Handbook of Finance: Investment Management and Financial Management

Chapter 85. Inventory Management

PAMELA P. DRAKE, PhD, CFA

J. Gray Ferguson Professor of Finance and Department Head of Finance and Business Law, James Madison University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor in the Practice of Finance, Yale School of Management

Abstract: Inventory management involves a tradeoff between the benefits of having sufficient inventory to meet demand and the costs of inventory (for example, the opportunity cost of funds, storage, and obsolescence). Models of inventory management, such as the economic order quantity model and the just-in-time technique, can be used to analyze and minimize the costs of inventory.

Keywords: inventory management, work-in-process inventory, holding cost, carrying cost, ordering cost, economic order quantity (EOQ) model, safety stock, lead time, allowance for stock-out, just-in-time (JIT) inventory model, total quality control (TQC), employee involvement (EI), number of days of inventory, inventory turnover

Inventory is the stock of physical goods for eventual sale and consists of raw material, work-in-process, and finished goods available for sale. There are many factors in a decision of how much inventory to have on hand. As with accounts receivable, there is a trade-off between the costs of investing in inventory and the costs of insufficient inventory. There is a cost associated with holding to too much inventory, and there is a cost associated with holding too little inventory.

REASONS FOR HOLDING INVENTORY

There are several ...