Chapter 8 Inventory Management

1. Chapter 8Inventory Management Accounting and Finance for Entrepreneurs FINANCE 292

2. Inventory Management • Inventory investment is the single most costly item of current asset investment in terms of acquisition, storage, and accountability. • Half of all Current Assets on average • Carry costs as high as 15 to 20% • Technology goods have short lives • Least liquid asset; requires the most planning

3. Rationales for Inventory • Inputs for Production • Raw materials • Parts and OEM assemblies • Administrative Support • Paper and Paper Forms • Computer Supplies: disks • Routine maintenance • Goods to Sell

4. Rationales for Inventory • Achieve economies of Scale • Better to buy in quantity – lower cost per unit • Achieve efficient transformation processes • Front-loading the production process • Separate Production and Consumption • Production: making and distributing • Consumption: acquisition and use • Hedge against supply interruptions • Production stoppage due to strikes, weather

5. Valuation of Inventory • Inventories are carried at cost • Does not include transportation and storage cost • Does not include insurance or shrinkage • Does not include technological obsolescence • Does include any labor added to increase utility

6. Inventory Control • Non-sales Related • EOQ (Economic Order Quantity) • Sales Related • MRP (Materials Requirements Planning) • JIT (Just in time) • Kanban (“empty” bin) • Perpetual Inventory Systems • Use of scan codes to update inventory records

7. Inventory Accounting Methods • The impact of Inflation and Turnover • Turnover: a measure of how quickly inventory is acquired and sold to customers. • The faster the turnover, the less the impact of inflation on computing the cost of goods sold. • FIFO (first in first out) is the preferred method • The slower the turnover, the greater the impact of inflation on computing the cost of goods sold. • LIFO (last in first out) is the preferred method

8. Hedging Adverse Movements in Price • Industrial Commodities; Gold, Silver, Copper • Using futures to hedge against adverse price movement before we make our purchases or sales • Futures Sales of On hand Inventories • Worry is that prices will drop – resulting in loss of profits • Hedge the possibility of lower prices by using a “short” hedge.

9. Hedging Adverse Movements in Price • Need to buy resupply in the future • Worry is that prices will rise – increasing acquisition costs • Hedge the possibility of higher prices by using a “long” hedge. • Short Hedges earn profits when prices decline. Long Hedges earn profits when prices increase. Profits help to offset effects of adverse price movements.

10. Homework Questions • 1. What are the types of carrying costs? How can they be controlled? • 2. How does the carry cost (c) affect the economic order quantity? • 3. How does the fixed ordering cost (F) affect the economic order quantity? • 4. How does the unit price (P) affect the economic order quantity? • 5. Set up an interview with one of the following and determine what special problems they have with inventory management: • a. The produce department of a super market. • b. A gift or novelty shop. • c. An automotive repair business. • d. A small machine shop. • e. A university book store. • 6. What assumption underlies the EOQ Model?