Inventory M AN AGEM EN T N O R S YAH R I D AH N O H T H E F U N DA M EN T ALS OF

The Fundamentals O F I N V E N TO R Y M A N A G E M E N T

Copyright @ 2021 ISBN 978-967-26297 Nor Syahridah binti Noh 200, Kampung Lembah 2, Mukim Hosba, 06000 Jitra, Kedah Darul Aman. [email protected] No part of this book may be reproduces, stored in retrivel system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior permission.

A C K N O W L E D G E M E N T S I cannot express enough thanks to everybody who give their continuos support and encouragement. I offer my sincere appreciation for the learning opportunities provided by Commerce Department POLIMAS to me in completing this e-book. My completion of this e- book could not have accomplish without all the support from my officemate. Finally, to my loving and supportive family for understanding and encourgement. iii

P R E F A C E With the name of Allah, Most Gracious, Most Merciful, Greetings to beloved Prophet Muhammad, I am grateful for His nearness and consent for this e-book to be prepared properly. This content of this e-book been developed as an additional guide as well as reading materials for students who take Financial Management subject. This ebook consists of the basic knowledge of inventory management, examples and exercise for the students to try on. Apart from that, there are also few QR Code attached in this book for students to get additional knowledge from selected videos. Lastly, it is my sincere hope that this e-book publication will benefit to all its readers. Thank you iv

Acknowledgement iii Preface iv Inventory Management 3 What is inventory? 4 Motives for Holding Inventory 10 Types of Inventory Management Costs 13 Economic Order Quantity 18 Calculating the Cost of Inventory 20 Re-order Level, Lead Time & Safety Stock 26 Calculating the Re-order Level 29 The Importance of Inventory Control 31 Summary 32 Review Questions 33 Glossary 36 References 37 Table Of Contents PAGE

Hi!! I’m Madam Syahridah I will help you in having a basic understanding of inventory and its management

Inventories are one of component in the capital structure of the company. As one of the company’s current assets, inventory needs to be well managed. This is because it can help in ensuring that the company can operate efficiently and smoothly. Inventory management is a business process which is responsible for managing, storing, moving, sorting, arranging, counting and maintaining the inventory i.e. goods, components, parts etc. Inventory management ensures that the right inventory is available as per the demand at low costs. Inventory management makes sure that the core processes of a business keep running efficiently by optimizing the availability of inventory. Inventory Management 3

Inventories are goods which been held for eventual sale by the business It can also be defined as the stock of products produced by a company for sale and also as the components that make up the product. In other words, inventory represents finished goods or goods in different stages of production that a company keeps at its premises or at third-party locations with ownership interest retained until goods are sold. As one of the company’s current assets, inventories form a link between the production and sale of the product. What isinventory? 4

5 Generally, there are three fundamental types of inventory when it comes to the products a business might sell. These are: 1. Raw materials 2. Work in process (WIP) 3. Finished Goods RAW MATERIALS Various materials a company purchases for its production process. These materials must undergo significant work before a company can transform them into a finished good. WORK IN PROCESS (WIP) Represent raw materials in the process of being transformed into a finished product. In other words, work-in-progress inventories refer to ‘semi-manufactured products’ which are not ready for sale yet. FINISHED GOODS Completed products readily available for sale to a company's customers.

Let ’s ta k e a l o o k o n t h e f o l l o w i n g e x a m p l e EXAMPLE: CONFECTIONERY INDUSTRY RAW MATERIALS Sugar, flour, egg, chocolate, etc WORK IN PROCESS Bakes tart bases for tarts & stores them until they are ready for use FINISHED GOODS Mini Chocolate Tarts 6

RAW MATERIALS: WORK IN PROCESS: FINISHED GOODS: EXAMPLE: AUTOMATIVE INDUSTRY 7

Check This Videos For Better Understanding Topic: Inventory Management Topic: Types of Inventory Topic: Examples of Inventory 8

It is very important for a company to keep a sufficient amount of inventory to meet the demand and supply from its customers. The main objective of having sufficient inventories is to reduce the cost associated with investment in inventory and maintaining efficiency in production and sales operations. A company has various motives for holding the inventory as stated below: 1. Transaction Motives 2. Precautionary Motives 3. Speculative Motives for holding inventories for thebusiness 10

SPECULATIVE MOTIVES • Inventories be held so that advantage can be taken of price fluctuations. • If the price of a particular raw material is expected to go up rather steeply, an enterprise may decide to hold a larger than necessary stock of the item 11 PRECAUTIONARY MOTIVES Inventories are held so that there is a cushion against unpredictable events. For instance, there may be a sudden and unforeseen spirit in demand for finished goods or there may occur a sudden and unforeseen slump or delay in supply of raw materials or other components needed for production. TRANSACTION MOTIVES A business maintains inventories to avoid bottlenecks in its production and sales. By maintaining inventories; the business ensures that production is not interrupted for want of raw material, on the one hand, and sales also are not affected on account of non-availability of finished goods, on the other.

