Formulas to Know: Average
Inventory
Month 1
+ Month 2 + Month 3
Number of months
Inventory valued at
$1,000,000
Product
Product
Product
Product
Product
Product
Product
Product
Sales = $1,000,000
Product
We sell a million dollars worth
of product out the door…
And replace it
with…
Product
Product
Product
Product
Product
Sales = $1 MM
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_______
Average inventory at retail
= $1,000,000
= $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_______
Average inventory at retail
= $1,000,000
= $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_______
Average inventory at retail
Product
= $1,000,000
= $1,000,000
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_______
Average inventory at retail
Product
= $2,000,000
= $1,000,000
= 2 inventory
turns
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_______
Average inventory at retail
Product
= $2,000,000
= $ 500,000
Product
Product
Product
Product
Product Product
Product
Product
Product
Product
Product
Sales = $2 MM
Average
inventory
valued at
$500,000
Net sales_______
Average inventory at retail
Product
= $2,000,000
= $ 500,000
Product
Product
Product
Product
Product Product
Product
Product
Product
Product
Product
Sales = $2 MM
Average
inventory
valued at
$500,000
Net sales_______
Average inventory at retail
Product
= $2,000,000
= $ 500,000
= 4 inventory
turns
Product
Product
Product
Product
Product Product
Product
Product
Product
Product
Product
Sales = $2 MM
Average
inventory
valued at
$500,000
Net sales_______
Average inventory at retail
Product
= $2,000,000
= $ 500,000
= 4 inventory
turns
Product
Product
Product
Product
Product Product
Product
Product
Product
Product
Product
Sales = $2 MM
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
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