Seminar on Financial Management · PDF file7 Shortening the cash conversion cycle is a good...
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Seminar on Financial Management Inventory Management Mark S. Maglana, CompE, MM
Transcript of Seminar on Financial Management · PDF file7 Shortening the cash conversion cycle is a good...
Seminar onFinancial Management
Inventory Management
Mark S. Maglana, CompE, MM
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Contents
» Inventory in context» Defining “inventory”» Managing inventories
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Let’s put things in context
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» Current Assets» Cash» Marketable Securities» Accounts Receivable» Inventory!
» Current Liabilities» Accounts Payable» Short-term Borrowings
Working Capital
You are here!
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Net Working Capital
Current Assets – Current Liabilities
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Payment for raw materials
AccountsReceivable
Period
InventoryPeriod
AccountsPayablePeriod
Cash Conversion Cycle
The Cash Conversion Cycle
Raw materials purchased
Sale offinished goods
Cash collectedon sales
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Shortening the cash conversion cycle is a good thing.
Optimizing inventory levels can shorten the cash conversion cycle.
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Cash Conversion Cycle
Inv. period + A/R period – A/P period
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Inventory Period
360 / (Inventory Turnover)
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Inventory Turnover
(CoGS)/(Average Inventory)
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But what is this “Inventory”that you speak of?
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Inventory is composed of
»Raw materials»Goods in progress»Finished goods
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The decision to hold inventory involves a trade-off .
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If you decide to buy materials only as needed you incur higher costs.
Holding too little finished goods introduces the risk of losing a sale.
Not holding inventory introduces the risk of production delays.
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On the other hand...
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Money tied up in inventory does not earn interest.
Storage and insurance must be paid for.
Inventory gets spoiled and deteriorates.
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So how do we manage this Inventory thing?
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Consider this problem
A builder’s merchant faces a steady demand for engineering bricks.
When the merchant runs out of inventory, it replenishes the supply by placing an order for more bricks from the manufacturer.
What is the optimum level of inventory to keep?
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We now use the EOQ model to solve the problem.
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EO What???
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Economic Order Quantity
A model that minimizes the total variable costs involved in ordering
and holding inventory.
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To understand complex ideas, we often must break them down to their simplest parts, examining each, and later re-assembling them.
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Thus the following assumptions...
» The demand for the item is known» The lead time is known and fixed» Inflation is negligible» The receipt of an order occurs in an instant» There are no quantity discounts» Shortages or stock-outs do not occur
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Num
ber
of b
ricks
Time
2x
x
0 t+1 t+2 t+3 t+4
Inventory
Average Inv.
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There are two costs associated with the merchant’s inventory of bricks:
» Order Cost» Handling expense
» Delivery charges
» Carrying Cost» Cost of space, insurance, and losses
» Opportunity cost of capital
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But what about item cost?
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Demand = P 1,000,000 bricks/yearItem cost = P 10/brick
Order Size Orders/Year Total Item Cost1,000,000 1.0 P 10,000,000
500,000 2.0 10,000,000
200,000 5.0 10,000,000
100,000 10.0 10,000,000
60,000 16.7 10,000,000
50,000 20.0 10,000,000
20,000 50.0 10,000,000
10,000 100.0 10,000,000
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Total Costs
Order Costs + Carrying Costs
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Order Costs
Orders per Year x Cost per Order
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Cost/order = P 900
Order Size Orders/Year Order Costs1,000,000 1.0 P 900
500,000 2.0 1,800
200,000 5.0 4,500
100,000 10.0 9,000
60,000 16.7 15,030
50,000 20.0 18,000
20,000 50.0 45,000
10,000 100.0 90,000
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Carrying Costs
Ave. Inventory x C/C per Item
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Order Size Orders/Year Ave. Inv. Carrying Costs
1,000,000 1.0 500,000 250,000
500,000 2.0 250,000 125,000
200,000 5.0 100,000 50,000
100,000 10.0 50,000 25,000
60,000 16.7 30,000 15,000
50,000 20.0 25,000 12,500
20,000 50.0 10,000 5,000
10,000 100.0 5,000 2,500
Average Inventory = Order Size / 2Carrying Cost/Brick = P 0.5
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Order Size Order Costs Carrying Costs Total Cost
1,000,000 P 900 P 250,000 P 250,900
500,000 1,800 125,000 126,800
200,000 4,500 50,000 54,500
100,000 9,000 25,000 34,000
60,000 15,000 15,000 30,000
50,000 18,000 12,500 30,050
20,000 45,000 5,000 50,000
10,000 90,000 2,500 92,500
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Total Costs
Carrying Costs
Order Costs
Order size
Inve
ntor
y co
sts,
100
0’s
of P
esos
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Optimal ordersize = 60,000 bricks
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The EOQ may be found at the point where the slope of the
Total Costs curve equals zero.
