ACT08-FINANCIAL MANAGEMENT 1

INVENTORY MANAGEMENT (EOQ)

J. VILLENA, CPA

ECONOMIC ORDER QUANTITY (EOQ)

Refers to the unit of materials that should be purchased to minimize
total relevant costs.
It is the point where total ordering cost equals the total carrying cost.
FORMULA:

ORDERING COST

Includes those spent in placing an order, waiting for an order, inspection and
receiving costs, setup costs, and quantity discount loss.
Cost per order=Total Ordering cost / No. Of orders
Total Ordering Cost= Cost per order / No. Of orders
No. Of orders=Annual Demand / order size
Order size refers to number of units or amount purchased per
order batch
CARRYING COST
Are those spend in holding, maintaining, or warehousing inventories such as
warehousing and storage cost, handling and clerical costs, property taxes and
insurance, deterioration and shrinkage of stocks, obsolescence of stocks,
interest and return on investment.
Carrying cost per unit=Total Carrying cost / Average Inventory
Carrying cost per unit=Unit Cost x Carrying Cost Ratio
Total Carrying Cost= Carrying cost per unit x Average Inventory
Average Inventory= Order size / 2

PROBLEM 1
Big City Corporation expects to use 10,000 units of material XPO per month in
2017. Last year, the total ordering cost amounted to P200,000 for a total of 40
orders. It is expected that prices in 2017 would be 10% higher that of last
year. Determine the expected ordering cost in 2017 if the company orders in a
batch of 12,000 units or 24,000 units.

PROBLEM 2
In 2011, Fit It Company incurred a total of P800,000 for inventory costs with
an average inventory of 200,000 units. What would be the total carrying costs
in 2012 if the order size is 500,000 units or 900,000 units, assuming the
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 ACT08-FINANCIAL MANAGEMENT 1
INVENTORY MANAGEMENT (EOQ)
J. VILLENA, CPA
company does not maintain safety stock quantity. Compute the total carrying
cost?

PROBLEM 3
Assume an annual requirement of 24,000 units, a cost per unit of P20, a cost
per order of P750, and a carrying cost percentage of 20%.
Compute the following:
1. EOQ
2. Total Ordering cost
3. Total Carrying cost
4. Total Relevant Cost

REORDERING POINT (ROP)

Refers to the inventory level where a purchase order should be placed.
ROP= Lead time Quantity + Safety stock Quantity
Lead time quantity=Normal usage x Normal lead time
Safety Stock=Safety stock in usage x Safety stock in time

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 ACT08-FINANCIAL MANAGEMENT 1
INVENTORY MANAGEMENT (EOQ)
J. VILLENA, CPA
Safety stock in usage=(Maximum usage-Minimum Usage) x normal
lead time
Safety stock in time=(Maximum lead time-Minimum lead time) x
normal usage
Maximum inventory level= Safety stock quantity + Order size

LEAD TIME refers to the waiting time from the date the order is
placed until the date of delivery is received.
LEAD TIME QUANTITY represents the normal usage during the
lead time period.
NORMAL USAGE means the average usage of inventory during a
period. (Annual demand/working days in a year)
SAFETY STOCK is set to serve as a margin in case of variations in
normal usage and normal lead time.

PROBLEM 4
Linda Corporation has the following production data:
Annual Requirement 40,000 units
Number of working days 320 days
Normal lead time 10 days
Maximum lead time 16 days
Maximum usage 150 units
EOQ 5,000 units

Determine the lead time quantity, safety stock quantities; reorder point and
maximum inventory levels.

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