chapter 5 financial impact of inventory. copyright © 2001 by the mcgraw-hill companies, inc. all...

CHAPTER 5

Financial Impact of Inventory

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

5-2Selected Financial Data for Manufacturers, Wholesalers, and Retailers for 1997 ($Millions)

Companies Sales Net Profits Net Profits as a Total Assets Inventory Investment Inventories as a

Percent of Sales Percent of Assets

Manufacturers

Abbott Laboratories $11,883 $2,094 18% $12,061 $1,280 11%

Borden, Inc. 1,488 221 15% 2,206 302 14%

The Clorox Company 2,741 298 11% 3,030 212 7%

Dresser Industries, Inc. 7,458 318 4% 5,099 972 19%

Ford Motor Company 153,627 6,920 5% 279,097 5,468 2%

General Electric Company 90,840 8,203 9% 304,012 5,895 2%

General Mills 6,033 422 7% 3,861 389 10%

Goodyear Tire & Rubber Co. 13,065 559 4% 9,917 1,835 19%

Harris Corp. 3,939 133 3% 3,784 604 16%

Honeywell Co. 8,028 471 6% 6,411 1,028 16%

NCR Corp. 6,598 7 0.11% 5,293 489 9%

Newell Co. 3,234 290 9% 3,944 625 16%

Pfizer, Inc. 12,188 2,213 18% 15,336 1,773 12%

Sara Lee Corp. 20,011 (523) -3% 10,989 2,882 26%

Xerox Corp. 18,166 1,452 8% 27,732 2,792 10%

Wholesalers and Retailers

Baxter International 6,138 300 5% 8,707 1,208 14%

Bergen Brunswig Corp. 11,661 82 1% 2,707 1,309 48%

Dayton Hudson Corp. 27,757 751 3% 14,191 3,251 23%

Fleming Companies, Inc. 15,372 25 0.16% 3,924 1,019 26%

Kmart Corporation 32,183 249 1% 13,558 6,367 47%

Nordstrom 4,852 186 4% 2,865 826 29%

Sears, Roebuck & Company 41,296 1,188 3% 38,700 5,044 13%

Supervalu Inc. 17,201 231 1% 4,093 1,116 27%

Wal-Mart Stores, Inc. 117,958 3,526 3% 45,384 16,497 36%

Winn-Dixie 13,219 204 2% 2,921 1,249 43%

Note: Ending inventory figures are used for inventory investment. All figures are for 1997.


5-3Cost Trade-offs in Marketing and Logistics

Product

Order processing and information

costs

Inventory carrying costs

Place/customer service levels

Order processing and information

costsPrice

Lot quantity costs Warehousing costs

Transportation costs

LO

GIS

TI C

SM

AR

KE

TIN

G


5-4Components of Inventory Carrying Costs

• Capital

• Inventory service

• Storage space

• Inventory risk


5-5Inventory Positions in the Manufacturer’s Logistics System

Finished goodsinventoryin field

Finished goodsinventoryat plant

Rawmaterialsinventory

In-processinventory

Assumptions: A one-time increase (decrease) in finished goods inventory results in a one-time increase (decrease) in raw materials purchased.


5-6Normative Model of Inventory Carrying Cost Method

Inventorycarrying

costs

Inventory investment

Insurance

Taxes

Obsolescence

Pilferage

Storagespace costs

Capitalcosts

Inventoryservicecosts

Inventoryrisk costs

Plant warehouses

Public warehouses

Rented warehouses

Company-owned warehouses

Damage

Relocation costs


5-7Adjusting the Cost of Money to Fit the Method of Inventory Valuation

One Method

Another method

Inventory at full costVariable cost is 80% of full costInventory at variable costCost of money before tax is 30%Cost of money associated with theinventory investment

$10,000,000 x 80%

$8,000,000 x 30%

$2,400,000

Cost of money before taxVariable cost is 80% of full costInventory at full costAdjusted cost of moneyCost of money associated with theinventory investment

30% 80%$10,000,000 x 24%

$2,400,000


5-8

StepNo Cost Category Source Explanation Amount (Current Study)1. Cost of Money Comptroller This represents the cost of having money invested

in inventory and the return should be comparable toother investment opportunities.

