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principles of finance a la shmoop just-in-time inventory capital

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management and inventory turnover well this is old school this is new school [scissors cutting grass then a lawn mower]

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and yet new school is usually better now let's think about the just-in-time or

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JIT world versus the old-school way of doing things in old school inventory

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management you know for a factory a division of the company might have [writing on white board]

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dedicated five thousand units times four hundred bucks each equals and about two

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million dollars in tire inventory and yeah those are kind of expensive tires

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couldn't that capital be used elsewhere well in the JIT way the capital needed

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for inventory was miniscule just a few tires here a few tires there refreshed [tires spinning]

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every day what happens if the inventory of tires runs into a mountain pass no

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Starman can't be refreshed daily yeah JIT only works when it works really well

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you could imagine the enormity of the cost to the manufacturer of cars if the [man driving truck]

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production line ran out of tires suddenly cars back up on the line and [production line of car bodies]

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there's nowhere to store them or even move them because well they have no

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tires then things back up more and more and let's say there's a run on rubber

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supplies and the company can't get tires for a month while suddenly sales to the [calendar]

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consumer there and the auto dealerships get cancelled and consumers buy another

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brand or make of car from another company or a competitor in fact it was a

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lot of this fear of supplies being cut mindset that created the quote over

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inventory unquote status that US automakers had in the 60s and 70s the [vintage car factory footage]

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children of world war ii knew very well that nothing was guaranteed and they [children marching]

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slept more soundly at night with 5,000 sets of tires in the garage but you know [garage full of tires]

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imagine what you'd do if milk was available only once a week for you as a [girl with a single cookie on the table]

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kid but the economies of the world grew up the distribution of commodities grew

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more global and liquid and supply lines just stopped getting cut in a world [writing on white board]

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generally at peace not at war anyway one key metric commonly used to assess the

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efficiency of capital use in companies that particularly in factories or

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manufacturing plants is the inventory turnover ratio for most companies this

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is a rel and not an absolute number that is one

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auto manufacturer can look at the turnover ratio of another and compare [car being compared]

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how they're doing relatively auto manufacturer really can't look at a

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video game maker or Facebook and glean anything relatively useful from their

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accountings for inventory because well they really don't have any like their

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inventory is you know kind of phantom that is Facebook's inventory in quotes

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is the blank space it serves on its computers when new people come on in [man in empty warehouse]

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view and or click on ads it sells in one package or another not the case and car

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tires there's actual real inventory there that cost real money so key

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concept number one is that the actual index number you get from inventory [writing on white board]

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turnover is just a relative thing and it's defined mathematically as cost of

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goods sold divided by yes inventory and you generally take an average inventory

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number there to come up with that number so let's cogitate on this whole thing a

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moment we're gonna use cogs or cost of goods sold is in the numerator here it's

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not a bad number it's car tires plus windshield wipers plus cup holder

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thingies plus engine blocks plus rich Corinthian leather seating by the mile

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plus so a bunch of other stuff as well as assembly labor shipping and a bunch

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of other costs that aren't inventory it all adds up to the cost of goods sold

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kind of in the gross margin lines there yeah and then we're dividing it all by

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inventory but wait what's the difference well aren't things that make up cogs

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just inventory no well at some point along the production line dance they [group of people dancing]

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will have been inventory but not necessarily at the moment snapshot was [full warehouse]

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taken or that time period was mentioned curveball to the head right cogs is an

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income statement item it measures the expenses we had in selling the goods we

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sold over a given period of time like last quarter or last year but inventory

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is a balance sheet item it's a snapshot at any given point in time albeit

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admittedly usually taken every quarter or month or year so this ratio links the [inventory in warehouse]

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balance sheet and the income statement in kind of a nifty way if you think

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about it by relating the volume of stuff sold in a given period with the stuff

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that you know our iPhones shotted the day we decided to take

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inventory of you know inventory so yeah that's what keeps the cogs of the

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machine you know running smoothly we hope

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