Chapter 4 Managing Inventory

INV

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The Cash Flow Timeline

Order Placed

Order Received

Payment Sent Cash Received Accounts Collection < Inventory > < Receivable > < Float >

Sale

Time ==>
Accounts < Payable > Disbursement < Float >

Invoice Received

Payment Sent Cash Disbursed Copyright 2005 by Thomson Learning, Inc.

Objectives

Appreciate impact of holding and ordering costs on order quantity Traditional EOQ & quantity discounts Appreciate JIT concepts Assess impact that different order quantities have on timing and amount of payments

Use of balance fractions to monitor inventory balances

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Concept of Inventory
Factor in the length of cash cycle Acts as a shock absorber Three types
raw materials work-in-process finished goods

Motives for holding inventory

transaction precautionary speculative

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Inventory Investment Function

Demand for product Cost of holding inventory
insurance storage cost of capital

Cost of ordering inventory Total cost = Order Cost + Holding Cost = F x (T/Q) + H x (Q/2)
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Order Cost and Holding Cost Tradeoff

$

Holding cost = H x (Q/2)

Order costs = F x (T/Q)

Order quantity, Q
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Economic Order Quantity

EOQ solution: Number of orders: Average inventory:

SQRT (2TF/H) T/Q Q/2

Usage rate:
Reorder point:

T/D

(D=days)

(T/D) x Delivery Time

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Quantity Discounts

TC = Order Cost TC =

+ Holding Cost + Item Cost (H x (Q/2)) + (C x T)

(F x (T/Q)) +

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Inventory and the Cash Flow Timeline

Inventory ordered and received < Inventory Held> Inventory ordered and received <Inventory Held>

Time=> Cash paid for inventory Cash paid for inventory Cash paid for holding & ordering costs

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Monitor the Inventory Balance

Inventory control systems Inventory turnover ratio

Sales or COGS / Inventory balance

Days COGS in inventory

Inventory balance / Daily COGS or Sales

Balance fraction approach

Develop monthly balance fractions based on the proportion of items remaining in inventory from a given months purchase.

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Reducing Investment in Inventory

Problems were solved by adding more inventory JIT redesigns system Redesign of production system
eliminate waste eliminate production errors improving quality

Need stable demand

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Summary

Inventory decisions should be based on:

cost of holding inventory cost or ordering inventory opportunity cost of funds quantity discounts is quantity workable within inventory management system?

Inventory, if properly managed can be a major contributor to cash flow... if mismanaged, it can be a significant drain on cash. Some traditional inventory monitoring tools can be biased by sales and production trends.

Copyright 2005 by Thomson Learning, Inc.