Inventory Cost

Business Administration
2022123268 Park Seoyeon
1.
In general, we do not think much about the cost of inventory other than the
cost incurred by holding inventory. Here, there are four hidden costs of
inventory: Component Devaluation Cost, Price protection Cost, Product Return
Cost, Obsolescence Cost.
Component Devaluation is the largest inventory cost in an environment where
the prices of key components fall quickly and steeply. In particular, in the
computer industry covered in the article, the replacement of new products and
old products occurs quickly, so the price of old products frequently falls. For
example, the price of a CPU can drop by as much as 40% over a nine-month
life cycle. The cost of inventory for holding excess parts in the event of a price
drop is enormous. At this time, companies cannot control the price drop of
parts, but they can control the amount of inventory held, so careful judgment
on this is important.
Price protection cost is the largest inventory cost in an environment where
sales are made through multiple channels that are not owned by the company.
Suppose that the market price of a product has fallen since the product has
already been shipped to the sales channel. At this time, the company must
compensate the channel partner for the difference for products that have not
yet been sold, and this cost is the price protection cost. Given how quickly the
value of the product declines, this inconsistent inventory exposes companies to
a large price protection cost risk.
Product Return Cost is the biggest factor in special channel inventory costs,
such as online. End users and agents may return the unsold product to the
manufacturer for a full refund. Returns incur operational costs such as
shipping, handling, and product re-examination, and extend the time spent in
the supply chain before the product reaches the end user, exposing the
company to additional component devaluation and inventory financial cost
risks.
Obsolescence Cost is a result of the relevant marketing activities necessary
to accelerate discounts and sales of aging products. All three of the above-
mentioned costs are essentially ongoing costs. These costs are always incurred
and can be calculated at any time. However, the cost of obsolescence is not
estimated until that point because it arises when an entity decides to dispose of
a particular product.
I have chosen two additional industries where inventory costs are problems:
Fashion Industry, Cafe Industry. Inventory costs are the most noticeable
occurrence in the Fashion Industry. Because it is an industry that is very
sensitive to Trent, companies in the industry constantly devise new products to
respond to rapidly changing trends. Zara announces new products every two
weeks, when existing products are sold through sales. The huge amount of
marketing costs to promote new products, the sale period, and the product
again exist as inventory costs. When you enter a cafe these days, you can see
many new menus designed to meet consumers' needs, such as seasonal
limited drinks and regional limited sales. Among these products, signature
menus, that is, products that can be sold continuously, are limited. At this time,
if consumers' demand is incorrectly predicted, a huge amount of food
ingredients will remain as inventory costs, causing great damage to the
company.
2.
Return On Net Assets is an indicator comparable to a company's net income,
and helps investors determine how well a company generates profits from its
assets. RONA is calculated by dividing Net profit by the sum of fixed assets and
net working capital. In contrast, Return on Sales is used to evaluate the
company's operational efficiency. ROS is calculated by dividing the operating
prop by net sales.
Most industries today are sensitive to price fluctuations. At this time, in order
to measure a company's financial health, it is necessary to focus on asset
management, not revue growth. As you can see from the above description,
what RONA is dealing with is asset management, and what ROS is dealing with
is reward growth. Therefore, return on net assets becomes a better financial
measure than return on sales.