Abuyog Community College

Abuyog, Leyte

Name:__________________________________ Section: ___________________

5 Inventory Management
INTRODUCTION

Inventory is the raw materials, components and finished goods a company sells or uses in
production. Accounting considers inventory an asset. Accountants use the information
about stock levels to record the correct valuations on the balance sheet.

INTENDED LEARNING OUTCOME

1. Define and explain inventory management
2. Compute and understand the Annual Stock Turnover
3. Compute and understand the Re-order point
4. Compute and understand the Economic Order Quantity
5. Describe the Distribution Strategies of Hospitality Industry.

ACTIVITY
List down inventory items as many as you can that a room attendant should always check in the
room before it will turn to VC status following the guide:

Furniture and fixture Linen Lights and Ventilation Consumables

Analysis
1.Why there is a need for inventory of these items?
2.When do we need to conduct inventory? Why do you say so?
3. What will be the result of proper inventory to the business?
 Abstraction
There are instances where efficiency in supply chain can be ensured by efficiencies in inventory, to
be more precise, by maintaining efficiency in inventory reductions. Though inventory is considered a
liability to efficient supply chain management, supply chain managers acknowledge the need of
inventory. However, the unwritten rule is to keep inventory at a bare minimum.
Many strategies are developed with the objective of streamlining inventories beyond the supply chain
and holding the inventory investment as low as possible. The supply chain managers tend to maintain
the inventories as low as possible because of inventory investment. The cost or investment related
with owning inventories can be high. These costs comprise the cash outlay that is necessary for
purchasing the inventory, the costs of acquiring the inventories (the cost of having invested in
inventories rather than investing in something else) and the costs related with managing the
inventory.

Role of Inventory
Before understanding the role of inventory in supply chain, we need to understand the cordial
relationship between the manufacturer and the client. Handling clients, coping up with their demands
and creating relationships with manufacturer is a critical section of managing supply chains.
There are many instances where we see the concept of collaborative relationship being marked as
the essence of supply chain management. However, a deeper analysis of supply chain relationships,
especially those including product flows, exposes that at the heart of these relationships is inventory
movement and storage.
More than half of it relies on the purchase, transfer or management of inventory. As we know,
inventory plays a very important role in supply chains, being a salient feature.
The most fundamental functions that inventory has in supply chains are as follows −

 To supply and support the balance of demand and supply.

 To effectively cope with the forward and reverse flows in the supply chain.
Companies need to manage the upstream supplier exchanges and downstream customer demands.
In this situation, the company enters a state where it has to maintain a balance between fulfilling the
demands of customers, which is mostly very difficult to predict with precision or accuracy, and
maintaining adequate supply of materials and goods. This balance can be obtained through
inventory.
Benefits of Inventory Management
The two main benefits of inventory management are that it ensures you’re able to fulfill
incoming or open orders and raises profits. Inventory management also:

 Saves Money:
Understanding stock trends means you see how much of and where you have something
in stock so you’re better able to use the stock you have. This also allows you to keep less
stock at each location (store, warehouse), as you’re able to pull from anywhere to fulfill
orders — all of this decreases costs tied up in inventory and decreases the amount of
stock that goes unsold before it’s obsolete.
 Improves Cash Flow:
With proper inventory management, you spend money on inventory that sells, so cash is
always moving through the business.
 Satisfies Customers:
One element of developing loyal customers is ensuring they receive the items they want
without waiting.

Inventory Management Challenges

The primary challenges of inventory management are having too much inventory and not
being able to sell it, not having enough inventory to fulfill orders, and not understanding
what items you have in inventory and where they’re located. Other obstacles include:

 Getting Accurate Stock Details:

If you don’t have accurate stock details,there’s no way to know when to refill stock or
which stock moves well.
 Poor Processes:
Outdated or manual processes can make work error-prone and slow down operations.
 Changing Customer Demand:
Customer tastes and needs change constantly. If your system can’t track trends, how will
you know when their preferences change and why?
 Using Warehouse Space Well:
Staff wastes time if like products are hard to locate. Mastering inventory management can
help eliminate this challenge.

Aspects of Inventory Management:

a. Stock Turnover
b. Re-order Point
c. Economic Order Quantity
d. Warehousing

a. Stock Turnovers

This is the balance between sales and inventory on hand, expressed by tock turnover, the number
of times during specified period that average inventory on hand is sold. Stock Turnover is
calculated in units and in pesos:
No.of units sold during the year
Annual Rate of Stock Turnover (In units)=
Average inventory on hand (in units)
 Cost of Good Sold
Annual Rate of Stock Turnover (In Pesos)=
Average inventory on hand (in Pesos)

Example:

For the year ending December 2022, Eat’s Showtime Restaurant Reported Cost of good sold for P525,000 and
an average of 5250 units which costs P52, 500. Compute for the Annual rate of stock turnover (in pesos).

