Formulas to Know: Average Inventory
Month 1 + Month 2 + Month 3
Number of months
Product
Inventory valued at$1,000,000
ProductProduct
ProductProduct
ProductProduct
ProductProduct
Product Sales = $1,000,000
We sell a million dollars worth of product out the door…
ProductProduct
Product
ProductProduct
And replace itwith…
Sales = $1 MM
Product
New inventory valued at$1,000,000
Product
Product
ProductProduct
ProductProduct
ProductProduct
Product
And replace itwith…
Sales = $1 MM
Product
Inventory valued at$1,000,000
Product
Product
ProductProduct
ProductProduct
ProductProduct
Product
We have turned over our inventoryone time.
Sales = $1 MM
Product
Inventory valued at$1,000,000
Product
Product
ProductProduct
ProductProduct
ProductProduct
Product
We have turned over our inventoryone time.
Net sales_______ = $1,000,000Average inventory at retail = $1,000,000
= 1
Sales = $1 MM
Product
Averageinventory valued at$1,000,000
Product
Product
ProductProduct
ProductProduct
ProductProduct
Product
Net sales_______ = $1,000,000Average inventory at retail = $1,000,000
Sales = $1 MM
However, it is average inventory.
ProductProduct
Product
ProductProduct
ProductProduct
ProductProduct
Product
ProductProduct
Product
Product Product
Sales = $2 MM
Averageinventory valued at$1,000,000
Net sales_______ = $1,000,000Average inventory at retail = $1,000,000
ProductProduct
Product
ProductProduct
ProductProduct
ProductProduct
Product
Net sales_______ = $2,000,000Average inventory at retail = $1,000,000
= 2 inventory
turns
ProductProduct
Product
Product Product
Sales = $2 MM
Averageinventory valued at$1,000,000
ProductProduct
Product
ProductProduct
ProductProduct
Net sales_______ = $2,000,000Average inventory at retail = $ 500,000
ProductProduct
Product
Product Product
Sales = $2 MM
Averageinventory valued at$500,000
ProductProduct
Product
ProductProduct
ProductProduct
Net sales_______ = $2,000,000Average inventory at retail = $ 500,000
ProductProduct
Product
Product Product
Sales = $2 MM
Averageinventory valued at$500,000
ProductProduct
Product
ProductProduct
ProductProduct
Net sales_______ = $2,000,000Average inventory at retail = $ 500,000
= 4 inventory
turns
ProductProduct
Product
Product Product
Sales = $2 MM
Averageinventory valued at$500,000
ProductProduct
Product
ProductProduct
ProductProduct
Net sales_______ = $2,000,000Average inventory at retail = $ 500,000
= 4 inventory
turns
ProductProduct
Product
Product Product
Sales = $2 MM
Averageinventory valued at$500,000
We have kept sales levels up, using lessaverage inventory.
PPT 12-6 Gross Margin %, Inventory Turnover, & GMROI for Selected Department
in Discount Stores
Inventory Turnover Part Two
Logistics and Supply Chain Management
Advantages of Rapid Turnover
• Increased sales volume
• Less risk of obsolescence and markdowns
• Money for market opportunities
• Decreased operating expenses
• Increased asset turnover
PPT 12-9
Disadvantages of Rapid Rate of Turnover
• Lowered sales volume.
• Increased cost of goods sold.• Increase logistics costs: expanded buying and
ordering time.
PPT 12-10
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
Turnover Affects Inventory Carrying Costs
Inventory turns
Average inventory
30% carry cost
Carry cost savings (from
$ previous cost)
1 $1,000,000 $300,000 -0-
2 $500,000 $150,000 $150,000
3 $333,333 $100,000 $100,000
4 $250,000 $75,000 $25,000
Turnover Affects Inventory Carrying Costs
Inventory turns
Average inventory
30% carry cost
Carry cost savings (from
$ previous cost)
1 $1,000,000 $300,000 -0-
2 $500,000 $150,000 $150,000
3 $333,333 $100,000 $100,000
4 $250,000 $75,000 $25,000
Turnover Affects Inventory Carrying Costs
Inventory turns
Average inventory
30% carry cost
Carry cost savings (from
$ previous cost)
10 $100,000 $30,000 3,333
11 $ 90,909 $27,273 $2,727
12 $83,333 $25,000 $2273
13 $76,923 $23,077 $1,923
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