Inventory Management Cost Inventory managements costs are all costs associated with ordering, holding and managing the inventory or stock of an operation or business These costs can be categorized under THREE categories: 1. Ordering Cost 2. Carrying Cost 3. Shortage Cost 14

WHAT IS ORDERING COST? An essentially costs incurred every time an order been placed from the supplier. There will be an ordering cost of some amount, no matter how small the order might be. The more orders placed, the greater the ordering costs. The ordering cost is a fixed cost in the inventory management. EXAMPLE OF ORDERING COST Clerical costs of preparing purchase orders — such as invoice processing, accounting, and communication costs. Cost of finding suppliers and expediting orders Receiving costs — includes costs of unloading goods at the warehouse and inventory’s inspection process. Cost of electronic data interchange (EDI) Transportation costs — the costs of moving the goods to the warehouse or store. These costs are highly variable across different industries and items. 15

WHAT IS CARRYING COST? Also known as holding costs. These are costs involved with storing inventory before it is sold. Carrying cost is a variable cost. It depends on the quantity of the inventory. EXAMPLE OF CARRYING COST Inventory financing costs —includes everything related to the investment made in inventory. For example costs like interest on working capital. Storage space costs — costs related to the place where the inventory is stored and will vary by location. Inventory services costs — includes the cost of the physical handling of the goods. Example: insurance, security, etc Inventory risk costs — the loss of products between purchasing from the supplier and final sale due theft, vendor fraud, shipping errors, damage in transit or storage, dead stock, etc 16

WHAT IS SHORTAGE COST? • Also called stock-out costs, occur when businesses become out of stock for whatever reason. This cost arise due to: Disrupted production: When production been disrupted, the business will have to pay for things like idle workers and factory overhead, even when nothing is being produced. Emergency shipments: For retailers, stock-outs could mean paying extra to get a shipment on time, or changing suppliers. Customer loyalty and reputation: Aside from the loss of business from customers who go elsewhere to make purchases, the company takes a hit to customer loyalty and reputation when their customers are unhappy 17

ECONOMIC ORDER QUANTITY Economic order quantity (EOQ) is a calculation designed to find the optimal order quantity for businesses to minimize. EOQ refers to the OPTIMUM AMOUNT of an item that SHOULD BE ORDERED at any given point in time, where such order will minimize the total annual cost of carrying and ordering cost. EOQ is also sometimes known as the optimum lot size. 18

The total ordering cost in an EOQ remains constant The total units that are to be consumedare certain The ordered inventory is delivered in one attempt The inventory costs are assumed constant The maximum quantity for every stock item is computed on a separate basis No availability of any discount on quantity or cash There is no fluctuation of lead time ASSUMPTIONS OF ECONOMIC ORDER QUANTITY 19

Total Ordering Cost EQONOMIC ORDER QUANTITY = 2 (O) (S) C Q: Quantity Ordered O: Ordering cost per order S: Annual Sales @ Demand (unit) C: Carrying cost per unit CALCULATING THE INVENTORY COST Average Inventory = Q/2 Ordering Frequency = S/Q Total Carrying Cost = C x Q / 2 20

Example 1: Mega Enterprise sells 9,800 units of products per annum. Carrying cost is 10% of the value of the products. The purchase price of the product is RM2.00 each and the ordering cost is RM500 for each order. Calculate the economic order quantity and the total inventory cost. SOLUTION: EOQ = 2(O)(S) C EOQ = 2(50O)(9800) 0.1 X 2 EOQ = 9800000 0.2 EOQ = 7000 units i. Economic Order Quantity: 21

700 = RM1400 Do you have any difficulties in solving this question? 22

Example 2: Sunshine Enterprise sold 500,000 units per year. The purchase price is RM6. Carrying cost of inventory is 20% of the purchase price. Each order involves a cost of RM1000. Calculate: i. the EOQ ii.the number of annual orders iii.the total cost of inventory i. Economic OrderQuantity: SOLUTION: EOQ = 2(O)(S) C EOQ = 2(100O)(500000) 0.2 X 6 EOQ = 28,868 units 23

1000 x 500,000 2 28,868 = RM 34641.02 24

Re-order Level A reorder level or point is the unit quantity that triggers the purchase of the inventory. It becomes an indicator for the storekeeper to restock the items that are finishing up in the store. Once the reorder point is hit, the business owner places a new order for the refilling of items so that he can fulfil his business’s need successfully without any halt. LEAD TIME demand need to be considered when we want to calculate reorder level. RE-ORDER LEVEL, LEAD TIME & SAFETY STOCK Quantity Q Order Receive Place Order Order Receive Place Order Order Receive Demand Time Re-order Level 26

