de guzman, rm 

LEARNING OBJECTIVES
1. Understand the objective of current assets
management.
2. Know the concept of cash conversion
cycle.
3. Explain the objectives of managing
a. Cash
b. Marketable Securities
c. Accounts Receivable
d. Inventory

4. Know the tools and techniques in

determining the optimum level of
a. Cash
b. Marketable Securities
c. Accounts Receivable
d. Inventory
LEARNING OBJECTIVES
5. Enumerate the costs associated with
investment in or holding-
a. Cash
b. Marketable Securities
c. Accounts Receivable
d. Inventory

6. Understand the techniques used in

evaluating a firm’s efficiency in
managing current assets.
Objective of Current
Asset Management
1. The total amount of liquidity necessary to
avoid the risk of insolvency; and
2. The amount of cash versus near cash
(marketable securities) to have in the liquidity
mix for transaction purposes.
 Cash Conversion Cycle
▪ is the average length of time involved- from the
payment of raw materials to the collection of
accounts receivable.
Inventory Receivable Payable Cash
Conversion Collection Deferral Conversion
Period Period Period Cycle

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠

𝑆𝑎𝑙𝑒𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦 𝑆𝑎𝑙𝑒𝑠 360 𝑑𝑎𝑦𝑠 𝑃𝑢𝑟𝑐𝑕𝑎𝑠𝑒𝑠 𝑝𝑒𝑟 𝑑𝑎𝑦
or
𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑆𝑎𝑙𝑒𝑠 360 𝑑𝑎𝑦𝑠
 Inventory Conversion Period
 the average time required to convert
materials into finished goods and then to
sell those goods.

 Receivables Collection Period

 The average length of time required to
convert the firm’s receivables into cash,
that is, to collect cash following a sale.

 Payables Deferral Period

 The average length of time between the
purchase of materials and labor and the
payment of cash for them
 Cash Management
 Involves the maintenance of a cash and

marketable securities investment level

which will enable the company to meet its
cash requirements and at the same time
optimize the income on idle funds.
OBJECTIVES:
1. To meet the cash disbursement needs

(payments schedule);
2. To minimize the funds committed to

transactions and precautionary cash

balances; and
3. To avoid misappropriation and
handling losses in the normal course of
business.
REASONS FOR HOLDING CASH
1. Transaction Motive
 cash is needed to facilitate the normal transactions of
the business, that is, to carry out its purchases and
sales activities

2. Precautionary Motive
 cash may be held beyond its normal operating
requirement level on order to provide for a buffer
against contingencies such as unexpected slow-down
in A/R collection, strike or increase in cash beyond
management’s original projections
REASONS FOR HOLDING CASH
3. Speculative Motive
 cash is held ready for profit-making or investment
opportunities that may come up such as a block of
raw materials inventory offered at a discounted prices
or a merger proposal

4. Contractual Motive
 a company may be required by a bank to maintain a
certain compensating balance in its demand deposit
account as a condition of a loan extended to it.
MANAGING CASH FLOWS
Determining the Cash Need
▪ The optimal cash balance may be derived
with the use of the following approaches,
namely:
1. Cash Budget
2. Cash Break-Even Chart
3. Optimal Cash Balance Model
CASH BUDGET
▪ Is a financial budget prepared to
calculate the budgeted cash
inflows and outflows during a
period and the budgeted cash
balance at the end of the period.
CASH BREAK-EVEN CHART
▪ Shows the relationship between the
company’s cash needs and cash
sources.
▪ It indicates the minimum amount of
cash that should be maintained to
enable the company to meet its
obligations.
OPTIMAL CASH BALANCE
(Baumol Model)
▪ In managing the level of cash (currency
plus demand deposits) for transaction
purposes versus near cash (marketable
securities), the following costs must be
considered:
1. Fixed and variable brokerage fees,
and
2. Opportunity costs such as interest
foregone by holding cash instead of
near cash.
OPTIMAL CASH BALANCE
(Baumol Model)
 This model balances the opportunity cost of
holding cash against the transactions costs
associated with replenishing the cash account
by selling off marketable securities or by
borrowing.
1. The total costs of cash balances consist of:
Total Costs = Holding Costs  Transaction Cost
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑪𝒂𝒔𝒉 𝑶𝒑𝒑𝒐𝒓𝒕𝒖𝒏𝒊𝒕𝒚
= 𝑩𝒂𝒍𝒂𝒏𝒄𝒆 𝑪𝒐𝒔𝒕 
𝑵𝒖𝒎𝒃𝒆𝒓 𝒐𝒇 𝑪𝒐𝒔𝒕 𝒑𝒆𝒓
𝒕𝒓𝒂𝒏𝒔𝒂𝒄𝒕𝒊𝒐𝒏𝒔 𝑻𝒓𝒂𝒏𝒔𝒂𝒄𝒕𝒊𝒐𝒏

