Finished Goods is a Necessary Evil

Inventory is a result of production, and managing production is the key to flow! Enjoy this video, an early one I did, famous for the use of dog bones to explain complex business processes! Then consider this, that dollar that had the bit scissored off is the difference between the sales price and the cost of raw materials. It is the money that is the lifeblood of your biz, and provides both the money to pay for everything else. Sitting where you can’t touch it it is doing you no good, but that is only on the day you make it and put it in inventory. Every day that passes that that money is tied up, the true cost to your company keeps increasing. Throughput accounting calls that Inventory Value Days, which are how many days the value of the inventory is locked up where you can’t use it to buy raw material and sell it and thereby make a profit.

The number of IVD’s or inventory value days multiplied by the value of the gross profit dollars that would be contributed by those items if they sold gives you the TVI, or the true value of inventory. Meaning, if you sell for 2 dollars and there is 1 dollar raw material cost, your gross profit dollar contribution, or throughput per item is 1 dollar. If you make a 100 that end up in inventory then the TVI the first day is 100 the second 200 the third day 300 etc.. And it gets worse after 30 to 45 days, depending on the lag time from ship to paid. If inventory is held beyond the payment cycle, the damages double up. There is no real way to measure the impact, but this calculation is much more accurate than the standard factors used in cost accounting.

Questions? Doubts? Feel free to make a comment…

About the Author

Dan Strongin works with medium to small companies, helping them master the art and science of managing.