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

Units Price Average LIFO FIFO

First Inventory 1000 1000

Second Inventory 1000 1050

Third Inventory 1000 1100

Fourth Inventory 1000 1150

Total Inventory 4000 4300

1075

Sales 1000 @ $1.50 $1,500 $1,500 $1,500

Cost of Goods 1075 1150 1000

Gross Profit $425 $350 $500

Starting Inventory 4300 4300 4300

Less COGS 1075 1150 1000

Ending Inventory 3225 3150 3300