𝐶 𝑇
= (K)  (F)
2 𝐶

where:

C = amount of cash raised by selling marketable

securities or by borrowing

𝐶
= average cash balance
2

C* = optimal amount of cash to be raised by selling

marketable securities or by borrowing
𝐶∗
= optimal average cash balance
2

F = fixed costs of making a securities trade or of

obtaining a loan

T = total amount of net new cash needed for

transactions during the period (usually a year)

K = opportunity cost of holding cash, net equal to

the rate of return foregone on marketable
securities or the cost of borrowing to hold
cash
 2. The minimum costs of cash balances are
achieved when C is set equal to C*, the optimal
cash transfer.
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 𝑜𝑓
𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓
2 𝑡𝑟𝑎𝑑𝑖𝑛𝑔 𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠 𝑜𝑟
𝑛𝑒𝑡 𝑛𝑒𝑤 𝑐𝑎𝑠𝑕 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑
𝑐𝑜𝑠𝑡 𝑜𝑓 𝑏𝑜𝑟𝑟𝑜𝑤𝑖𝑛𝑔
C* =
𝑜𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑕𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑎𝑠𝑕

or

2 𝑇 𝐹
C* =
𝐾

Note: The optimal cash balance computation resembles that of the EOQ
Illustrative Case. Determination of Optimal Average Cash Balance
Consider a business with total payments of 10M for one
year, cost per transaction of P100, and the interest rate on
marketable securities is 8%. The optimal cash balance is
calculated as follows:

2 10𝑀 100
C* =
8%

= P 158,113.88

𝑃 158,113.88
optimal average cash balance =
2
= P 79,056.94
Techniques for Lessening Cash Needs
1. ACCELERATING COLLECTIONS
a) High standards on credit approval
b) Shorter trade discount and credit period
c) Efficient and effective billing system
d) Cost-effective collection systems such as
1) Frequency of collection follow-up
2) Visibility of collection personnel
3) Use of specialized postal system (i.e. lockbox plan)
 Lockbox plan- a procedure used to speed up
collections and reduce floats through the use of
post office boxes in payer’s local areas
4) Electronic fund transfer
5) Concentrating banking
Techniques for Lessening Cash Needs
2. SLOWING DISBURSEMENTS
a. Centralized processing of payables
 this permits the finance manager to evaluate the
payments coming due for the entire firm and to schedule
the availability of funds to meet these needs on a
company-wide basis.
 it also results to more efficient monitoring of payables and
float balances.
 Care, however, should be taken so as not to create ill will
among suppliers of goods and services or raise the
company’s cost if bills are not paid on time
Techniques for Lessening Cash Needs
2. SLOWING DISBURSEMENTS
b. Zero balance accounts (ZBA)
 These are special disbursement accounts having a
zero peso balance on which checks are written.
 As checks are presented to a ZBA for payment, funds
are automatically transferred from a master account.

c. Delaying payment
 if one is not going to take advantage of any offered
trade discount for early payment, pay on the last day
of the credit period.
Techniques for Lessening Cash Needs
2. SLOWING DISBURSEMENTS
d. “Play the Float”
 involves taking advantage of the time it takes for the
company’s check to clear the banking system.

e. Less frequent payroll

 Instead of paying the workers weekly, they may just
be paid semi-monthly
Techniques for Lessening Cash Needs
3. REDUCING THE NEED FOR
PRECAUTIONARY BALANCE
a. More accurate cash budgeting
 The closer the fit between cash inflows and
outflows, the more certain the forecast the less
need for precautionary balances

a. Line of credit
 Is a pre-arranged loan where the company can
withdraw anytime within the period agreed upon.