Solution:

Cost of Good Sold

Annual Rate of Stock Turnover (In Pesos)=
Average inventory on hand (in Pesos)

P 525, 000
Annual Rate of Stock Turnover (In Pesos)=
P 52,500

Annual Rate of Stock Turnover (In Pesos)= 10x

In other words, within a year, the company tends to turn over its inventory 10 times.

b. Re-order Point

The reorder point establishes an inventory level at which new sales orders must be placed. The re-order
point depends on: order lead time, usage rate, and safety stock.

Order Lead Time- is the period from date a sales order is placed until the date goods are ready for sale or
use.(received, checked, and altered if necessary)

Usage rate- means the average sales in units per day or rate at which s product is used in a production
process.

Safety stock- is the extra merchandise kept on hand to protect agaiants ouy-of-stock conditions resulting
from unexpectedly High demand, greater-than-anticipated production volume and delivery delays.

The re-order Point formula is:

Reorder Point= (order lead time X usage rate) + safety stock

 Example:

A fast-food restaurant needs to find when it should place for a specific food product from its manufacturer.
Compute for the Reorder Point Using the following relevant information:

-average usage: 600 units per day

-average lead time: 17 days
-safety Stock: 253 units
EOQ: 35,000 units

Solution:

Reorder Point= (order lead time X usage rate) + safety stock

Reorder Point= (17days X 600 units ) + 253

Reorder Point= 10,453 units

In short, the company should re-order another set of inventory when the level of inventory is at 10,453
units.

c. Economic Order Quantity

There are 2 types of cost related to the maintenance of inventory in a firm.

1. Carrying Cost- refers to the cost of carrying one unit of inventory into stock. It can be defined
as expenses involve in keeping and maintain a stock. Example: rent of space, equipment,
materials, labor, insurance,security, interest and other direct expenses.

2. Ordering cost- refers to the cost of placing an order for an item. This is the amount of money
that you spend on ordering items from vendors as well as the labor
Average value of inventory is used to offset seasonality effects. It is calculated by
adding the value of inventory at the end of a period to the value of inventory at the end of
the prior period and dividing the sum by 2.

Cost of goods sold (COGS) is also known as cost of sales. Analysts use COGS instead of
sales in the formula for inventory turnover because inventory is typically valued at cost,
whereas the sales figure includes the company’s markup. Some companies may use
sales instead of COGS in the calculation, which would tend to inflate the resulting ratio

What Inventory Turnover Can Tell You

A high inventory turnover ratio, on the other hand, suggests strong sales. Alternatively, it
could be the result of insufficient inventory. As problems go, ensuring a company has
sufficient inventory to support strong sales is a better one to have than needing to scale
down inventory because business is lagging.

 
A low inventory turnover ratio can be an advantage during periods of inflation or supply
chain disruptions, if it reflects an inventory increase ahead of supplier price hikes or
higher demand. Retail inventories fell sharply in the first year of the COVID-19 pandemic,
leaving the industry scrambling to meet demand during the ensuing recovery

Ordering cost and inventory level have an inverse relationship. This means that more inventories on
stock do not require frequent orders resulting in over ordering cost.

The level of inventory to be maintained by a firm is that level will put total inventory cost at a
minimum. Total inventory cost simply refers to the sum of carrying and ordering cost. The total
inventory cost at its lowest level under the inventory level where carrying amount and ordering costs
are equal. This level is known as Economic Order Quantity or EOQ. It is the order volume
corresponding to the lowest sum of ordering cost and inventory holding or carrying costs. The formula
is:

2xDxO

EOQ√ C

Where: D –demand or requirment units for the period

O- Ordering cost

C- carrying cost

Example:
The demand of a product at a Restaurant is 9,000 servings per year. It incurs a fixed ordering cost
of P50.00 each time an order is placed. The carrying cost of each unit of product is P10.00. Compute
for the economic order quantity.

Solution:

2xDxO

EOQ√ C

2x9000 units X P50 per order

EOQ√ P10 per unit

900,000

EOQ√ 10

EOQ√ 90,000

EOQ= 300 units

d. Warehousing
A warehouse is a facility that, along with storage racks, handling equipment and personnel and
management resources, allows us to control the differences between the incoming flow of goods
(received from suppliers, production centers, etc.) and the outgoing flow of goods (goods being
sent to production, sales, etc.). Usually, these flows are not coordinated, and this is one of the
reasons why it is important to have storage facilities.

Transportation

Air Freight, Road Freight, Sea Freight and Rail Freight. These are the four major
modes of transport (or types) in the logistics industry

Distribution Channels of Hospitality Industry

To increase and enhance the sales of the hotels, the hotel management require using the distribution
channels for hotels. The online system helps a lot in attracting guests and customers to the hotels.

In today’s cut throat competition, technology is the

only medium through which one can really push hard
to stand in the crowd. But what technology would you
choose to solve your problems. In hospitality there are
numerous software which can really help your
hotel to gain new customers and facilitate seamless
activities.

Technology has really changed the hotel industry.

There were days when there was no reliability or
guarantee on an arrival – guest, and when they arrive, they will stay if there was a room or else they
are gone. This seriously hampers the business in the long run when the guests start assuming that
your hotel would be fully occupied. So rather coming to you, they go to check different hotels for the
rooms. Now, to avoid such scenario in the current market scene, it is important to use the latest
technology which helps you to provide an actual status of your hotel to the customer before they plan
or leave their homes.

