Címke: CFA Level I|corporate finance|Economic order quantity|EOQ|Inventory|JIT|just-in-time|working capital
Inventory Management and the Ice-lolly Stand
If you have studied working capital management, or ever run a business that makes things, you’ll be fully familiar with inventory management.
Stock costs money. Lots of it. First of all you have to pay for the stuff (cash outflow), then you have to store it, keep it dry or wet or hot or cold, insure it, waste some of it during any manufacturing process, and of course take the risk that you’ll run out of it and lose sales.
There are two classic methods for managing inventory: economic order quantity (EOQ) and just-in-time (JIT). With EOQ we assume that each order has costs associated with it: skipping the algebra it should be intuitive that the order size goes up if the ordering cost increases (so we have fewer larger orders per year) and down if storage costs increase (so we hold less stock at any time).
With JIT, storage costs are removed and the burden is passed to the suppliers to deliver the right stuff to the right place at the right time. Efficient if you can do it (great examples are Toyota and Dell), much harder for smaller enterprises.
Now cast your mind to that high-tech process-driven sales arena known as the school summer fair. In particular, the ice-lolly stand. We* had this arduous responsibility for a full 45 minutes one sunny afternoon recently, and such was the thrill of being surrounded by a field full of sugar-high little darlings (including our own – no parent can escape) that my mind started pondering inventory management.
The set-up: a table with shopping bags filled with ice, two or three different types of ice-lolly, and a 32-degree temperature. “Two or three”: who would have guessed that Mini Milks have such a low melting temperature? So, two types.
With two of us on the stand we quickly worked out segregation of duties: my wife was in charge of the shop front, sales, marketing, cash flow (well, buttons) management, customer service, and manning the Sorry-They’ve-All-Melted helpline; I was running the warehouse, i.e. making endless journeys from the stand, through a classroom, along a corridor, through the main school hall, through a “Private – Staff Only” door (four decades on, walking through such a door still gives me a thrill), into the kitchen, and finally into the freezer (Aaaaaaaahhhhhh my reason for doing this job), then back again with a big handful of still-frozen lollies.
So what is the EOQ? Using the earlier discussion my consignment should be BIGGER with higher ordering costs (in this case a long walk through the school while children are demanding more sugar), but SMALLER with higher storage costs (the main cost here being temperature-caused attrition).
However many I decided to carry, in the end it worked out to be more of a just-in-time system, as we had run out of stock by the time I had got back from every journey. Oh well. Maybe the temptation of standing a little bit too long in front of an open freezer door was irresistible.
Had our duty lasted longer than 45 minutes I would already have written the follow-up topics of:
- Hedging ice-lolly sales with weather derivatives, and
- School fairs and the button economy.
* Responsibility here was with Nick plus family – not Nick plus Quartic. Observations made here regarding the distribution and retail sale of ice-lollies are unlikely to benefit many of our classroom delegates over the summer months. Sorry.
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