b. Temporary investments
 Investments in highly liquid securities may be
maintained instead of holding idle precautionary
cash balance
Internal Control for Cash
o The cash department should under the supervision of the
Treasurer.

o The cash department should be separated from the

accounting and other departments that keep records of
transactions and events.

o All cash transactions must be supported by available proof

of accuracy. All cash receipts must be issued pre-
numbered official receipts. All official receipts must be
multi-copied and preferably machine validated. All check
issuances must be supported by delivery receipts, sales
invoices, receiving reports, board resolutions or official
receipts.

o All cash receipts must be deposited intact in the

designated depository on the day of collection or in the
following business day.
Internal Control for Cash
o Bank deposit slips must always be on file, complete and
available

o Periodic reconciliation of bank and book records must be

done

o Cash count should always be done and with an element

of surprise

o All checks must be properly signed and approved by at

least two signatories

o Cash personnel must be properly selected and trained

o Cashiers must be bonded

o Cashiers should be rotated, periodically or surprisingly

Internal Control for Cash
o A cashier’s manual must be made available

o Use of mechanical or electronic equipment in issuing

checks and official receipts

o Preparation and verification of daily cash report

OBJECTIVE:
o MARKETABLE SECURITIES
 securities that can be sold on short notice
 Highest investment grade usually consist
of:
 Treasury bills
 Commercial paper
 Certification of time deposits from
commercial banks

“Management of cash and marketable securities

cannot be separated. Thus, management of one
implies management of the other.”
REASONS FOR HOLDING
MARKETABLE SECURITIES
1. They serve as a substitute for cash

balances
2. They are held as temporary
investment
3. They are built up to meet known

financial requirements
FACTORS INFLUENCING the CHOICE of
MARKETABLE SECURITIES
1. Risks
a) Default risk
-the risk that the issuer of the security can not pay the
principal or interest at due dates
b) Interest rate risk
-the risk of declines in market values of the security due
to rising interest rates
c) Inflation risk
-the risk that inflation will reduce the “real” value of the
investment.

2. Maturity
 Marketable securities held should mature or can be
sold at the same time cost is required.
FACTORS INFLUENCING the CHOICE of
MARKETABLE SECURITIES
3. Yield or Returns on Securities
- The higher a security’s risk, the higher its required
return.
- The portfolio should consist of highly liquid short-
term securities issued by the gov’t. or very strong
corporations.
- Treasurers should not sacrifice safety for higher
rates of return

4. Marketability (Liquidity) Risk

-refers to the risk that securities cannot be sold at close
to the quoted market price and is closely associated with
liquidity risk.
Illustrative Case. Buying and Selling Marketable Securities
Taehyung Inc. has P2 million in excess cash that it might
invest in marketable securities. In order to buy and sell the
securities, however, the firm must pay a transaction fee of
P45,000.

REQUIRED:
a. Would you recommend purchasing the securities if they
yield 12% annually and are held for
1. One month?
2. Two months?
3. Three months?
4. Six months?
5. One year?
b. What minimum required yield would the securities have
to return for the firm to hold them for three months
(what is the break-even yield for 3-month holding
period)?
Solution:
a. Recommendation
1. P2,000,0000 (0.12) (1/12) = P20,000 < P45,000 No
2. P2,000,0000 (0.12) (1/12) = P40,000 < P45,000 No
3. P2,000,0000 (0.12) (1/12) = P60,000 > P45,000 Yes
4. P2,000,0000 (0.12) (1/12) = P120,000 > P45,000 Yes

5. P2,000,0000 (0.12) (1/12) = P240,000 > P45,000 Yes

b. Let (%) be the required yield. With P2million to invest for three
months:
P2,000,000 (%) (3/12) = P45,000
P2,000,000 (%) = P180,000
𝑃180,000
(%) =
2,000,000

(%) = 9%

The break-even yield, therefore, is 9%.

OBJECTIVE:
 To encourage sales and gain additional
customers by extending credit.

 FINANCE OFFICER
 Responsible in:
o evaluating the pertinent costs and benefits
related to credit extension;
o financing the firm’s investment in A/R,
o implement the firms chosen credit policy; and
o enforcing collection.
Credit Management
▪ Strategically defines the quality of accounts
receivable collections.
▪ Credit and collection have a direct relationship. If
credit standards are high, the rate of collection is
expected to be high and vice-versa.

