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Inventory and Production
Management
Chapter 13
Chapter Objectives
• Distinguish between variable and fixed costs.
• Understand how to determine product costs, set
prices, and reduce costs.
• Understand inventory management.
• Understand how to forecast inventory needs.
• Understand the costs associated with managing
inventory.
(continued)
Chapter Objectives (continued)
• Calculate the optimum economic ordering quantity.
• Describe inventory turnover and inventory
obsolescence.
• Calculate manufacturing costs, including labor costs.
Key Terms
• Variable costs: Costs varying with each unit produced.
• Semivariable costs: Costs varying with the amount of activity but
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that are not directly proportional to the amount of activity.
Fixed costs: Costs staying the same no matter what changes
occur in usage or sales.
(continued)
Key Terms (continued)
• Direct costs: Costs directly associated with a specific activity
(e.g., player salaries, equipment).
• Indirect costs: Costs not associated with a specific activity (e.g.,
administrative overhead and support, scouts for a pro sports
team).
• Hidden costs: Costs unforeseen at the start of a project.
Examples of Sport Business Costs
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Personnel
Maintenance
Player salaries
Storage
Coaches
Marketing
Scouts
Advertising
Administrative
Graphics
• Legal
• Travel
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Accountant
Media
Insurance
Media food table
Facility
Media guides
Utilities
Modem lines
Cost Summary Sheet
To fully appreciate an item’s cost, a cost summary
sheet must be developed.
Inclusions
• Various categories of costs over and above the
raw materials used to create the item
• Examples
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taxes
depreciation
profits
related expenses
(continued)
Cost Summary Sheet (continued)
• Numerous pro forma budgets fail investor
scrutiny because the pro forma fails to identify
these cost categories.
• A cost sheet makes it more difficult to overlook
any cost category.
Sample Cost Summary Sheet
Turn to the table on page 247 in the text.
Reviewing the Cost Summary Sheet
The cost sheet establishes several key variables
that help Speedway Motorsports determine its
profitability and related standards:
• Speedway Motorsports’ profit is $12, which is
built into the cost analysis.
• Profit as a percentage of sales price is 8%
($96.25 target price / $12 profit = 8%).
• Gross margin is net sales price ($104) minus the
material costs ($25) = $79.
(continued)
Reviewing the Summary Cost
Sheet (continued)
• Value added is the net sales price ($104) minus
total purchases ($27.50) = $76.50.
• Cash flow is the after-tax profits ($12) plus
depreciation ($10) = $22.
• Contribution margin is the net sales price ($104)
minus total variable cost ($57.75) = $46.25.
Reducing Costs
Besides analyzing costs, it is important to examine
techniques to reduce costs. Methods include
• reducing labor costs, and
• streamlining the manufacturing process
(possibly through the use of machinery).
Inventory Management
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Forecasting inventory
Purchasing inventory
Storing inventory
Auditing inventory
Utilizing inventory
Inventory Management: Forecasting
• A cost of sales questionnaire (an example is on page 249 in the text)
• identifies some of the dynamic issues associated with determining the
potential costs of manufacturing an item, and
• identifies variables that can affect pricing and might represent a potential
area for cost savings.
• Forecasting involves both science and art to effectively set the stage
for determining optimum sales, inventory, production levels, and
manufacturing costs.
• Inventory forecasting helps establish what inventory purchases will
need to be made throughout the year as well as the most effective
techniques for reordering additional inventory.
Inventory Management: Purchasing
• Examine buying patterns for costly
inefficiencies.
• Here are some of the commonplace
inefficiencies a company might face:
• Intermittent, ineffective, or short production runs (a
production run is a manufactured amount that has
been predetermined, such as when a company has a
production run of 1,000 items planned for February)
• Double handling of materials because some
materials were not available when needed
• Inadequate development of proper tooling methods
because the production runs are too short
(continued)
Inventory Management: Purchasing
(continued)
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• Failure to realize quantity discounts
• Failure to define economical order quantities
Inventory turnover is a method used to
determine if in fact inventory is just sitting
around.
