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Page 2 of 3 Three Cases | Price | $28.00 | | | | Labor Cost/Unit | $7.56 | | | | Material Cost/Unit | $10.38 | | | | Total Unit Cost | $17.94 | | | | Contribution Margin | $10.06 | | | | | | | | | | Case 1 | Case 2 | Case 3 | | | Stock Out | Just In Time | 120 Days | | Units Demanded | 1,200 | 1,200 | 1,200 | | Units Produced | 1,000 | 1,201 | 1,594 | | Units Sold | 1,000 | 1,200 | 1,200 | | Units In Inventory | 0 | 1 | 394 | | Missed Unit Sales | 200 | 0 | 0 | | | | | | | Cash | $7,068 | $7,066 | $1 | | Inventory Value | $0 | $2 | $7,067 | | | | | | | | | | | | REVENUE | Able | Able | Able | | Sales | $28,000 | $33,600 | $33,600 | | VARIABLE COSTS | | | | | Direct Labor | $7,556 | $9,068 | $9,068 | | Direct Material | $10,378 | $12,454 | $12,454 | | Inventory Carry | $0 | $2 | $848 | | Total Variable Costs | $17,934 | $21,523 | $22,369 | | Contribution margin | $10,066 | $12,077 | $11,231 | | PERIOD COSTS | | | | | Depreciation | $2,880 | $2,880 | $2,880 | | SG&A: R&D | $0 | $0 | $0 | | Promotion | $800 | $800 | $800 | | Sales | $800 | $800 | $800 | | Admin | $245 | $301 | $319 | | Total Period Costs | $4,725 | $4,781 | $4,799 | | Net Margin | $5,341 | $7,296 | $6,431 | | | | | | | Missed Net Margin | $2,013 | | | | Inventory Carry | $0 | | | | Taxes | $705 | | | | Missed Profits | $1,308 | | | In Case 1 you stock out and miss sales of 200 thousand units. Notice that the period costs are already covered by the sales that you did make. Therefore, any missed sales would have gotten a free ride on Depreciation, SG&A expense, even associated interest expenses. The missed sales would only incur taxes. In this example, your missed profits are $1.3 million. In the proformas that drove this example, total profits were $5.2 million. A small stock out can make a significant difference in Net Profit.In Case 2 your hopes come true. You build 1201 and 1200 are sold. Inventory Carry costs are minuscule. In Case 3 your fears are realized. You build 1594 but only sell 1200, leaving 120 days of inventory in the warehouse. This incurs an Inventory Carry cost of $848 thousand. As inventory days increases, so do the carrying costs. For purposes of the Forecasting category, we make a policy decision that anything beyond 120 days is excessive. You might want to set tighter limits, say 90 days. Consider the rows labeled "Cash" and "Inventory Value". In all three cases your Working Capital requirements are the same. When the Inventory is sold, it is converted to Cash. When it does not sell, Cash is converted to Inventory. The combined position of $7.1 million represents a policy decision for 120 days of inventory. As discussed in The Working Capital category, that $7.1 million is not free. If you could invest it at 10% it would earn $710 thousand. If you set a policy of 90 days, you would only require $5.3 million (but you expose yourself to more risk of stock outs.)
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