Working on Capital Management

(Financial Management)

Management of Cash
Management of Receivables
Recap:

Ratio of Average Receivables

Average
Receivable of = Net Sales
Sales
Recap:

Net Sales
Receivable
Turnover = Average Receivable
Recap:

Average 360 days

Collection = Receivable Turnover
Period
Working on Capital Management
Management of Inventories
Zita M. Getigan
What is Inventory Management?
Inventory Management

- Refers to the PROCESS of ordering, storing, using, and , selling a

company’s inventory.

- This includes the management of raw materials, components, and

finished products, as well as warehousing & processing of such items.
Main classifications of inventories are:

For Manufacturing Firms For Trading Firms

- Raw materials - merchandise
- Goods-in-process
- Finished goods
- Factory Supplies
Who is responsible for Inventory Management?

- It is the responsibility of the INVENTORY MANAGER/FINANCIAL

OFFICER to maintain a sufficient amount of inventory to ensure the
smooth operation of the firm’s production and marketing functions
and at the same time avoid tying up funds in excessive and
slow-making inventory.
Question:

Is the inventory manager or finance officer is the only

responsible person for Inventory management?
Managerial Functions:

PLANNING ORGANISING

CONTROL COORDINATION
Objectives of IM:

1. Operational - is to maintain sufficient inventory, to meet demands for

product by efficiently organising the firm’s production & sales
operations.

2. Financial - is to minimise inefficient inventory and reduce inventory

carrying cost.
An effective inventory management should:

● Ensure a continuous supply of raw materials and supplies to facilitate

uninterrupted production,
● Maintain sufficient stocks of raw materials in periods of short supply and
anticipate price changes
● Maintain sufficient finished goods inventory for smooth sales operation, and
efficient customer service
● Minimise the carrying costs and time, and
● Control investment in inventories and keep it an optimum level
Cost Associated w/Investment In Inventory:
I. Carrying Cost
*Cost of capital tied up in inventory*Storage and handling cost
*Insurance*Property taxes*Depreciation and obsolescence
*Administrative cost
II. Ordering, Shipping & Receiving Cost

*Cost of placing orders including production and setup costs

*Shipping and handling costs

III. Cost of Running Short

*Loss of Sales *Loss of customer goodwill

*Description of production schedules
INVENTORY MANAGEMENT
TECHNIQUES
Inventory Management Techniques

EOQ Model
Reorder Point
EOQ (Economic Order Quantity) Model:
EOQ (Economic Order Quantity) Model:

FORD WHITMAN HARRIS first presented the familiar EOQ model in paper
published in 1913. Even though Harris’s original paper was disseminated
widely, it apparently was unnoticed for many years before its rediscovery in
1988.
EOQ (Economic Order Quantity) Model:

a.) Total Inventory Costs = Total ordering cost + total carrying cost
b.) Total Ordering Costs = Annual demand in units x Ordering cost
EOQ or order size per order
c.) Total carrying cost = Average Inventory X carrying cost per unit
d.) Average Inventory = EOQ or order size
2
Illustrative Case. Economic Order Quantity
Assume that a local gift shop is attempting to determine how many
sets of wine glass to order. The store feels it will approximately 800
sets in the next year at a price of P18 per set. The wholesale price
that the store pays per set is P12. Costs of carrying one set of wine
glasses are estimated at P1.50 per year while ordering cost are
estimated at P25.

Determine the EOQ for the sets of wine glasses.

Illustrative Case. Economic Order Quantity
Assume that a local gift shop is attempting to determine how many sets of wine glass to order.
The store feels it will approximately 800 sets in the next year at a price of P18 per set. The
wholesale price that the store pays per set is P12. Costs of carrying one set of wine glasses are
estimated at P1.50 per year while ordering cost are estimated at P25.

Determine the EOQ for the sets of wine glasses.

Answer:
EOQ = 2 X 800 X P25
P1.50
= 163 units per order
Illustrative Case. Economic Order Quantity
Assume that a local gift shop is attempting to determine how many
sets of wine glass to order. The store feels it will approximately 800
sets in the next year at a price of P18 per set. The wholesale price
that the store pays per set is P12. Costs of carrying one set of wine
glasses are estimated at P1.50 per year while ordering cost are
estimated at P25.

