Formulas to Know: Average Inventory

Month 1 + Month 2 + Month 3 Number of months

Product Product Product Product Product Inventory valued at $1,000,000

Product Product Product Product Sales = $1,000,000 We sell a million dollars worth of product out the door…

Product Product Product Product Product Sales = $1 MM And replace it with…

And replace it with… Product Product Product Product Product Sales = $1 MM Product Product Product Product Product New inventory valued at $1,000,000

Product Product Product Product Product Sales = $1 MM Product Product Product Product Product Inventory valued at $1,000,000 We have turned over our inventory one time.

Net sales_______ = $1,000,000 Average inventory at retail = $1,000,000 = 1

Product Product Product Product Product Sales = $1 MM Product Product Product Product Product Inventory valued at $1,000,000 We have turned over our inventory one time.

Net sales_______ = $1,000,000 Average inventory at retail = $1,000,000

Product Product Product Product Product Sales = $1 MM Product Product Product Product Product

Average

inventory valued at $1,000,000 However, it is

average

inventory.

Net sales_______ = $1,000,000

Average

inventory at retail = $1,000,000

Product Product Product Product Product Product Product Product Product Product Sales = $2 MM Product Product Product Product Product Average inventory valued at $1,000,000

Net sales_______ = $2,000,000

Average

inventory at retail = $1,000,000

Product Product Product Product Product Product Product Product Product Product Sales = $2 MM Product Product Product Product Product

= 2 inventory turns

Average inventory valued at $1,000,000

Net sales_______ = $2,000,000

Average

inventory at retail = $ 500,000

Product Product Product Product Product Product Product Product Product Product Sales = $2 MM Product Product Average inventory valued at $500,000

Net sales_______ = $2,000,000

Average

inventory at retail = $ 500,000

Product Product Product Product Product Product Product Product Product Product Sales = $2 MM Product Product Average inventory valued at $500,000

Net sales_______ = $2,000,000

Average

inventory at retail = $ 500,000

Product Product Product Product Product Product Product Product Product Product Sales = $2 MM Product Product

= 4 inventory turns

Average inventory valued at $500,000

Net sales_______ = $2,000,000

Average

inventory at retail = $ 500,000

Product Product Product Product Product Product Product Product Product Product Sales = $2 MM Product Product

= 4 inventory turns

Average inventory valued at $500,000 We have kept sales levels up, using less average inventory.

PPT 12-6

Gross Margin %, Inventory Turnover, & GMROI for Selected Department in Discount Stores

Inventory Turnover Part Two

Logistics and Supply Chain Management

PPT 12-9

Advantages of Rapid Turnover

• Increased sales volume • Less risk of obsolescence and markdowns • Money for market opportunities • Decreased operating expenses • Increased asset turnover

PPT 12-10

Disadvantages of Rapid Rate of Turnover

• Lowered sales volume.

• Increased cost of goods sold.

• Increase logistics costs: expanded buying and ordering time.

Inventory Carrying Costs

• Capital costs on inventory investment.

• Inventory service costs.

• Storage space costs.

• Inventory risk costs.

Capital Costs on Inventory Investment.

• Opportunity cost of capital: rate of return if money were invested elsewhere.

• Hurdle rate: minimum rate of return on new investments.

--Can we make more money earning interest in marketable securities?

--Can we make more money retiring debt, thus eliminating interest charges?

Capital Costs on Inventory Investment - Cash Value of Inventory • Manufacturers: --Direct costs: fixed/variable determined and only variable costs counted.

--Absorption (full costing) fixed overhead is calculated in inventory value.

• Wholesalers and retailers: --Replacement cost (plus freight).

--Market price if product phased out.

Inventory Service Costs

• Taxes --Ad valorem (personal property) taxes.

--Vary with size of inventory.

• Insurance --Somewhat fixed.

Storage Space Costs

• Plant warehouses. Fixed costs (except for variable throughput costs).

• Public warehouses.

• Rented or leased warehouses.

• Company-owned warehouses.

Inventory Risk Costs

• Obsolescence costs.

• Damage costs.

• Shrinkage costs.

• Relocations costs (transshipped to another warehouse to avoid obsolescence).

Turnover Affects Inventory Carrying Costs

Net sales_______ = $1,000,000 Average inventory at retail = $1,000,000 Turnover = 1

Turnover Affects Inventory Carrying Costs

Net sales_______ = $1,000,000 Average inventory at retail = $1,000,000 Turnover = 1 Inventory carrying costs = 30% Inventory carrying costs = $300,000

Turnover Affects Inventory Carrying Costs

Net sales_______ = $1,000,000 Average inventory at retail = $ 500,000 Turnover = 2 Inventory carrying costs = 30% Inventory carrying costs = $150,000 Savings = $150,000

3 4 2 1

Turnover Affects Inventory Carrying Costs

Inventory turns Average inventory $1,000,000 30% carry cost $300,000 Carry cost savings (from $ previous cost) -0 $500,000 $150,000 $150,000 $333,333 $250,000 $100,000 $75,000 $100,000 $25,000

3

4

2 1

Turnover Affects Inventory Carrying Costs

Inventory turns Average inventory $1,000,000 30% carry cost $300,000 Carry cost savings (from $ previous cost) -0 $500,000 $150,000 $150,000 $333,333

$250,000

$100,000

$75,000

$100,000

$25,000

Inventory turns 10

Turnover Affects Inventory Carrying Costs

Average inventory $100,000 30% carry cost $30,000 Carry cost savings (from $ previous cost) 3,333 11 $ 90,909 $27,273 $2,727 12 13 $83,333 $76,923 $25,000 $23,077 $2273 $1,923