3. Two-bin system
4. Order Cycling Method
5. Min-max method
6. ABC Classification

Inventory Model Pros Cons

Two-Bin System -in this
system, you have a main
bin and a backup bin of
products.
Order-Cycling System-
This system lets you do
inventory checks at set
intervals (e.g. 30 days) and
reorder products that are
likely to run out by the
next check.
You’ve always got spare The products in the backup
products for emergencies bin could spoil or become
and sudden rises in obsolete unless they are
demand. cycled into the main bin
every now and then. Also,
you need to keep an eye on
your carrying costs.
If you’re REALLY good at This system is risky and
inventory management, costly! Doing a physical
you might be able to pull inventory check every 30
this off. It certainly days or so will get expensive
doesn’t require as much quickly. And there’s no
time as other methods. margin for error on ordering
the right amount of products
at each check.

Min-Max System. After a This method is simple Its simplicity could lead to
careful examination of and it makes the task of trouble because you might
your inventory needs, you balancing inventory fairly order too many products or
set two lines – one at the straightforward. run out before they arrive.
top and one at the bottom
of how much of each
product you must keep on
hand
ABC Analysis- Separate
your products into three
groups: A, B and C.
Expensive items go into A,
less-expensive items go
into B, and small parts
and other inexpensive
items go into C.
This system doesn’t set It still requires a lot of work
rigid standards on how to maintain healthy
many products to keep on inventory levels.
hand; it simply tells you
how long it will take to
order those products.

THE EOQ MODEL

-refers to the units of materials that should be purchased to minimize total

relevant inventory cots.

Ordering Costs

-include those spent in placing an order, waiting for an order, inspection and
receiving costs, setup costs and quantity discounts lost.

-taken from the historical records of the organization

Carrying Cost

-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.

Necessary Formula Involving Ordering and Carrying Cost

Cost per order = Total ordering costs/ no. of orders

Total Ordering Costs = Cost per order x no. of orders

No. of orders = Annual Demand / order size

Carrying cost per unit = Total carrying cost / average inventory

Total carrying Cost = Carrying cost per unit x average inventory

Average inventory = Order size/ 2

Carrying cost = Unit cost x carrying costs ration

Carrying cost ratio = Carrying cost per unit/ unit cost

Economic Order Quantity

is a decision tool used in cost accounting. It's a formula that allows you to
calculate the ideal quantity of inventory to order for a given product. The calculation is
designed to minimize ordering and carrying costs.

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

EOQ (units) = √ 𝒄𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

EOQ (pesos) = √ 𝒄𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝒄𝒐𝒔𝒕 𝒓𝒂𝒕𝒊𝒐

Sample Problem

Assume an annual requirement of 24, 000 units, a cost per unit of P20, a cost per
order of P750 and a carrying cost percentage of 20%. Applying the formula to these
data, the EOQ is

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

EOQ (units) = √ 𝒄𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

𝟐 𝒙 𝟐𝟒,𝟎𝟎𝟎 𝒙 𝟕𝟓𝟎
= √
𝟒

= 3, 000 units

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

EOQ (pesos) = √ 𝒄𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝒄𝒐𝒔𝒕 𝒓𝒂𝒕𝒊𝒐

𝟐 𝒙 𝟐𝟒,𝟎𝟎𝟎 𝒙 𝟕𝟓𝟎
= √
𝟐𝟎%

= P60,000.00

If we change the order quantity, it can affect the different types of inventory costs in
different ways. Larger order size results in lower order costs because fewer orders need
to be placed to cover the annual demand. This however results in higher holding costs
because of the increase in inventory levels. Conversely, smaller order size results in
lower holding costs because of the decline in average inventory level. However, as
lower quantity of inventory is ordered each time, the number of orders needed to
increase in order to fulfill the annual demand which leads to higher ordering costs.
Reducing the order size may also affect the cost of purchase due to the loss of trade
discounts that are based on the order quantity.

Order Size Ordering Cost Carrying Cost

Increases Decreases Increases
Decreases Increases Decreases

Note: In order to minimize carrying cost and at the same time ordering cost, our goal is
to get the equilibrium between the carrying and ordering cost. TOC must equal TCC in
order to have an effective EOQ and in order to achieve minimal inventory management
costs.

EOQ generally minimizes the total inventory cost. However, EOQ may not be optimal
when discounts are factored into the calculation. The optimum quantity is determined
by comparing the total inventory cost of the different order quantities listed above.

Reorder Point

-refers to the inventory level where a purchase order should be placed

Reorder point = Lead time quantity + Safety stock quantity

Lead time quantity = normal usage x normal lead time

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

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 period.

Safety stock is set to serve as a margin in case of variations in normal usage and
normal lead time.
Sample Problem

Linda Corporation has the following production data:

Annual requirement 40, 000 units

Number of working days 320 days
Normal lead time 10 days
Maximum lead time 16 days
Maximum usage 150 units
Economic order quantity 5,000 units

Determine lead time quantity, safety stock quantities, reorder point and maximum
inventory levels.

Lead time quantity = normal usage x normal lead time

= 125 units x 10 days
= 1250 units

Safety stock = safety stock (in usage)* + safety stock (in time)**
= 250 units + 750 units
= 1,000 units

Reorder Point = LTQ + SSQ

= 1250 + 1000
= 2250 units

*SSQ (in usage) = (150units-125units) x 10 days = 250 units

**SSQ (in time) = (16days-10days) x 125 units = 750
1,000 units

Maximum Inventory Level = SSQ + OS

= 1000 + 5000
= 6,000 units

Minimum Inventory Level = SSQ

= 1000 units

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ABEY GAY A. AMANTE
BSA III