Determine the annual inventory cost for the firm if it

Orders in this quantity?
Illustrative Case. Economic Order Quantity
Assume that a local gift shop is attempting to determine how many sets of wine glass to order.
The store feels it will approximately 800 sets in the next year at a price of P18 per set. The
wholesale price that the store pays per set is P12. Costs of carrying one set of wine glasses are
estimated at P1.50 per year while ordering cost are estimated at P25.
Determine the annual inventory cost for the firm if it
Orders in this quantity?

a.) Total Inventory Costs = Total ordering cost + total carrying cost

b.) Total Ordering Costs = Annual demand in units x Ordering cost

EOQ or order size per order

c.) Total carrying cost = Average Inventory X carrying cost per unit

d.) Average Inventory = EOQ or order size

2
Illustrative Case. Economic Order Quantity
Assume that a local gift shop is attempting to determine how many sets of wine glass to order.
The store feels it will approximately 800 sets in the next year at a price of P18 per set. The
wholesale price that the store pays per set is P12. Costs of carrying one set of wine glasses are
estimated at P1.50 per year while ordering cost are estimated at P25.
Determine the annual inventory cost for the firm if it
Orders in this quantity?

Answer:

Total inventory cost = 800 163

P25 P1.50
163 2

= P244.95
Another example:
Dairy Ice Cream sells 12,000 gallons of ice cream each month from
its central storage facility. Monthly carrying costs are P0.10 per
gallon and ordering costs are P50 per order.

What is the EOQ for the ice cream?

What is the average inventory?
EOQ (Economic Order Quantity) Model:

a.) Total Inventory Costs = Total ordering cost + total carrying cost
b.) Total Ordering Costs = Annual demand in units x Ordering cost
EOQ or order size per order
c.) Total carrying cost = Average Inventory X carrying cost per unit
d.) Average Inventory = EOQ or order size
2
REORDER POINT = Lead Time Usage + Safety Stock
Illustrative Case. EOQ, Reorder point Determination
The following inventory information and relationships for the Baguio Corp. are
available:
1. Orders can be placed only in multiples of 100 units.
2. Annual unit usage is 300,000. (Assume a 50-week year in your calculations.)
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. (This does not include delivery-time
stock.)
7. Delivery time is two weeks.
What is the EOQ optimal level?
At what inventory level should a reorder be made?
 Illustrative Case. EOQ, Reorder point Determination
Answer:
The following inventory information and relationships
for the Baguio Corp. are available: EOQ = 2 X 300,000 X P50
1. Orders can be placed only in multiples of 100
units. 10 x 0.30
2. Annual unit usage is 300,000. (Assume a
50-week year in your calculations.) = 3,162 units but
3. The carrying cost is 30% of the purchase price of since orders must be placed in multiples
the goods.
4. The purchase price is P10 per unit. of 100 units, the effective EOQ becomes
5. The ordering cost is P50 per order. 3,200
6. The desired safety stock is 1,000 units. (This
does not include delivery-time stock.) REORDER POINT:
7. Delivery time is two weeks.

What is the EOQ optimal level? = 300,000 X 2 + 1,000

50
At what inventory level should a reorder be made? = 13,000 UNITS
GENERALLY-KNOWN
INVENTORY CONTROL SYSTEMS
Generally-Known Inventory Control Systems

1. Fixed Order Quantity System

2. Fixed ReOrder Cycle System

3. Optional Replenishment System
4. ABC Classification System
1. Fixed Order Quantity System

This 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.
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.
2. Fixed Reorder Cycle System

M = B + D (R + L)
where : M = Replenishment level in units
B = Buffer stocks in units
D = Average demand per day
R = Time internal in days, between reviews
L = lead time in days
Sample
Fixed Reorder Cycle System
M = B + D (R + L)
sample :
B = 1000 units
D = 100
R = 15
L=7
Answer:
Fixed Reorder Cycle System
M = 1000 + 100 (15 + 7)
= 3, 200
sample :
B = 1000 units
D = 100
R = 15
L=7
3. Optional Replenishment System

Represents a combination of the important control mechanics of

the other two systems described above. Replenishment level is
computed by the use of the following equation:
3. Optional Replenishment System

P = B + D (L + R/2)
where : P = Reorder point in units
B = Buffer stocks in units
D = Average demand per day
L = Lead time in days
R = Time between review in days
Sample
Optional Replenishment System
P = B + D (L + R/2)
sample :
B = 1000 units
D = 100
R = 15
L=7
Answer:
Optional Replenishment System
M = 1000 + 100 (7 + 15/2)
= 2,450
sample :
B = 1000 units
D = 100
R = 15
L=7
ABC Analysis

A = items very important for an organization

B = items are important but less important than item A
C = Significant in value and are marginally important
Techniques: Inventory Planning
ABC Analysis
Classification system:

A = 20% of items account for 70% annual consumption value of items

B = 30% of items account for 25% annual consumption of value of items

C = 50% of the items account for 5% annual consumption of value of items

Benefits of I.M.:

1. Saves Money
2. Improves Cash Flows
3. Satisfies Customers
Risk Associated with Inventory:

1. Price Decline
2. Product Deterioration
3. Obsolescence
Thank you