Inventory Management and Receivables: Optimizing Stock Levels and Credit Policies, Exams of Financial Market

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Lecture:

Receivables and Inventory Management

Syed Karim Bux Shah (PhD)

Assistant Professor

IBA, University of Sindh, Jamshoro.

Financial Management

Outline

• Inventory Management

• JIT system

• ABC method

• Economic order quantity

• Safety stock

Just in Time (JIT) System

• JIT breaks with the conventional wisdom of maintaining large

inventory stocks as buffers against uncertainties.

• The basic objective of JIT is to produce (or receive) a required item

at the exact time needed, or “just in time”.

• Inventories should be increased as long as the resulting savings exceed the total cost of holding the added inventory.

• The balance finally reached depends on the estimates of actual

savings, the cost of carrying additional inventory, and the efficiency

of inventory control.

• This requires coordination of the production, marketing, and

finance areas of the firm in keeping with an overall objective.

ABC method of inventory control.

• Inventory items are classified as A, B, and C, where A

represents most valuable items (or running items).

• Classify inventory items in such a fashion that we ensure that

the most important inventory items are reviewed most often.

• Items classified as A are reviewed more often than B and C.

• This is like triage during Covid- 19. Which patient needs to be

what level of care?

Economic order quantity

Ordering costs (O) : Ordering costs (O) represent

• costs involved in placing an order
• costs of receiving and checking the goods once they arrive.
• scheduling a production run.
• When setup costs are, ordering costs can be quite significant.
• Ordering cost per unit decreases as the size of the order is increased. Carrying costs (C): Carrying costs per unit (C) represent
• cost of inventory storage , handling , and insurance
• required return on the investment in inventory over the period.
• These costs are assumed to be constant per unit of inventory, per period of time.
• Thus the total carrying cost for a period is the carrying cost per unit times the a verage number of units of inventory for the period. The optimal size (Q):* The optimal quantity of an inventory item to order at any one time is that quantity, Q*, that minimizes total inventory costs over our planning period.

Economic order quantity

Example : Determine EOQ for following firm.

• Usage of an inventory item (S) = 2,000 during a 100-day planning period,
• Ordering costs are $100 per order, and
• carrying costs are $10 per unit per 100 days. Solution
• No of orders = S / Q* → = 2000/200 = 10 times.
• No of days = Total period / No of orders → = 100 days / 10 orders = 10 days (i.e. Order every 10th day) Redo this for S = 4000 units
• Q = 280* , why not 400? (Economies of scale) → As usage increases, then, the optimal order size and the average level of inventory increase by a lesser percentage. In other words, economies of scale are possible.

Safety stock

• Inventory stock held in reserve as a

cushion against uncertain demand (or

usage) and replenishment lead time.

• When demand and/or lead time are

uncertain , then the order point is:

Order Point =(Avg. lead time x Avg. daily

usage) + Safety stock

Safety stock

• Things to consider for the proper amount of safety stock.

• Amount of uncertainty in inventory demand
• Amount of uncertainty in the lead time
• Cost of running out of inventory → SS increase
• Cost of carrying inventory → SS minimize