Inventory management, EOQ and creditor management

Inventory is stock — raw materials, work in progress, finished goods and supplies — and it ties up large amounts of the firm's resources: cash that could otherwise be earning elsewhere. Treasury's goal is the optimum level, where the benefits of holding stock less the costs of doing so are at their maximum.

The trade-off runs through everything in this step. Hold more finished goods and you gain flexibility — you fill customer orders without waiting for production — but you pay storage, capital and obsolescence costs. Hold too little and you lose sales you could not supply.

Inventory must be financed, and there are five main methods, running roughly from cheapest and most automatic to most structured.

Trade credit is the least expensive: as you buy goods the supplier allows you time to pay, typically 30–60 days. It is spontaneous finance — it rises and falls with your inventory levels without anyone applying for it. Supply chain financing goes a step further: the seller arranges finance for the buyer against purchase orders from large buyers, the seller gets a lower rate because the large buyer effectively guarantees the order, and the buyer keeps the debt off its balance sheet.

• Collateralised loans — inventory serves as collateral; the bank lends a set percentage of its value, typically 50–80%.
• Asset-based loans — the lender advances against inventory value rather than the company's financial strength, taking physical possession (public or field warehouse) on default.
• Floor planning — for high-value durables like vehicles and heavy equipment: the lender finances individual items by serial number, and each loan is repaid when its item sells.

The pattern to remember: the weaker the borrower's own credit, the more the financing leans on the inventory itself — from unsecured trade credit at one end to the lender holding the keys to a warehouse at the other.

JIT minimises inventory by receiving materials just in time to use them, not weeks before. Purchasing under JIT aims at a reduction of raw material stock through frequent deliveries of smaller orders from fewer suppliers, held together by long-term contracts that make schedules predictable — with quality assurance shifted to the supplier, who inspects before shipping rather than the buyer after receiving.

JIT production applies the same idea inside the factory: low-cost, high-quality, on-time production to order, achieved by minimising idle stock between processes.

• Lower inventory means lower storage and capital costs.
• Savings in storage space and handling.
• Better quality and customer satisfaction — eliminating waste exposes defects early.
• Weaknesses become visible — bottlenecks, unreliable suppliers and documentation gaps can no longer hide behind buffer stock.
• Flexibility to supply small batches as demand varies.

The catch is that JIT replaces buffer stock with dependence on delivery reliability. For a Zambian manufacturer, the two practical barriers are exactly there: transport infrastructure that makes frequent small deliveries unreliable, and a thin supplier base that leaves few alternatives when one fails. A JIT programme in that environment starts with supplier development and dual sourcing, not with cutting the stock.

EOQ is the quantity to order each time that minimises total inventory cost. Total cost is the sum of ordering costs and holding costs, and they pull in opposite directions: bigger orders mean fewer orders (ordering cost falls) but more stock sitting in the warehouse (holding cost rises). EOQ is the point where the two balance.

The lecture's example: XYZ Ltd needs 1,000 units of material X a month, each order costs ZMW 30 to place, and holding costs ZMW 2.88 per unit per year. Annual demand is 12,000 units, so EOQ = √(2 × 12,000 × 30 ÷ 2.88) = √250,000 = 500 units.

XYZ should order 500 units at a time — 24 orders a year, one roughly every 15 days. Order more and holding costs dominate; order less and ordering costs do. The exam asks for any of the three numbers, so know the follow-on divisions as well as the square root.

Trade credit is normally viewed as a free source of finance, and the standard treasury policy is to pay suppliers as late as possible while honouring your obligations and keeping the relationship sound. Every extra day of payables shortens the cash conversion cycle and cuts the working capital the business must fund.

Creditor management mirrors debtor management — the same metrics run in reverse. But "as late as possible" has a limit that the formula does not show: delay payment too long and cash-strapped suppliers struggle and can ultimately fail, threatening the supply chain your production depends on. A supplier driven under by your payment terms is not a financing win.