The digital revolution has really come off age with the latest online reservation solutions. Today the
guests can book their rooms by using their iPad or mobile phone months in advance or while moving.

As a hotel owner you are required to consider the changes. You cannot escape the digitalization of
the business processing; it helps in the long run strategy and planning. This revolution opens multiple
distribution channels for the hotels which allow the hotels to increase their visibility on the internet
among the online users. There are a number of blogs, websites, review sites which helps the hotels
to grow on the internet.

For anyone to understand the advantages of online reservation, he/she should look into the facts that
nowadays people are more likely to book and reserve rooms online than travel agents. It is a lot
cheaper in comparison to the services of the travel agents.

Distribution channel for hotels is an approach currently accepted by most of the hotels for an
aggressive sales and distribution purpose. The matter of the fact is that the ultimate goal of the hotels
are to create better visibility on all distribution channels so that customers can find them easily and
book a room.
Having a better distribution channel for hotels will mean that you can enhance your reputation
among the users and guests. But it requires a better management to handle the online distribution
channels.
A lot of hotels rely on the distribution channels to set their pricing after looking at their competitors.
This can be misleading. The guests always pay for the services that you are offering than the price
you have placed for things that doesn’t interest him/her. So maintenance of standard of services will
increase customers than the emphasis on pricing. The distribution channels for hotels allow the
hoteliers to earn from direct sales.
An effective management of distribution channel for hotels require an eye on the reviews and
optimization of the hotel on the internet.

Other Inventory Management Strategies

Optimization Models
Optimization models of supply chain are those models that codify the practical or real life issues into
mathematical model. The main objective to construct this mathematical model is to maximize or
minimize an objective function. In addition to this, some constraints are added to these issues for
defining the feasible region. We try to generate an efficient algorithm that will examine all possible
solutions and return the best solution in the end. Various supply chain optimization models are as
follows −

Mixed Integer Linear Programming

The Mixed integer linear programming (MILP) is a mathematical modeling approach used to get the
best outcome of a system with some restrictions. This model is broadly used in many optimization
areas such as production planning, transportation, network design, etc.
MILP comprises a linear objective function along with some limitation constraints constructed by
continuous and integer variables. The main objective of this model is to get an optimal solution of the
objective function. This may be the maximum or minimum value but it should be achieved without
violating any of the constraints imposed.
We can say that MILP is a special case of linear programming that uses binary variables. When
compared with normal linear programming models, they are slightly tough to solve. Basically the
MILP models are solved by commercial and noncommercial solvers, for example: Fico Xpress or
SCIP.

Stochastic Modeling
Stochastic modeling is a mathematical approach of representing data or predicting outcomes in
situations where there is randomness or unpredictability to some extent.
For example, in a production unit, the manufacturing process generally has some unknown
parameters like quality of the input materials, reliability of the machines and competence within the
employees. These parameters have an impact on the outcome of the manufacturing process but it is
impossible to measure them with absolute values.
In these types of cases, where we need to find absolute value for unknown parameters, which cannot
be measured exactly, we use Stochastic modeling approach. This modeling strategy helps in
predicting the result of this process with some defined error rate by considering the unpredictability of
these factors.
Uncertainty Modeling
While using a realistic modeling approach, the system has to take uncertainties into account. The
uncertainty is evaluated to a level where the uncertain characteristics of the system are modeled with
probabilistic nature.
We use uncertainty modeling for characterizing the uncertain parameters with probability
distributions. It takes dependencies into account easily as input just like Markov chain or may use the
queuing theory for modeling the systems where waiting has an essential role. These are common
ways of modeling uncertainty.

Bi-level Optimization
A bi-level issue arises in real life situations whenever a decentralized or hierarchical decision needs
to be made. In these types of situations, multiple parties make decisions one after the other, which
influences their respective profit.
Till now, the only solution to solve bi-level problems is through heuristic methods for realistic sizes.
However, attempts are being made for improving these optimal methods to compute an optimal
solution for real problems as well.

Assessment
Test I. Briefly answer the following: (5pts each)

1. Define inventory management. Explain its importance in the hospitality industry.

2. What will be the result of  the hotel has  better distribution channels?

Test II. Compute for the following (show your solution, 5pts)

1. For the year ending December 2020, in the restaurant reported cost of good sold of the PHP 156,200 and
average  inventory of 5,252 units which cost PHP 26,330. Compute for the annual rate  of stock turnover (in
pesos).
2. Mckenly ,a fast-food restaurant, needs to find when it should place orders for specific food product from its
manufacturer. Compute for the Reorder Point using the following relevant information:
- Average usage-500 units per day
- Average Lead Time: 25days
- Safety Stock-250 units
- EOQ- 35,000
3. The demand for special Bulalo at Bami’s Restaurant is 120,000 servings per year. Bami incurs a
fixed ordering cost of PHP60.00 each time an order is placed. The carrying coast of each unit of
a product is PHP10.00. Compute for the economic order quantity.