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CORPORATE FINANCE

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ABHIJEET CHANDRA
Vinod Gupta School of Management, IIT KHARAGPUR

Lecture 32: Inventory Management - III

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⮚ Re-order Point

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⮚ Inventory management analysis

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Order Point: When to Order?
• In addition to knowing how much to order, the firm also needs to
know when to order.
• The quantity to which inventory must fall in order to signal a reorder of
the EOQ amount

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• Earlier assumed that inventory can be ordered and received
without delay.

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• Time lapse between placement of a purchase order and receipt of the

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inventory, or in the time it takes to manufacture an item after an order is
placed.
• This lead time must be considered.
Re-order Point: Certainty
• The point where the order for next lot should be placed, to avoid production
hurdles and delays.
• When there is certainty about demand and supply: Order point (OP) = Lead
time × Daily usage

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Re-order Point: Certainty
Example:
• EOQ: 200 units
• Order frequency: 10 days

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• Lead time: 0 day (assumed)

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• Daily usage: 20 units

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Now, revise the assumption that 5 day lead period is required before it runs
out of stock:
• The Order Point = 5 days x 20 units = 100 units
Order Point

Units

200

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EOQ
100

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5 10 20 Days

Lead
time
Re-order Point: Uncertainty
• The point where the order for next lot should be placed (in case of uncertain scenario)
• Reorder point = (Lead time x average usage) + safety stock

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Other Inventory Control System
• Just-in-Time (JIT) Systems
• Out-sourcing
• IT/ITeS firms providing inventory management services
Computerized Inventory Control System

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•

• Sophisticated software, e.g. PosMaid, inFlow, BS1

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• Help run lean operations

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• Strengthen vendor relationship
• Forecast with confidence
• Timely information and insights
Inventory Management: Analysis
• Estimation of incremental operating profit
• Estimation of incremental investment in inventory
• Estimation of the incremental rate of return (IRR)

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Comparison of the incremental rate of return with the required rate

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•

of return (RRR)

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• Optimum inventory:
• IRR = RRR
Inventory Management Decisions: CBA
• Costs-Benefits Analysis: Trade-off
• Smaller the inventory, lower the costs; but production/sales delays!
• Higher the inventory, smoother the operations; but higher costs as well!

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Costs Benefits

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• Ordering/acquisition costs • Uninterrupted and
• Carrying costs independent operation:
• Arising due to inventory • Purchasing

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storage • Production
• Opportunity costs of • Selling
funds
Inventory Management: Process
• Explicitly state the inventory policy
• Create an inventory monitoring cell
• Management group for controlling purchases

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• Periodic meetings between purchase, materials planning and production

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executives

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• Monthly reviews of total inventory at plant/corporate level
• Dovetail inventory control to the total budgeting system
• Identify critical inventory items for closer scrutiny
CONCLUSION

• Inventory management is a continuous exercise in a company, where

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• Re-order level is the point where the order for next lot of inventory

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shall be
placed.

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• Management of inventory is a tool to enhance value of the firm by way of
reducing the working capital requirements.
REFERENCES

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⮚ Corporate Finance, 2nd ed. (2012), Clayman et al. Wiley

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⮚ Financial Management, 14th ed (2021), Pandey, Pearson

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