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Comment by grecy | Hacker News Reader

> That means on the average day you have 150 metric tons of wheat flour in stock. At today’s prices, you’ve tied up $73,000. Forever.

What's so bad about having that money tied up in inventory? Once it's in there, you can just forget about it, and it has no impact. If you reduce your inventory and "free up that money", you're just going to spend it on something else, and then be on an endless quest to forever reduce inventory, because the money you "free up" kind of looks like revenue, which you are obviously trying to increase. Continuing down this path has no future.

At some point you can't reduce inventory any more (lets even say you get it to zero with JIT), at which point your "revenue" will "fall" compared to last year/quarter and everything looks bad.

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From an economic sense, the problem of the money tied up in inventory is precisely the interest on $73,000. (Interest rate you pay on loans if you have any loans, interest you'd get from a bank account if you don't have loans.) So around a dollar a day at today's interest rates. (It gets worse if you figure in the small probability of spoilage or damage that is uninsured.)

More concisely (or generally, or just nebulously), it represents an opportunity cost.

True, though the factory's owners (its shareholders) assume that the factory will beat the return of the market as a whole, and the rate of any loans they have. Otherwise they'd just invest in the market, e.g. via an index tracker. So for them at least the opportunity cost is a little higher.

Interestingly I had a friend who had a business in the bulk flour business.

They were moving enough stock but profits weren't coming through.

We did some analysis on cashflow and stock and found that the sitting costs of too much flour were eating cashflow. Basically he was paying upfront for bulk flour and then receiving the cash from customers over 60 and 90 days. One of the costs of holding too much inventory is real estate - bulk flour costs floorspace to store. In a low-margin business, just a few percent here and there can turn something from profitable to loss making pretty easy.

That's not really applicable to software, which is generally a high margin business, but having too much inventory is definitely a problem.

It's not about reducing or increasing revenue, it's about trimming down the size of the balance sheet.

An important economic concept is return on investment. Generally speaking, the main goal of business owners is to try to maximize dollars earned/dollars invested.

High inventory costs increase the denominator, which reduces ROI-the very thing you're trying to maximize.

This all assumes that capital is your main constraint. But you can apply the same concepts to any other constraint. For example, if you're trying to maximize dollars earned/hour of labor, you want to minimize the amount of labor tied up in inventory.

Your raw profit (not revenue) may fall, but there are lots of other numbers a decent investor will look at. Total profits make for good headlines and bad analysis.

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