 Credit Policy – set of decisions that include a

firm’s credit period, credit standards, collection
procedures and discounts offered

 Collection Policy – procedures that a firm

follows to collect A/R
Credit Management
Credit Effects to
Credit
Management
Policy Receivable Receivable Collection
Variables Collection
Balance Turnover Period

High Faster Decrease Increase Shorter

Discount
Rate
Low Slower Increase Decrease Longer

Short/strict Faster Decrease Increase Shorter

Discount
Time
Long / Lax Slower Increase Decrease Longer

Short/strict Faster Decrease Increase Shorter

Credit Period
Long / Lax Slower Increase Decrease Longer
FACTORS in DETERMINING A/R POLICY
1. Credit Standards
-if credit policy is relaxed, while sales may increase, the quality
of A/R may suffer; may result to longer average collection
period.

o OPTIMAL CREDIT POLICY

-extending trade credit more liberally until the marginal
profitability on additional sales equals the required return
on the additional investment in receivables.
- Is a trade-off between the profits on sales that give rise to
receivables on one hand and the cost of carrying these
receivables plus bad-debt losses on the other.

2. Credit Terms
-involved both the length of the credit period and the discount
given.
FACTORS in DETERMINING A/R POLICY
3. Collection Programs
-the greater the relative amount spent on collection procedures,
the lower the proportion of bad-debt losses and the shorter the
average collection period, all other things remaining the same.

4. Delinquency and Default

-increasing the total accounts receivable costs.

The optimal credit policy that should be

adopted is the one that provides the greatest
marginal benefit.
Costs Associated with A/R
1. Credit analysis, accounting and collection
costs
2. Capital costs
3. Delinquency costs
4. Default costs (Bad debts)
Summary of TRADE-OFF in
Credit and Collection Policies
Trade-offs
BENEFIT COST
1. Relaxation of a. Increase in sales a. Increase in credit
and total processing costs.
credit
contribution b. Increase in
standards collection costs.
margin
c. Higher default
costs (bad debts).
d. Higher capital
costs (opportunity
cost)

2. Lengthening a. Increase in sales a. Higher capital

and total costs (opportunity
of credit
contribution cost of higher
period investment in
margin
receivables)
Summary of TRADE-OFF in
Credit and Collection Policies
Trade-offs
BENEFIT COST
3. Granting a. Increase in sales and a. Lesser profit
cash total contribution
discount margin
b. Opportunity income
on lower investment
in receivable
4. Intensified a. Lower default costs a. Higher collection
collection (bad debts) expenses
efforts b. Lower opportunity b. Lower sales
cost or capital costs
 Marginal or Incremental
Analysis of Credit Policies
MARGINAL ANALYSIS
- Is performed in terms of a systematic comparison of the
incremental returns and the incremental costs resulting
from a change in the firm’s credit policy.

All things being equal, the decision concerning the change

in credit policy is made using the following rules:
1) Incremental profit > Incremental cost : then ACCEPT the
contribution change in credit
policy
2) Incremental profit < Incremental cost : then REJECT the
contribution change in credit
policy
3) Incremental profit = Incremental cost : then be indifferent
contribution to the change in
credit policy
Illustrative Case. Relaxation of Credit Policy

Jungkook Corporation’s products sells for 10 a unit of which 7

represents variable costs before taxes including department cost.
Current annual credit sales are P2.4 million. The firm is considering
a more liberal extension of credit, which will result in a slowing in the
average collection period from one month to two months.

The relaxation in credit standards is expected to produce a 25%

increase in sales. Assume that the firm’s required rate of return on
investment is 20% before taxes. Bad debts losses will be 5% of
incremental sales and collection expenses will increase by P20,000.

REQUIRED: Should the company liberalize its credit policy?

