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• Module overview
• 1. Introduction to budgets
  • 1.1 Introduction to the Budget Process
  • 1.2 Budget types
    • 1.2.1 The Budget Guidelines
    • 1.2.2 The Sales Budget
    • 1.2.3 Budget for Operating Expenses
    • 1.2.4 Profit Budget
    • 1.2.5 Cash-Flow Budget
    • 1.2.6 The Financial Position Budget
    • 1.2.7 Additional Types of Budgets
    • 1.2.8 Additional Budgeting Techniques
  • 1.3 The budget process and its objectives
  • 1.4 Budgets for performance management
    • 1.4.1 Master budget

• 2. Planning the budget

  • 2.1 Planning the Budget
    • 2.1.1 Business income
    • 2.1.2 Visual representation of sales and budgets
    • 2.1.3 The break-even point
    • 2.1.4 Contribution margin

• 3. Controlling the budget

  • 3.1 Controlling budgets
    • 3.1.1 Variance analysis
    • 3.1.2 Taking action to achieve the objectives of the budget
    • 3.1.3 Resource acquisition and usage

• 4. Introduction to Financial Management

  • 4.1 Business Objectives
    • 4.1.1 Maximising profit
    • 4.1.2 Maximising wealth
  • 4.2 Ethics and conflicts in business
    • 4.2.1 The dilemma of ethics in finance, investment and accounting
  • 4.3 Financial Managers
    • 4.3.1 Financial information and objectives
    • 4.3.2 Accounting, the financial information system
  • 4.4 The finance function
    • 4.4.1 Business and financial calculations

• 5. Elements of Business and Financial Management

  • 5.1 Business Structures
    • 5.1.1 Sole proprietors
    • 5.1.2 Partnerships
    • 5.1.3 Corporations and companies
  • 5.2 Reporting financial data and information
  • 5.3 Financial reports
    • 5.3.1 Statement of financial performance (profit and loss statement)
  • 5.4 Capital Markets
    • 5.4.1 Capital Markets
  • 5.5 Regulation and financial institutions
    • 5.5.1 Interest rates, supply and demand and market efficiency
  • 5.6 An overview of taxation implications

• 6. Obtaining Funds: Sources of Long Term and Short Term Finance

  • 6.1 Finance from external sources
    • 6.1.1 Equity finance
  • 6.2 Debt
  • 6.3 Long-term debt
    • 6.3.1 Debentures and unsecured notes (bonds)
    • 6.3.2 Mortgage loans
  • 6.4 Hybrids of debt and equity
  • 6.5 Leasing
    • 6.5.1 Operating Lease
    • 6.5.2 Financial Lease
    • 6.5.3 Distinguishing between an operating lease and a financial lease
    • 6.5.4 Sale and Leaseback
    • 6.5.5 The issue of gearing
  • 6.6 Short-term debt
    • 6.6.1 Bank Overdrafts
    • 6.6.2 Fully drawn advance
  • 6.7 Retained Earnings, internal funds and depreciation

• 7. Managing Working Capital

  • 7.1 Managing current assets and current liabilities
    • 7.1.1 Appropriate level of working capital
  • 7.2 Managing inventories
    • 7.2.1 Reasons for holding inventories
    • 7.2.2 The economic order quantity (EOQ)
    • 7.2.3 Re-order point (ROP)
    • 7.3.4 Safety stock (SS)
    • 7.2.5 Quantity discounts
  • 7.3 Managing trade debtors (accounts receivable)
    • 7.3.1 Credit policies
    • 7.3.2 Collection period
    • 7.3.3 Managing cash and near-cash assets
    • 7.3.4 Managing trade creditors (accounts payable)

• 8. Job Costing

  • 8.1 Accounting information about product, service and project costs
    • 8.1.1 Full costing
    • 8.1.2 Single product/service line
    • 8.1.3 Multi product/service
    • 8.1.4 Direct and indirect costs
  • 8.2 How costs behave
    • 8.2.1 Allocating Overheads
  • 8.4 Cost drivers
    • 8.4.1 ABC and the service industry
  • 8.5 Conclusion

7.2.4 Safety stock (SS)

To safeguard against unforseen events that could cause the firm to run out of inventory and lose sales, some minimum level of inventory (inventory is also called 'stock') must be kept. Without perfect knowledge about demand patterns or re-order lead-times, it is difficult to decide on a re-order point. The answer is to hold a certain level of safety stock, which reduces the risk of running out of inventory. The larger the safety stock held the lower the risk of running out of stock.

Safety stock levels are usually established by management policy. Such a policy decision considers the degree to which back ordering is acceptable to its customers and the loss of goodwill (in sales forgone) that could arise through an out-of-stock condition. In this case safety stock levels are set by the rate of demand for a product.

Note re-order point calculations are affected by the amount of safety stock held. Under such conditions, the re-order point will be the safety stock plus the demand during lead-time.

Example

You are asked to advise management on its current inventory management policy. Management provides the following information about one of its top-selling items.

• The annual demand is 9000 units and the current policy places an order for 750 units on the first day of each month
• The cost per unit is $12.00
• Company sales records show that demand is uniform over time
• The ordering costs are $80 per order and the annual holding costs are estimated to be 25% of the average cost of inventory held (carried)
• The company has good relationships with its suppliers and can reasonably expect any of its orders to be filled within 6 working days
• The company holds a minimum safety stock level to cover demand for a 5 work ing-day period. Assume 250 working days per year.

1. What is the total relevant cost of the current inventory policy? (Remember to include safety stocks)
2. What is the economic order quantity?
3. What will be the total relevant cost (including safety stocks) if the company uses the economic order quantity?
4. What is the re-order point?

Answers

1. Total relevant cost
   Safety stock = (demand per day) x safety period = (9000/250)5 days = 36 x 5 = 180 units
   
   average inventory = safety stock + (order quantity/2) = 180 + (750/2) = 180+ 375 = 555 units
   
   annual holding costs = average inventory x H = 555 x (25% x $12) = 555 x 3 = $1665
   
   annual order costs = orders per year x OC = 12 x $80 = $960
   
   total relevant cost (including safety stock) = annual holding costs + annual order costs = 1665 + 960 = $2625 per annum
   
2. Economic order quantity
   EOQ = 2DC = 2 x 9000 x 80 = 480 000 = 693 units per order H 3
   
   
3. Total relevant costs for EOQ (including safety stocks)
   TRC = (O x EOQ) + (CHx SS) = (3 x 693) + (3 x 180) = $2619
   
   
4. Re-order point (ROP)
   ROP = SS + (demand during lead-time) = 180 x (36 x 6) = 396 units

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