The faster the inventory is turned over, the
more money will be made.
(continued)
Inventory Management: Purchasing
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Finished goods turnover ratio equals cost of goods sold divided
by average finished goods inventory.
• If cost of goods sold = $385,000 and average finished goods = $65,000,
then the turnover ratio will be $385,000 / $65,000 = 5.92.
• To calculate the number of working days, divide the number of
working days in the year (253; constant for companies closed on
weekends and federal holidays) by the turnover ratio (5.92).
• Thus, 253 / 5.92 = 42.7 days of unsold finished goods sitting in inventory.
Centralization of Inventory Purchasing
• Managers can focus on their specialties rather than on
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administrative issues surrounding purchasing.
Responsibility is given to a single person rather than
numerous individual managers.
Clerical effort and inventory control problems can be
reduced.
Problems of potential shortages can be identified early.
Price negotiation can be improved because of the ability to
buy bigger lots and redistribute the materials throughout
an organization.
Inventory Management: Storing
• Raw materials
• Work-in-process (refined raw materials that have not yet
reached the finished product stage)
There are four main areas of costs associated with inventory:
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Carrying (storing) costs
Ordering costs
Shipping and receiving costs
Costs associated with running out of inventory
(continued)
Inventory Management: Storing
(continued)
There are three helpful formulas regarding
carrying costs (see text for specific formulas):
1.Average inventory level
2.Total carrying costs
3.Total ordering costs
Inventory Management: Auditing
• Often people just count physical units, which is
not the most effective way to take inventory.
• For example, an inventory taker counts the
number of potato chip bags on the shelf to
determine when it is time to order.
(continued)
Inventory Management: Auditing
(continued)
• An inventory-taking protocol can do the following:
• Analyze the degree of obsolescence in the inventory
• Identify fast- and slow-moving items
• Properly classify the inventory based on need, value, or
other variables
• Identify the cause of lost or stolen inventory items
• Identify techniques to help move slow inventory (Feiner,
1977)
Inventory Management: Utilizing
Determine whether raw materials are being
effectively utilized:
• How effective has management been in
increasing the inventory turnover rate?
• How is purchasing controlled to make sure
purchases are in economical quantities that do
not unduly increase inventory carrying costs?
• Are any components of the manufacturing
process sent to external sources for finishing,
and can any such steps be completed internally?
(continued)
Inventory Management: Utilizing
(continued)
• What is the relationship between direct and
indirect labor costs?
• What steps are taken to reduce the need for
overtime labor?
• Are the labor and materials costs clearly defined
to allow accurate tracking?
(continued)
Inventory Management: Utilizing
(continued)
• Are accurate records kept concerning
equipment maintenance and repair costs?
• Who contracts for equipment rental or leasing,
and how is that process supervised?
• What control mechanisms are in place to reduce
pilferage and deterioration of supplies?
Questions for Class Discussion
1. What do you think is the most effective way to manage
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inventory?
What forecasting strategies would you use if you were
managing a ski resort that dealt with uncontrollable weather
factors?
What strategies do you think might be useful in reducing
employee theft if you ran a team’s gift shop? Would your
strategies change if you were managing a concession stand and
employees took food or beverages?
What cost reduction strategies could be used by Speedway
Motorsports? Should coaches receive large contractual perks?
If so, what are some means to deal with Title IX or Equal Pay
Act concerns? Should coaches be paid more than teachers?
(continued)
Questions for Class Discussion
(continued)
5. If you overproduced T-shirts for a given team and could
not resell the remaining shirts, what would you do with
them?
6. Develop a list of all the fixed costs that you can imagine
for a NBA team.
7. Develop a list of all the variable costs that you can imagine
for a nonprofit sports event such as a 5K road race.
8. How should professional sports teams handle their high
labor costs, especially when fans are upset that they have
to pay so much to attend games?