1. Management Accounting for Business
Chapter 6
INVENTORY MANAGEMENT
Dr. Mohamed A. Hamada
Lecturer of Accounting Information Systems

2. LEARNING OBJECTIVES
Describe the traditional inventory management model.
Explain the calculation of Economic Order Quantity EOQ
Discuss JIT inventory management.

3. What Is Inventory? Stock of items kept to meet future demand
Purpose of inventory management
how many units to order
when to order

4. Types of Inventory Raw materials Purchased parts and supplies
Work-in-process (partially completed) products (WIP)
Items being transported
Tools and equipment

5. Inventory Costs cost of holding an item in inventory
Carrying cost
cost of holding an item in inventory
Ordering cost
cost of replenishing inventory
Shortage cost
Temporary losses of sales when demand cannot be met

6. Inventory Control Systems
Continuous system (fixed-order-quantity)
constant amount ordered when inventory declines to predetermined level
Periodic system (fixed-time-period)
order placed for variable amount after fixed passage of time

7. Economic Order Quantity (EOQ) Models
optimal order quantity that will minimize total inventory costs
Basic EOQ model
Production quantity model

8. EOQ: Definition
Is a model that calculates the best quantity to order or produce. (Economic Order Quantity)

9. What are 2 basic questions addressed by EOQ?
How much should be ordered (produced)?
When should the order be placed (setup done)?

10. TOTAL COST: Background
The total cost (TC) formula includes the following:
P = $25 per order [cost of placing & receiving order (setup & production)]
D = 10,000 [known demand]
Q = 1,000 [order size (or production lot size)]
C = $2 per unit [carrying cost of 1 unit for 1 year]

11. FORMULA: Total Cost Total cost (TC) equation 1:
Total cost looks at all inventory costs.
Total cost (TC) equation 1:
= Ordering cost + Carrying cost
= PD/Q + CQ/2
PD/Q = [(10,000/1,000) x $25] = $ 250
CQ/2 = [(1,000/2) x $2] = $1,000
TC = $1,250

12. How can the total cost be reduced?
The EOQ model will compute the cheapest batch order size.

13. FORMULA: EOQ EOQ equation 2: = √ 2 x Order costs ÷ Unit Carrying cost
EOQ is a calculation intended to lower total inventory costs.
EOQ equation 2:
= √ 2 x Order costs ÷ Unit Carrying cost
= √ 2PD/C
= √ 2 x $25 x 10,000 / $2
= √ 250,000
= 500

14. What do you do with the order quantity calculated by the EOQ model?
Enter the order quantity into the TC equation in 1.

15. FORMULA: EOQ Cost Total cost (TC) equation 1:
EOQ Total cost calculates TC using the EOQ batch size in units to cut total cost by $250.
Total cost (TC) equation 1:
= Ordering cost + Carrying cost
= PD/Q + CQ/2
PD/Q = [(10,000/500) x $25] = $ 500
CQ/2 = [(500/2) x $2] = $ 500
TC = $1,000

16. FORMULA: Reorder Point (ROP)
ROP identifies the proper time to place an order to avoid stockout.
Reorder Point (ROP) equation 3:
= Rate of usage x Lead time
= 50 parts per day x 4 days
= 200 parts

17. FORMULA: Safety Stock Safety stock provides a buffer to reorder point.
= Lead time x (maximum – average usage)
= 4 days x (60 – 50)
= 40 parts

18. FORMULA: ROP + Safety Stock
Safety stock adds a buffer to reorder point.
Reorder Point (ROP) equation 4:
= Rate of usage x Lead time + Safety stock
= 50 parts per day x 4 days + 40
= 240 parts

19. Example
Alex Company is a wholesaler. Alex purchases 800,000 units of product X each year for sale to retailers. The cost of placing an order is $40. The cost of holding one unit of inventory for one year is $4.
Required
1. Compute the economic order quantity.
2. How many orders would Alex place under the EOQ policy?
3. Compute the annual ordering cost for the EOQ.
4. Compute the annual carrying cost for the EOQ.
5. Compute the total inventory-related cost at the EOQ.

20. Solution

21. JUST-IN-TIME (JIT): Definition
Is a demand-pull manufacturing system that requires goods to be pulled through the system by present demand.
It enables a firm to produce only what is required, in the correct quantity and at the correct time.
Information is exchanged with suppliers and customers through EDI (Electronic Data Interchange) to help ensure that every detail is correct.

22. Electronic Data Interchange

23. JIT: Strategic Objectives
Increase profits
Improve competitive position BY
Controlling costs
Improving delivery performance
Improving quality

24. Advantages of JIT
Lower stock holding means a reduction in storage space which saves rent and insurance costs
As stock is only obtained when it is needed, less working capital is tied up in stock
There is less likelihood of stock perishing

25. LIMITATIONS OF JIT
Time is required to build sound relations with suppliers
Workers experience stress in changing over to JIT
Production may be interrupted because of absence of inventory supply buffer

26. Very thanks