Chapter 6 Managing Inventories

Management Difficulties  Hard to measure and value  The value may change  Subject to fraud  Hidden costs  Physical count

Fraudulent Inventory Practices  Leave higher cost in inventory – sell the cheaper costing product first  Damaged goods labeled as work in progress  Obsolete inventory kept at full cost  Moving inventory and counting twice  Contents of boxes mislabeled

Most Inventory Problems  Management buys or produces too much of the wrong merchandise at the wrong price.  Operations Manager’s Job

The Operation Perspective  Production Process Continuous production  Raw material is consistent  Little work in progress (no inventory)  But what happens if demand falls  And what happens if demand rises Project production  No finished goods  Immediate delivery  Easily controlled raw materials

The Operation Perspective Job-shop production  Product made to order  Short production period Assembly Line Production  Inventory is based on the product

The Tradeoffs  Too much inventory means Funds are tied up Storage expenses Handling expenses Damaged inventory Vulnerable to theft Physical Obsolescence (Spoilage) Economic Obsolescence

Financial Perspective  Volatile Demand – Greater loss potential Build to order Divide into components (Integrate) Increase capacity when needed

Financial Perspective  Seasonal Demand Give incentives for early sales (Dating)  Customer commitment  Warehouse filled with your product and not the competitions  Less storage for your inventory  Less Product handling  Better loan credentials

Financial Perspective  Stable Demand Even if seasonal can it be predicted and aligned with production Some products can be stored cheaper than offering incentives Increased demand is usually not a serious problem

Financial Perspective  Inventory Reduction Sell the inventory Give away inventory for tax benefit Sell inventory at discount Cut production rate for next year

Financial Perspective  Building to order or speculation Avoids work in progress Can offer a build and hold plan  Watch encumbered accounts Get deposit or letter of intent to purchase Make production timelines from realistic sales estimates

Managerial Decisions  Offer build and hold instead of discount  Determine how far in advance to produce orders  Sell as a pseudoconsignment  Managing pipeline inventory Understand the initial stocking of new products

Inventory Valuation  Average Cost Method  LIFO (Last In First Out)  FIFO (First In First Out)

Average Cost Method  Seldom Used  Total cost of goods in inventory are summed and averaged to give a cost of goods value  No real value for this method

FIFO  First Inventory purchased is assigned to cost of goods sold  More recent purchases are applied to the inventory values  Decrease cost of Goods  Increase inventory value  Increase profit =higher taxes  Most accurate for real life experience

LIFO  Most recent inventory costs become cost of of goods sold  Older purchases are assigned to inventory  Higher cost of goods  Decrease Inventory value  Decrease Profits = lower taxes

How they compare UnitsPriceAverageLIFOFIFO First Inventory1000 Second Inventory Third Inventory Fourth Inventory Total Inventory Sales $1.50$1,500 Cost of Goods Gross Profit$425$350$500 Starting Inventory4300 Less COGS Ending Inventory