30% pretax

2. Averagemonthlyinventory valuedat variable costsdelivered to thedistributioncenter

1. Standard cost data -- comptroller'sdepartment

2. Freight rates and product specs are from distribution reports

3. Average monthly inventory in casesfrom printout received from salesforecasting

Only want variable costs since fixed costs go onregardless of the amount of product manufacturedand stored -- follow steps outlined in body of report.

$7,800,000 valued at variable costdelivered to the D.C. (Variablemanufactured cost equaled 70% offull manufactured cost. Variablecost FOB the DC averaged 78% offull manufactured cost)

3. Taxes The comptroller's department Personal property taxes paid on inventory $90,948 which equals 1.17%4. Insurance The comptroller's department Insurance rate/$100 of inventory (at variable costs) $4,524 which equals 0.06%5. Recurring

storage (publicwarehouse)

Distribution operations This represents the portion of warehousing coststhat are related to the volume of inventory stored.

$226,654 annually which equals2.89%

6. Variable storage(plantwarehouses)

Transportation services Only those costs that are variable with the amountof inventory stored should be included.

Nil

7. Obsolescence Distribution department reports Cost of holding product inventory beyond its usefullife

0.80% of inventory

8. Shrinkage Distribution department reports Requires managerial judgment to determine theportion attributable to inventory storage. $100,308 which equals 1.29%

9. Damage Distribution department reports Requires managerial judgment to determine theportion attributable to inventory storage.

10. Relocation costs Not available Only relocation costs incurred to avoidobsolescence should be included.

Not available

11. Total carryingcosts

Calculate the numbers generated in steps3, 4, 5, 6, 8, 9 and 10 as a percentage ofaverage inventory valued at variable costdelivered to the distribution center and addthem to the cost of money (step 1).

36.21%

© Douglas M. Lambert

Summary of Data Collection Procedure


5-9

123456789

101112131415

$750,000375,000250,000187,500150,000125,000107,143

93,75083,33375,00068,18262,50057,69253,57150,000

$300,000150,000100,000

75,00060,00050,00042,85737,50033,33330,00027,27325,00023,07721,42820,000

$150,00050,00025,00015,00010,000

7,1435,3574,1673,3332,7272,2731,9231,6491,428

InventoryTurns

AverageInventory

Carrying Costat 40 Percent

Carrying CostSavings

The Impact of Inventory Turns on Inventory Carrying Costs


5-10Relationship Between Inventory Turns and Inventory Carrying Costs

Inventory Turns

$300,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

$250,000

$200,000

$175,000

$150,000

$125,000

$100,000

$75,000

$50,000

$37,500$25,000

0

Inventory carrying costs

$225,000

$275,000

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.


5-11Annual Inventory Carrying Costs Compared to Inventory Turnovers

Variable Manufacturing CostCarrying Cost %Annual Cost to Carry in InventoryMonthly Cost (1/12)

$100x 30%$30

$2.50

Inventory Turns

Inventory carrying costs (per unit)

1 2 3 4 5 6 7 8 9 10 11 1 2

15.00

12.50

10.00

7.50

5.003.752.50

0

$30.00

6.00


5-12Inventory Positions and Major Flows in a Supply Chain

Variable costof product

Full manufac-tured cost

Sellingprice

$5

$7

$10

Variable costof material

Acquisitioncost

Other variablecosts

Total variablecost of product

Full manufac-tured cost

Sellingprice

$10

$1

$14

$25

$40

$60


Other acquisitioncosts

Sellingprice

$60

$2

$70


Other acquisitioncosts

Sellingprice

$70

$2

$120

Suppliers Wholesalers RetailersManufacturer

Orders

Payments

Information

Product

Orders

Payments

Information

Product

Orders

Payments

Information

Product

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.

chapter 5 financial impact of inventory. copyright © 2001 by the mcgraw-hill companies, inc. all...

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