Lead Time Lead time is the length of time between the placement of an order for an inventory item and when the item is received in inventory. In other words, lead time is the amount of time between when a purchase order is placed to replenish products and when the order is received in the warehouse. Lead time helps the company in predicting their sales, making operations efficient, and improves customer satisfaction. Quantity Q Order Receive Place Order Order Receive Place Order Order Receive Reorder Point Demand Time Lead Time RE-ORDER LEVEL, LEAD TIME & SAFETY STOCK 27

Safety Stock A specific quantity of products kept aside by business owner; so that they can be used in times of emergency or during stock-outs. Safety stock will cause the average inventory to increase. When the average inventory increase, carrying cost also will be increased. Therefore, there will be some changes happen in calculating inventory cost. Quantity Q Order Receive Place Order Order Receive Place Order Order Receive Lead Time Reorder Point Demand Time Safety Stock RE-ORDER LEVEL, LEAD TIME & SAFETY STOCK 28

S a f e t y S t o c k ] 29

17320.22 = RM 35841.02 30

of inventory control in the business Organized Warehouse Increased Consumer Satisfaction Repetitive Customers Save Time and Money Increased Efficiency and Productivity Accurate Order Fulfilments Improved Accuracy of Inventory Orders Better Inventory Planning & Ordering 5 6 7 1 2 3 4 8 31

Summary Inventories are one of the factors that can contribute to an efficient and smooth business operation. Inventories can be categorized as raw materials. Work in process and finished goods. Inventory management cost consists of total carrying cost and total ordering cost. Carrying cost is a variable cost in inventory management while ordering cost is a fixed cost to the company. Reorder level can help the company’s management to ensure sufficient amount of inventories available for business’s operation. Safety stock also can be one of the important aspects that company should consider in ensuring the business goes well. 32

TRUE / FALSE QUESTIONS Review Questions 1. Inventory management is business operation. a key component of effective 2. Inventory is a stock of items kept to meet future demand. 3. Work in process inventory awaiting delivery of. is the goods the customer are 4. The ordering cost per order of an inventory is RM300 with an annual carrying cost of RM10 per unit. The Economic Order Quantity for an annual demand of 2000 units is 400. 5. The cost that are considered in the basic EOQ model are annual ordering cost and annual holding cost. 6. Carrying cost is the cost of holding an item in inventory. 7. Shortage cost is the cost of replenishing inventory. 8. Lead time is the quantity that indicate the business have lower stock for the operation. 9. A good inventory management can helps business owner runs their operation efficiently. 10. The higher the amount of economic order quantity, the higher the total amount of ordering cost. 33

PROBLEM SOLVING QUESTIONS Question 1: The annual demand for Product A is 300,000 units and an order for new inventory is placed each month. Each order costs RM 267 to place. The carrying cost of Product A 10 cents per unit per year. a) Calculate the EOQ for Product A. b) How many number of orders been made annually? c) How much is the total cost of inventory for Product A? d) If Product A has a safety stocks of 20,000 units, how much is the new total inventory cost? Review Questions 34

PROBLEM SOLVING QUESTIONS Question 2: Megah Holdings, an electrical company has an annual demand of 80,000 units of Product X. The cost to place one order is RM1200 and the cost per unit is RM50. If the carrying cost is 6% of the unit cost, calculate: a) The economic order quantity b) Number of order per year c) The total ordering cost d) The total carrying cost e) The total cost of inventory Review Questions 35

Carrying costs—the costs associated with having specific quantities of inventory. Carrying costs primarily include the cost of the inventory investment and the costs associated with storing the inventory. Demand—the need for a specific item in a specific quantity. Economic order quantity—a calculation (or the result of a calculation) that determines the most cost effective quantity to order (purchased items) or produce (manufactured items) by finding the point at which the combination of order cost and carrying cost is the least. Finished goods—inventory that is in a saleable or shippable form based upon its location within the supply chain Inventory—any quantifiable item that you handle, buy, sell, store, consume, produce, or track. Lead Time—The amount of time it takes from the intent to restock an item until it is on-hand. Order cost—the sum of the fixed costs that are incurred each time an item is ordered or produced. Raw materials—inventory used in the manufacturing process. Reorder point—the inventory level set to trigger an order of a specific item. Safety stock—quantity of inventory used in inventory management systems to allow for variation in demand or supply that cannot be effectively forecast. Stockout—a situation where you have inadequate inventory levels to meet current demand. Work in process—represents partially completed goods. These goods are also referred to as goods-in-process. G L O S S A R Y 36

REFERENCES Ng Kean Kok, Z.W. (2017). Financial Management (3rd ed). Malaysia: Oxford Fajar Faizah Sahbudin & Muhamad Nazri A.H. (2019). Polytechnic Series Business Finance (2nd ed). Malaysia: Oxford Fajar Jae K.Shim, Joel G. Siegel. (2005). Schaum’s Outlines: Financial Management. McGraw Hill 37

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