Inventory Spikes

During 2021, much of the talk concerning inventory surrounded shortages due to a variety of factors. In response, many companies increased production and orders to combat supply chain disruptions and increased consumer demand coming out of COVID-19 lockdowns. Now, it appears that companies have overshot demand as inventories have surged. For example, inventories for global manufacturing companies reached a record $1.87 trillion. As a result, inventory turnover for manufacturers increased to 81.1 days. And retailers are no different: Inventory for Macy's, Target, Walmart and other large retailers has increased from 17 to 45 percent compared to last year. This increased inventory is a boon for off-price retailers like Ross and TJ Maxx, which have a larger supply from big retailers offloading inventory. For many corporations, the excess inventory will likely negatively impact the bottom line.

Supply Chain Issues

Increasing demand for products in the U.S. has resulted in supply chain problems for many companies. For example, shipping from one Chinese manufacturer, which was 30 days a year and a half ago, is now three months and shipping costs have increased 50 percent. U.S. ports are a major bottleneck and ships can sit offshore for weeks at a time. Overall, global delivery times are the second longest on record. Shortages are the most severe for semiconductors, as demand increased when workers bought electronics to create home offices. In fact, the German Association of the Automotive Industry announced that only 240,000 passenger cars were made in February, about half of the November output. The reason given was the shortage of semiconductors.

Granting Credit

As with many other decisions in corporate finance, the decision to grant credit is industry specific. A recent survey indicates that the median company grants credit to about 30 percent of its customers. The 25th percentile company grants credit to 20 percent of its customers and the 75th percentile company grants credit to 50 percent of its customers. Car dealers grant credit about 83 percent of the time, while health care companies grant credit only 30 percent of the time. As with most decisions, remember the decision to grant credit is an NPV decision.

Inventory Shortage Costs

What is the optimal days' sales in inventory? It depends! Too much in inventory will result in large opportunity costs. In other words, a company has cash tied up in inventory that costs the company money and does not earn a return. However, too little inventory can be problematic as the company can experience shortage costs. In this article, the costs of inventory shortages are explained. For example, although just-in-time delivery is popular, it does create problems in supply chain management. Not only does a company need to monitor its suppliers to ensure they will be able to meet obligations, but a company must also monitor the supplier of the company's supplier. A disruption at any point in the supply chain can result in an inventory shortage. So, how much does an supply chain disruption affect a company's value? One study indicates that supply chain disruption can reduce a company's value by up to 7 percent.