Inventory Management & Investment Valuation: A Comprehensive Guide

Posted on Nov 11, 2024 in Economy

Inventory Management

Stock Definition

Inventory encompasses all materials a company possesses in its warehouse to fulfill its operational needs. There are six main types:

  • Raw Materials: Materials intended to become part of finished products after processing.
  • Semi-Finished Products: Products made by the company but not intended for sale and require further processing.
  • Finished Products: Manufactured products ready for final consumption.
  • Merchandise/Stock: Materials purchased for resale.
  • Other Supplies: Incorporated materials.
  • Byproducts, Waste, and Recoverable Materials: Residual materials from production.

Cost Classification

Inventory costs fall into three categories:

  • Ordering Costs: Costs associated with placing orders.
  • Acquisition Costs: The price of products purchased from suppliers.
  • Holding Costs: Costs to store a specific quantity of stock.
  • Shortage Costs: Costs incurred when the company runs out of stock.

Wilson Model (Optimum Order Quantity)

This model applies when the following conditions are met:

  • Replenishment occurs in product lots.
  • Consistent product quality.
  • Constant and known product demand.
  • Constant product price and lead time.

Short-Term Financing

Resources

  • Short-Term Loans: Borrowing money to cover short-term costs, repaid within 12 months with interest.
  • Bank Credit:
    • Overdraft: Using funds exceeding the available account balance.
    • Line of Credit: A flexible financing option for uncertain amounts.
  • Trade Credit: Deferring payment to suppliers after purchasing goods.

Investment Analysis

Characteristics of an Investment

  1. Initial Outlay (D0): The amount paid at the time of asset purchase.
  2. Investment Duration (n): The number of years the asset generates cash flows.
  3. Cash Flows (F1): The difference between revenues and expenses.
  4. Residual Value: The asset’s value at the end of its useful life.

Investment Valuation Methods

  • Static Methods (assume constant money value):
    • Payback Period: Time to recover the initial investment.
  • Dynamic Methods (account for time value of money):
    • Net Present Value (NPV): The present value of all future cash flows.
    • Internal Rate of Return (IRR): The discount rate that makes the NPV zero.

Financing Sources

Financing sources can be categorized in three ways:

  1. Repayment Term: Short-term and long-term.
  2. Origin: Internal (earnings, asset sales) or external (capital, loans).
  3. Ownership: Equity (owner’s funds) or debt (borrowed funds).

Internal Financing (Equity)

  • Capital: Shareholder contributions.
  • Retained Earnings: Profits reinvested in the company.
  • Amortization: Funds set aside to replace assets.
  • Provisions: Funds allocated for future losses.

Long-Term Financing

External Resources

  • Long-Term Loans: Funds borrowed from financial institutions.
  • Bonds: Debt securities issued by companies.

Average Maturity Period

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