Chapter 15 Working Capital Management 489computer decline to a set level, the computer sends an order to the supplier’s com-
puter, specifying exactly what is needed. The computer also reports how fast items
are moving. If an item is moving too slowly, the computer will suggest a price cut to
lower the inventory stock before the item becomes obsolete. Manufacturers such as
GE use similar systems to keep track of items and to place orders as they are needed.
Although inventory management is important, it is under the operational control
of production managers and marketing people rather than! nancial managers. Still,
! nancial managers are involved in several ways. First, it is expensive to install and
maintain the computer systems used to track inventories; and the capital budgeting
analysis discussed earlier in the text must be used to determine which system is best.
Second, if the! rm decides to increase its inventory holdings, the! nancial manager
must raise the capital needed to acquire the additional inventory. And third, the
! nancial manager is responsible for identifying any area of weakness that affects the
! rm’s overall pro! tability, using ratios and other procedures for comparing the! rm
to its benchmark companies. Therefore, the CFO will compare the! rm’s inventory-
to-sales ratio with those of its benchmarks to see if things look “reasonable.”
Since inventory management is outside the mainstream of! nance, we cover it
in Web Appendix 15A rather than in the text chapter. However, “Supply Chain
Management,” provided at the top of this page, discusses how inventories are
managed by modern corporations.
Herman Miller, Inc., manufactures a wide variety of o$ ce furni-
ture; and a typical order from a single customer might require
work at " ve di! erent plants. Each plant uses components from
di! erent suppliers, and each plant works on orders for many
customers. Imagine all the coordination that’s required. The
sales force generates the order, the purchasing department
orders components from suppliers, and the suppliers must
order materials from their own suppliers. Then the suppliers
ship the components to the appropriate Herman Miller plant,
the plants build the products, the di! erent products are gath-
ered together to complete the order, and the order is shipped
to the customer. If one part of that process malfunctions, the
entire order will be delayed, inventory will pile up, and extra
costs to expedite the order will be incurred. Moreover, the
company’s reputation will be damaged, hurting future sales.
To prevent such consequences, Herman Miller employs
a process called supply chain management (SCM). The key
element in SCM is sharing information all the way from the
point of sale at the retailer to suppliers and even back to sup-
pliers’ suppliers. SCM requires sophisticated software; but
even more important, SCM requires cooperation among the
di! erent companies and departments in the supply chain. A
new culture of open communication is required, and this is
often di$ cult for many companies because they are reluc-
tant to divulge operating information. Many of Herman
Miller’s suppliers were initially wary of these new relation-
ships. However, SCM has been a win-win situation, with
increases in value for Herman Miller and its suppliers.
SCM enabled Herman Miller to sharply reduce its inven-
tory, to cut 2 weeks o! delivery times to customers, and to
operate its plants at a 20% higher volume without further
capital expenditures. The results were much higher earnings,
cash # ows, and stock price.Sources: Elaine L. Appleton, “Supply Chain Brain,” CFO, July 1997, pp. 51–54; Kris Frieswick, “Up Close and Virtual,” CFO, April 1998, pp. 87–91.
SUPPLY CHAIN MANAGEMENT
SELF^ TEST What are the three primary tasks of the " nancial manager regarding inventory
management?