C HAPTER 8 I NVENTORY M ANAGEMENT Accounting and Finance for Entrepreneurs FINANCE 292

I NVENTORY M ANAGEMENT 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

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

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

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

I NVENTORY C ONTROL 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

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

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.

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.

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?