Professional Documents
Culture Documents
Management of Working Capital (2) - Inventory
Management of Working Capital (2) - Inventory
Chapter 4
MANAGEMENT OF WORKING CAPITAL
(2) – INVENTORY
1. Introduction
The purpose of this chapter is to examine approaches to managing inventory efficiently. The
two most important approaches are the EOQ model and the ‘Just-in-time’ approach.
For example, if a company needs a total of 12,000 units each year, then they could decide to
order 1,000 units to be delivered 12 times a year. Alternatively, they could order 6,000 units to
be delivered 2 times a year. There are obviously many possible order quantities.
We will consider the costs involved and thus decide on the order quantity that minimises
these costs (the economic order quantity).
Free ACCA notes t Free ACCA lectures t Free ACCA tests t Free tutor support t StudyBuddies t ACCA forums
September-December 2016 Examinations ACCA F9 26
3. Costs involved
3.1. The costs involved in an inventory ordering systems are as follows:
๏ the purchase cost
๏ the reorder cost
๏ the inventory-holding cost
3.2. Purchase cost
This is the cost of actually purchasing the goods. Over a year the total cost will remain
constant regardless of how we decide to have the items delivered and is therefore irrelevant
to our decision.
(Unless we are able to receive discounts for placing large orders – this will be discussed later
in this chapter)
If there is a fixed amount payable on each order then higher order quantities will result in
fewer orders needed over a year and therefore a lower total reorder cost over a year.
Higher order quantities will result in higher average inventory levels in the warehouse and
therefore higher inventory holding costs over a year.
Free ACCA notes t Free ACCA lectures t Free ACCA tests t Free tutor support t StudyBuddies t ACCA forums
September-December 2016 Examinations ACCA F9 27
4. Minimising costs
One obvious approach to finding the economic order quantity is to calculate the costs p.a. for
various order quantities and identify the order quantity that gives the minimum total cost.
Example 1
Janis has demand for 40,000 desks p.a. the purchase price of each desk is $25. There are ordering
costs of $20 for each order placed. Inventory holding costs amount to 10% p.a. of inventory value.
Calculate the inventory costs p.a. for the following order quantities, and plot them on a
graph:
(a) 500 units
(b) 750 units
(c) 1000 units
(d) 1250 units
2CoD
EOQ =
CH
D = annual demand
Example 2
For the information given in Example 1,
(a) use the EOQ formula to calculate the Economic Order Quantity.
(b) calculate the total inventory costs for this order quantity.
Free ACCA notes t Free ACCA lectures t Free ACCA tests t Free tutor support t StudyBuddies t ACCA forums
September-December 2016 Examinations ACCA F9 28
6. Quantity discounts
Often, discounts will be offered for ordering in large quantities. The problem may be solved
using the following steps:
Example 3
For the information given in Example 1 the supplier now offers us discounts on purchase price as
follows:
Order quantity discount
0 to < 5,000 0%
5,000 to < 10,000 1%
10,000 or over 1.5 %
Calculate the Economic Order Quantity.
Free ACCA notes t Free ACCA lectures t Free ACCA tests t Free tutor support t StudyBuddies t ACCA forums
September-December 2016 Examinations ACCA F9 29
The conditions necessary for the business to be able to operate with minimum inventories
include the following:
When you finished this chapter you should attempt the online F9 MCQ Test
Free ACCA notes t Free ACCA lectures t Free ACCA tests t Free tutor support t StudyBuddies t ACCA forums
September-December 2016 Examinations ACCA F9 30
Free ACCA notes t Free ACCA lectures t Free ACCA tests t Free tutor support t StudyBuddies t ACCA forums