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Managing Inventory and Service Costs
After studying this chapter, you should be able to:
1 Identify the different types of inventory in manufacturing, service, and merchandising organizations and understand how these inventory costs are reflected on the income statement and balance sheet. 2 Analyze the levels of raw materials, work-inprocess, and finished goods inventories in a manufacturing organization.
3 Understand how merchants manage inventory in their organizations. Measure profitability and personnel utilization in a service organization.
6 Calculate and interpret holding costs in merchandising and service businesses. 7 Use classic quantitative tools in inventory management (economic order quantity, reorder point, and safety stock).
5 Describe how the concept of just-in-time (JIT) inventory systems is used to improve cost, quality, and timely performance in organizations.
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Sam Walton didn’t invent discount retailing, but the company he founded, WAL-MART, is now the undisputed giant in the field.1 Sam Walton started his career in retailing at a J.C. PENNEY store in Des Moines, Iowa. Sam was a good salesperson, though he disliked the bookkeeping that went along with the job: “[I] couldn’t stand to leave a new customer waiting while I fiddled with paperwork on a sale I’d already made.” After World War II, Sam borrowed $20,000 from his father-in-law and bought a variety store in Newport, Arkansas. By 1962, Sam Walton had built a chain of 16 variety stores located in Missouri, Arkansas, and Kansas. By this time, however, Walton had become convinced that there were big opportunities in opening discount retail locations in the smaller U.S. towns and cities that were being overlooked by the traditional retailers such as SEARS. Walton pitched his idea to a couple of retail chains, but he couldn’t generate any interest. He finally had to fund the start-up of his first discount store with his own money, putting up 95% of the financing, with another 3% coming from his skeptical brother Bud and 2% from the person he hired to manage the store. On July 2, 1962, this first Wal-Mart opened its doors. Today, Wal-Mart Stores, Inc. is the world’s largest retailer ($218 billion in sales in 2002), employing approximately 1.3 million people in more than 4,300 stores. Each week, more than 100 million customers visit Wal-Mart stores worldwide.
Setting the Stage
Two other well-known discount retailers also began operations in 1962: KMART and TARGET.
Providing the management accounting information necessary to effectively control this massive merchandising organization is no easy task. Providing merchandise at the right time, to the right place, and at the right price is how a retailer “wins” customers. Sound simple? Consider that at any given moment, a typical WalMart discount store has more than 70,000 different items of inventory in stock. Every one of these items must be identified, ordered, inventoried, and replenished—all the while keeping an eye on costs. (Inventory costs at a typical Supercenter are even tougher to manage because these stores also carry more than 20,000 grocery items, many of them perishable.) The crucial idea behind discount retailing is that lower prices will lead to a large enough increase in sales volume to make up for the fact
that a smaller profit is made on each inventory item. As the discount retailing industry has expanded and become more competitive, Wal-Mart has had to be ever more aggressive in cutting its profit margins in order to keep its prices low. To illustrate, in 1980 Wal-Mart’s gross profit percentage was 27%; in 2003, the percentage had dropped to 22%. For a company wrestling with tightening margins, inventory control is a...