Solution:
Incremental CM from additional units
( 60,000 x P3) P180,000
Less: Bad Debts (P600,000 x 5%) 30,000
Collection Expenses 20,000
Total P50,000
Net incremental profit P130,000

Required return on additional investment:

Present level of Receivables
(P2.4 million / 12mos.) P200,000
Level of Receivables after
change in credit policy
(P3 million / 6mos.) 500,000
Additional Receivables P300,000
Additional investment in receivables
(P300,000 x 70%) P 351,900
Multiply by: Required Return 20%
Required return on
Additional Investment P42,000

Conclusion:
As the net incremental profit exceeds the
required return on the additional investment, the
firm would be well-advised to relax its credit
standards.
Illustrative Case. Change in Credit Terms
Jimin Company has 12% opportunity cost of capital and currently
sells on terms n/20. It has current annual sales of P10 million, 80%
of which are on credit. Current average collection period is 60 days.
It is now considering to offer terms of 2/10, n/30 in order to reduce
the collection period. It expects 60% of its customers to take
advantage of the discount and the collection period to be reduced
to 40 days.
REQUIRED: Should the company change its terms from n/20 to
2/10, n/30?
Solution: Present Proposed
Opportunity cost
(ROI x Average
Receivables)
Present (12% x P1.333M) P160,000
Proposed (12% x P0.888M) P106,667
Sales discount
_________ 96,000
(P8M x 60% x 2%)
TOTAL P160,000 P202,667
OBJECTIVE:
 To maintain a sufficient amount of
inventory to insure the smooth operation
of the firm’s production and marketing
functions and at the same time avoid
tying up funds in excessive and slow-
moving inventory.
Functions of Inventories
o INVENTORIES
- life blood of the production- distribution system.
Within this system of production and distribution, the following
functions and uses of inventories can be identified:
1. Pipeline or Transit Inventories
▫ Are inventories which are being moved or transported from
one location to another and they fill the supply pipelines
between stages of the entire production-distribution system.
2. Organizational or Decoupling Inventories
▫ Are inventories that are maintained to provide each link in the
production-distribution chain a certain degree of
independence from the others.
3. Seasonal or Anticipation Stock
▫ are built up in anticipation of the heavy selling season or in
anticipation of price increase or as part of promotional sales
campaign.
Functions of Inventories
4. Batch or Lot-size Inventories
▫ Are inventories that are maintained whenever the user
makes or buys material in larger lots than are needed
for his immediate purposes

5. Safety or Buffer Stock

▫ Inventories maintained to protect the company from
uncertainties such as unexpected customer demand,
delays in delivery of goods ordered, etc.
Inventory Management Techniques
 INVENTORY PLANNING
 Involves the determination of what inventory quality,
quantity, timing, and location should be in order to meet
future business requirements.

1. Economic Order Quantity (EOQ) – refers to the units of

materials that should be purchased to minimize total relevant
inventory costs.

Formula:
2 ×𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 ×𝐶𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
EOQ =
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

𝑇𝑜𝑡𝑎𝑙 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡𝑠

a) Total inventory costs = 
𝐶𝑜𝑠𝑡𝑠 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
Inventory Management Techniques
 Ordering Costs – include those spent in placing an order, waiting
for an order, inspection and receiving costs, setup costs and
quantity discounts lost. Its total cost is taken from the historical
records of the organization.

Formula:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔
b) Total ordering costs = ×
𝐸𝑂𝑄 𝑜𝑟 𝑂𝑟𝑑𝑒𝑟 𝑠𝑖𝑧𝑒 𝐶𝑜𝑠𝑡𝑠

 Carrying Costs – 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 ROI. (e.g. lost return on investment tied up in
inventory).
Formula:
c) Total carrying costs = Average Inventory  Carrying Costs per Unit

𝐸𝑂𝑄 𝑜𝑟 𝑂𝑟𝑑𝑒𝑟 𝑆𝑖𝑧𝑒

d) Average Inventory =
2
Inventory Management Techniques
Relationship between order size, ordering costs
and carrying costs

Order Size Ordering Costs Carrying Costs

Increase Decrease Increase

Decrease Increase Decrease

Inventory Management Techniques
 INVENTORY PLANNING

2. Reorder Point – it refers to the inventory level where a purchase

order should be placed
Formula:
Reorder Point = Lead Time Usage  Safety Stock

 Lead Time – it refers to the waiting time from the date order is
placed until the date the delivery is received.
 Lead Time Usage - represents the normal usage during the lead
time period
 Safety Stock - is set to serve as a margin in case of variations in
normal usage and normal lead time
Lead Time Usage = Normal Usage x Normal Lead Time
𝑎𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑
Normal Usage =
𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟
Illustrative Case.
RM shop is attempting to determine how many
sets of wine glass to order. The shop feels it will
sell approximately 1000 sets in the next year at a
price of P15 per set. The wholesale price that
the store pays per set is P9. Costs of carrying
one set of wine glasses are estimated at P3.50
per year while ordering costs are estimated at
P20.

