Cash-Flow Based Dynamic Inventory Management

Michael N. Katehakis, Benjamin Melamed, Jim Junmin Shi

Research output: Contribution to journalArticlepeer-review

26 Scopus citations

Abstract

Small-to-medium-sized enterprises (SMEs), including many startup firms, need to manage interrelated flows of cash and inventories of goods. In this study, we model a firm that can finance its inventory (ordered or manufactured) with loans in order to meet random demand which in general may not be time stationary. The firm earns interest on its cash on hand and pays interest on its debt. The objective is to maximize the expected value of the firm's capital at the end of a finite planning horizon. The firm's state at the beginning of each period is characterized by the inventory level and the capital level measured in units of the product, whose sum represents the “net worth” of the firm. Our study shows that the optimal ordering policy is characterized by a pair of threshold parameters as follows. (i) If the net worth is less than the lower threshold, then the firm employs a base stock order up to the lower threshold. (ii) If the net worth is between the two thresholds, then the firm orders exactly as many units as it can afford, without borrowing. (iii) If the net worth is above the upper threshold, then the firm employs a base stock order up to the upper threshold. Further, upper and lower bounds for the threshold values are developed using two simple-to-compute myopic ordering policies which yield lower bounds for the value function. We also derive an upper bound for the value function by considering a sell-back policy. Subsequently, it is shown that policies of similar structure are optimal when the loan and deposit interest rates are piecewise linear functions, when there is a maximal loan limit and when unsatisfied demand is backordered. Finally, further managerial insights are provided with extensive numerical studies.

Original languageEnglish (US)
Pages (from-to)1558-1575
Number of pages18
JournalProduction and Operations Management
Volume25
Issue number9
DOIs
StatePublished - Sep 1 2016

All Science Journal Classification (ASJC) codes

  • Management Science and Operations Research
  • Industrial and Manufacturing Engineering
  • Management of Technology and Innovation

Keywords

  • inventory-finance decision
  • myopic policy
  • sell-back policy
  • threshold values

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