chapter 13 Inventory and Production Management Lonni Steven

chapter 13 Inventory and Production Management Lonni Steven Wilson, Medaille College

Key Chapter Objectives • Distinguish between variable and fixed costs. • Understand how to determine product costs and prices and how to reduce costs. • Understand inventory management. • Understand how to forecast inventory needs.

Key Terms variable costs—Costs that vary with each unit produced. semivariable costs—Costs that vary with the amount of activity but that are not directly proportional to the amount of activity. fixed costs—Costs that stay the same no matter what changes occur in usage or sales. 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 that are not obvious at the start of a project.

Examples of Sport Business Costs • • • Personnel Maintenance Player salaries Storage Coaches Marketing Scouts Advertising Administrative Graphics • • • Legal Travel 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 – – 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. • Refer to table 13. 1 in the text for a detailed cost summary sheet (it also appears on the next three slides).

Sample Cost Summary Sheet Table 13. 1 Super Putter Cost Sheet Description Cost per packaged unit ($) Part A 10. 00 Part B 6. 00 Part C 4. 00 Part D 1. 00 Primer 0. 75 Paint 1. 25 Packaging 2. 00 Material costs $25. 00 Supplies and repairs 1. 50 Utilities 1. 00 Total $27. 50 (continued)

Sample Cost Summary Sheet (continued) Description Cost per packaged unit ($) Cost at step 1 14. 00 Cost at step 2 5. 00 Cost at step 3 1. 50 Quality-related losses 4. 00 Sales and distribution costs 5. 00 Short-term interest 0. 75 Total variable costs $57. 75 Manufacturing 7. 25 Distribution 3. 50 Research and development 2. 50 Administrative 2. 00 (continued)

Sample Cost Summary Sheet (continued) Description Cost per packaged unit ($) Long-term interest 1. 25 Total manufacturing cost less $74. 25 depreciation Depreciation 10. 00 Total cost $84. 25 Net profit 12. 00 Target price after tax $96. 25 Provisions for taxes 7. 75 Net target selling price $104. 00 Discount and terms 6. 00 Total target price $110. 00

Reviewing the Cost Summary Sheet The cost sheet establishes several key variables that help SMC determine its profitability and related standards: • SMC’s 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 • • • Forecasting inventory Purchasing inventory Storing inventory Auditing inventory Utilizing inventory

Inventory Management: Forecasting • Cost of sales questionnaire (an example is in the text) – identifies some of the dynamic issues associated with determining the potential costs of manufacturing an item – identifies variables that can affect pricing and that 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 that a company might face: – Intermittent, ineffective, or short production runs (a production run is a manufactured amount that has been predetermined, such as when SMC has a production run of 1, 000 clubs 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) – Failure to realize quantity discounts – Failure to define economical order quantities – Downtime of machines that are waiting for parts but still incur all fixed operating costs (Feiner, 1977) • 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 (continued) • 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 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 (Feiner, 1977)

Inventory Management: Storing • • Raw materials Work-in-process: A term for refined raw materials that have not yet reached the finished product stage There are four main areas of costs associated with inventory: – – 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): • Average inventory level • Total carrying costs • 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. • 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? • What is the relationship between direct and indirect labor costs? (continued)

Inventory Management: Utilizing (continued) • What steps are taken to reduce the need for overtime labor? • Are the labor and materials costs clearly defined to allow accurate tracking? • 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 In-Class Discussion 1. What do you think is the most effective way to manage inventory? 2. What forecasting strategies would you utilize if you were managing a ski resort that had to deal with uncontrollable weather factors? 3. 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 employees took food or beverages? 4. If you overproduced T-shirts for a given team and could not resell the remaining shirts, what would you do with them? 5. Develop a list of all the variable costs you could imagine for a nonprofit sports event such as a 5 K road race. 6. 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?