CHAPTER 5

Financial Impact of
Inventory
 Selected Financial Data for Manufacturers, Wholesalers, and 5-2
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.
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 Cost Trade-offs in 5-3

Marketing and Logistics

Product

MARKETING
Order processing
Price and information
costs

Place/customer
service levels
Inventory
LOGISTICS

Transportation
carrying costs
costs

Lot quantity costs Warehousing costs

Order processing
and information
costs
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 Components of Inventory 5-4

Carrying Costs

• Capital
• Inventory service
• Storage space
• Inventory risk

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 Inventory Positions in the 5-5

Manufacturer’s Logistics System

Raw Finished goods Finished goods

In-process
materials inventory inventory
inventory
inventory at plant in field

Assumptions: A one-time increase (decrease) in finished goods inventory

results in a one-time increase (decrease) in raw materials purchased.

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 Normative Model of Inventory 5-6

Carrying Cost Method

Capital
costs Inventory investment

Inventory Insurance
service
costs Taxes

Inventory Plant warehouses

carrying
costs Storage Public warehouses
space costs
Rented warehouses
Company-owned
warehouses

Obsolescence
Inventory Damage
risk costs
Pilferage
Relocation costs

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 Adjusting the Cost of Money to Fit the 5-7

Method of Inventory Valuation

One Method
Inventory at full cost $10,000,000
Variable cost is 80% of full cost x 80%
Inventory at variable cost $8,000,000
Cost of money before tax is 30% x 30%
Cost of money associated with the
inventory investment $2,400,000
Another method
Cost of money before tax 30%
Variable cost is 80% of full cost 80%
Inventory at full cost $10,000,000
Adjusted cost of money x 24%
Cost of money associated with the
inventory investment $2,400,000

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 5-8
Summary of Data Collection Procedure
Step
No Cost Category Source Explanation Amount (Current Study)
1. Cost of Money Comptroller This represents the cost of having money invested 30% pretax
in inventory and the return should be comparable to
other investment opportunities.
2. Average 1. Standard cost data -- comptroller's Only want variable costs since fixed costs go on $7,800,000 valued at variable cost
monthly department regardless of the amount of product manufactured delivered to the D.C. (Variable
inventory valued 2. Freight rates and product specs are and stored -- follow steps outlined in body of report. manufactured cost equaled 70% of
at variable costs from distribution reports full manufactured cost. Variable
delivered to the 3. Average monthly inventory in cases cost FOB the DC averaged 78% of
distribution from printout received from sales full manufactured cost)
center forecasting
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 Distribution operations This represents the portion of warehousing costs $226,654 annually which equals
storage (public that are related to the volume of inventory stored. 2.89%
warehouse)
6. Variable storage Transportation services Only those costs that are variable with the amount Nil
(plant of inventory stored should be included.
warehouses)
7. Obsolescence Distribution department reports Cost of holding product inventory beyond its useful 0.80% of inventory
life
8. Shrinkage Distribution department reports Requires managerial judgment to determine the
portion attributable to inventory storage. $100,308 which equals 1.29%
9. Damage Distribution department reports Requires managerial judgment to determine the
portion attributable to inventory storage.
10. Relocation costs Not available Only relocation costs incurred to avoid Not available
obsolescence should be included.
11. Total carrying Calculate the numbers generated in steps 36.21%
costs 3, 4, 5, 6, 8, 9 and 10 as a percentage of
average inventory valued at variable cost
delivered to the distribution center and add
them to the cost of money (step 1).

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M.2001 by The McGraw-Hill Companies, Inc. All rights reserved.
Lambert
 The Impact of Inventory Turns on 5-9

Inventory Carrying Costs

Inventory Average Carrying Cost Carrying Cost
Turns Inventory at 40 Percent Savings
1 $750,000 $300,000
2 375,000 150,000 $150,000
3 250,000 100,000 50,000
4 187,500 75,000 25,000
5 150,000 60,000 15,000
6 125,000 50,000 10,000
7 107,143 42,857 7,143
8 93,750 37,500 5,357
9 83,333 33,333 4,167
10 75,000 30,000 3,333
11 68,182 27,273 2,727
12 62,500 25,000 2,273
13 57,692 23,077 1,923
14 53,571 21,428 1,649
15 50,000 20,000 1,428

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 Relationship Between Inventory Turns 5-10

and Inventory Carrying Costs

Inventory carrying costs
$300,000

$275,000

$250,000

$225,000

$200,000

$175,000

$150,000

$125,000

$100,000

$75,000

$50,000
$37,500
$25,000

0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Inventory Turns

Source: Douglas M. Lambert, and Robert H. Quinn, “Profit Oriented Inventory Policies Require a Documented
McGraw-Hill/Irwin Copyright
Inventory Carrying Cost,” Business © 2001
Quarterly by 3The
46, no. McGraw-Hill
(Autumn 1981), Companies,
p.65. Inc. All rights reserved.
 Annual Inventory Carrying Costs 5-11

Compared to Inventory Turnovers

Inventory carrying costs (per unit)
$30.00

Variable Manufacturing Cost $100

Carrying Cost % x 30%
Annual Cost to Carry in Inventory $30
Monthly Cost (1/12) $2.50

15.00

12.50

10.00
7.50
6.00
5.00
3.75
2.50
0
1 2 3 4 5 6 7 8 9 10 11 12
Inventory Turns
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 Inventory Positions and Major Flows 5-12

in a Supply Chain
Orders Orders Orders
Payments Payments Payments
Suppliers Information Manufacturer Information Wholesalers Information Retailers

Product Product Product

Variable cost Variable cost Variable cost Variable cost

of product $5 of material $10 of product $60 of product $70

Full manufac- Acquisition Other acquisition Other acquisition

tured cost $7 cost $1 costs $2 costs $2

Selling Other variable Selling Selling

price $10 costs $14 price $70 price $120

Total variable
cost of product $25

Full manufac-
tured cost $40

Selling
price $60

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
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and Management Research, School of Business administration, by The
University ofMcGraw-Hill Companies,
Oklahoma, 1982), p. 127. Inc. All rights reserved.