CHAPTER 5 Financial Impact of Inventory

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-2 Selected Financial Data for Manufacturers, Wholesalers, and Retailers for 1997 ($Millions) Note: Ending inventory figures are used for inventory investment. All figures are for 1997.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-3 Cost Trade-offs in Marketing and Logistics Product Order processing and information costs Inventory carrying costs Place/customer service levels Order processing and information costs Price Lot quantity costsWarehousing costs Transportation costs LOGISTICS MARKETING

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-4 Components of Inventory Carrying Costs Capital Inventory service Storage space Inventory risk

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-5 Inventory Positions in the Manufacturer’s Logistics System Finished goods inventory in field Finished goods inventory at plant Raw materials inventory In-process inventory Assumptions: A one-time increase (decrease) in finished goods inventory results in a one-time increase (decrease) in raw materials purchased.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-6 Normative Model of Inventory Carrying Cost Method Inventory carrying costs Inventory investment Insurance Taxes Obsolescence Pilferage Storage space costs Capital costs Inventory service costs Inventory risk costs Plant warehouses Public warehouses Rented warehouses Company-owned warehouses Damage Relocation costs

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-7 Adjusting the Cost of Money to Fit the Method of Inventory Valuation One Method Another method Inventory at full cost Variable cost is 80% of full cost Inventory at variable cost Cost of money before tax is 30% Cost of money associated with the inventory investment $10,000,000 x 80% $8,000,000 x 30% $2,400,000 Cost of money before tax Variable cost is 80% of full cost Inventory at full cost Adjusted cost of money Cost of money associated with the inventory investment 30% 80% $10,000,000 x 24% $2,400,000

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-8 © Douglas M. Lambert Summary of Data Collection Procedure

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin $750, , , , , , ,143 93,750 83,333 75,000 68,182 62,500 57,692 53,571 50,000 $300, , ,000 75,000 60,000 50,000 42,857 37,500 33,333 30,000 27,273 25,000 23,077 21,428 20,000 $150,000 50,000 25,000 15,000 10,000 7,143 5,357 4,167 3,333 2,727 2,273 1,923 1,649 1,428 Inventory Turns Average Inventory Carrying Cost at 40 Percent Carrying Cost Savings The Impact of Inventory Turns on Inventory Carrying Costs

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-10 Relationship Between Inventory Turns and Inventory Carrying Costs Source: Douglas M. Lambert, and Robert H. Quinn, “Profit Oriented Inventory Policies Require a Documented Inventory Carrying Cost,” Business Quarterly 46, no. 3 (Autumn 1981), p.65.

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-11 Annual Inventory Carrying Costs Compared to Inventory Turnovers Variable Manufacturing Cost Carrying Cost % Annual Cost to Carry in Inventory Monthly Cost (1/12) $100 x 30% $30 $2.50 Inventory Turns Inventory carrying costs (per unit) $

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin 5-12 Inventory Positions and Major Flows in a Supply Chain Source: Adapter from Douglas M. Lambert, and Mark L. Bennion, “New Channel Strategies for the 1980’s,” in Marketing Channels: Domestic and International Perspectives, ed. Michael G. Harvey and Robert F. Lusch (Norman: Center for Economic and Management Research, School of Business administration, University of Oklahoma, 1982), p. 127.