a) Determine the EOQ for the sets of wine

glasses.

b) Determine the annual inventory costs for the

firm if it orders in this quantity.
Solution:
2 × 1000 × 20
a. EOQ = = 107 units per order
3.5

1000 107
b. Total Inventory Costs = 20 + 3.5
107 2

= P374.17
Illustrative Case. Costs Associated with Safety Stock

Given the following inventory information and relationships

for the Suga Corporation:
1. Orders can be placed only in multiples of 100 units.
2. Annual unit usage is 300,000. (Assume a 50-week year)
3. The carrying cost is 30% of the purchase price of the goods.
4. The purchase price is P10 per unit.
5. The ordering cost is P50 per order.
6. The desired safety stock is 1,000 units. (not include in delivery-
time stock)
7. Delivery time is two weeks.

Given the information:

a. What is the optimal EOQ level?
b. How many orders will be placed annually?
c. At what inventory level should a reorder be made?
Solution:
2 ×300,000 ×𝑃50
1. EOQ =
10 x 0.30

= 3,162 units but since orders must be placed

in multiples of 100 units, the effective EOQ
becomes 3,200.

300,000
2. Number of orders = = 93,75 orders per year
3,200

3. Reorder Point = Lead usage time  Safety Stock

300,000
= × 2  1,000
50
= 13,000 units
 Inventory Management Techniques
 INVENTORY CONTROL SYSTEM
v

 Inventory Control
 Is the regulation of inventory within predetermined
limits.

1. Fixed Order Quantity System

 is a system wherein each time the inventory goes down to a
predetermined level known as the reorder point, an order
for a fixed quantity is placed.
 Requires the use of PERPETUAL INVENTORY RECORDS
or the continuous monitoring of the inventory level.

2. Fixed Reorder Cycle System

 Known as the periodic review or the replacement system
where orders are made after a review of inventory levels
has been done at regular intervals.
Inventory Management Techniques
 INVENTORY CONTROL SYSTEM
v

2. Fixed Reorder Cycle System (cont.)

 The quantity ordered under this system is variable
depending on usage or demand during the review period.

 Replenishment level is computed by the following formula:

M = B  D(RL)

where: M = Replenishment level in units

B = Buffer Stock in Units
D = Average demand per day
R = Time interval in days,
between reviews
L = Lead Time
Inventory Management Techniques
 INVENTORY CONTROL SYSTEM
3. Optional Replenishment System
▫ This system represents a combination of the important control
mechanisms of the other two systems discussed earlier.
▫ Replenishment level is computed by the use of this:
P = B  D (L  𝑅 2)

where: P = Reorder point in units

B = Buffer Stock in units
D = Average daily demand in units
L = Lead time in days
R = Time between review in days
Inventory Management Techniques
 INVENTORY CONTROL SYSTEM
4. ABC Classification System
▫ Segregation of materials for selective control is made.

Controls on the following items:

• A items (high-value items)
 Complete, accurate records
 Regular review by top supervisor
 Blanket orders with frequent deliveries from vendor
 Close follow-up through the factory deliveries from vendor
 Close follow-up through the factory to reduce lead time

 Careful accurate determination of order quantities and order

point with frequent review to reduce, if possible.
• B items (medium cost items)
 Good records and regular attention
 Good analysis for EOQ and order point but reviewed
quarterly only or when major changes occur

• C items (low cost items)

 periodic review of physical inventory with no records or
only the simplest notations that replenishment stocks
have been ordered
 No EOQ or order point calculations
 Inventory Class

A B C

Money Value High Middle Low

Quality Control Very Strict Not too strict Strict

Inventory Movements Slow Relatively Fast Fast

Level of safety stock Low Moderate High

Quality of personnel Best available Average Fair

Quality of records Error-free Highly reliable Reliable

Replacement Time ASAP Normal Can be long

Inventory Turnover Low Average High

 Jeongmal
Gamsahamnida!