Inventory Management Summary

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 You’ve always got spare The products in the backup
system, you have a main products for emergencies bin could spoil or become
bin and a backup bin of and sudden rises in obsolete unless they are
products. demand. cycled into the main bin
every now and then. Also,
you need to keep an eye on
your carrying costs.
Order-Cycling System- If you’re REALLY good at This system is risky and
This system lets you do inventory management, costly! Doing a physical
inventory checks at set you might be able to pull inventory check every 30
intervals (e.g. 30 days) and this off. It certainly days or so will get expensive
reorder products that are doesn’t require as much quickly. And there’s no
likely to run out by the time as other methods. margin for error on ordering
next check. 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 This system doesn’t set It still requires a lot of work
your products into three rigid standards on how to maintain healthy
groups: A, B and C. many products to keep on inventory levels.
Expensive items go into A, hand; it simply tells you
less-expensive items go how long it will take to
into B, and small parts order those products.
and other inexpensive
items go into C.
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

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

EOQ (units) = √ 𝒄𝒂𝒓𝒓𝒚𝒊𝒏𝒈 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕
𝟐 𝒙 𝟐𝟒,𝟎𝟎𝟎 𝒙 𝟕𝟓𝟎
= √
𝟒
= 3, 000 units

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
********
ABEY GAY A. AMANTE
BSA III

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A Summary of INVENTORY MANAGEMENT

Traditional Inventory Management

Materials purchased are warehoused as well as the finished goods.

Inventory Model Pros Cons

THE EOQ MODEL

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

-taken from the historical records of the organization

-spent in holding, maintaining or warehousing inventories such as warehousing

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

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

𝟐 𝒙 𝑨𝒏𝒏𝒖𝒂𝒍 𝑫𝒆𝒎𝒂𝒏𝒅 𝒙 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕

Order Size Ordering Cost Carrying Cost

-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

Normal usage means the average usage of inventory during a period.

Linda Corporation has the following production data:

Annual requirement 40, 000 units

Lead time quantity = normal usage x normal lead time

Reorder Point = LTQ + SSQ

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

Maximum Inventory Level = SSQ + OS

Minimum Inventory Level = SSQ

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