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oa
i CQ
SCC
QQTC
OCCCTC
+=
+=
2)(
Where: Q = Order SizeCCi = Carrying Cost per ItemSa = Annual SalesCo = Cost per Order
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)(
2)(
Q
CSCC
dQ
QdTC
CQ
SCC
QQTC
oai
oa
i
−=
+=
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i
oa
oai
oai
CC
CSQ
Q
CSCC
Q
CSCC
2
2
20
2
2
2
=
=
−=
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i
oa
CC
CSQ
2=∗
Economic Order Quantity (A.K.A. Q Star)
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000,6050.0
)900)(000,000,1(2
=
×=∗Q
Using the formula in our example...
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But you can’t ignore quantity discounts!!?
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Demand = P 1,000,000 bricks/year
Order Size Orders/Year Item Cost Total I/C1,000,000 1.0 P 9 9,000,000
500,000 2.0 9 9,000,000
200,000 5.0 9 9,000,000
100,000 10.0 9 9,000,000
60,000 16.7 10 10,000,000
50,000 20.0 10 10,000,000
20,000 50.0 10 10,000,000
10,000 100.0 10 10,000,000
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Order Size Total Costs Total I/C TC + TIC
1,000,000 P 250,900 P 9,000,000 P 9,250,900
500,000 126,800 9,000,000 9,126,800
200,000 54,500 9,000,000 9,054,500
100,000 34,000 9,000,000 9,034,000
60,000 30,000 10,000,000 10,030,000
50,000 30,050 10,000,000 10,030,050
20,000 50,000 10,000,000 10,050,000
10,000 92,500 10,000,000 10,092,500
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Total Costs
Carrying Costs
Order Costs
Order size
Inve
ntor
y co
sts,
100
0’s
of P
esos
Item Cost
Qb
Breakpoint Quantity
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Qb Q* QbQ* Qb
Case 1 Case 2 Case 3
Q*
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To find the new Q*
First, check if your computed Q* is more than or equal to Qb.
If so, order at Q*.
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Qb Q*
Case 1
Order size
Inve
ntor
y co
sts,
100
0’s
of P
esos
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Otherwise...
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To find the new Q*
» Compute the Total Costs at Q* and Qb
including the Total Item Cost» Make sure to use the correct amount for Cost
per Item» Without discount for Q*
» With discount for Qb
» If Total Costs at Q* is less than Total Costs at Qb order at Q*
» Otherwise, order at Qb
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Q* Qb
Case 2
Order size
Inve
ntor
y co
sts,
100
0’s
of P
esos
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Q* Qb
Case 3
Order size
Inve
ntor
y co
sts,
100
0’s
of P
esos
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In our example...
Is Q* >= Qb?
No. Move along, folks!
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Compute for TC(Q*) and TC(Q b)
TC(Q*) = CC + OC + TIC= 15,000 + 15,000 + 10,000,000= 10,030,000
TC(Qb) = CC + OC + TIC= 25,000 + 9,000 + 9,000,000= 9,034,000
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Advanced EOQ can incorporate
» Unknown demand» Unknown lead times» Inflation» Delays in receipt of orders» Shortages or stock-out possibilities
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Remember...
» Short Cash Conversion Cycles are good for the company’s bottom line.
» Optimize your Inventory Period to minimize your Cash Conversion Cycle.
» One way to optimize Inventory Period is to use EOQ.
» One other (non-recommended) technique is the Hawaiian Method.
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Let’s give it a try...
» Suppose that a liter of chlorine for sanitizing swimming pools costs P25.
» 20 liters are consumed per day. » Each time an order is made, a total of P50 in
ordering charges is incurred while keeping it in stock costs P0.30 per liter-day.
» Just today, the supplier called in for a promo such that if you order 150 liters or more, you will get a 10% discount.
» Will you avail of the discount?
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End of Session
