Question

(Forecasting inventories​) Findlay Instruments produces a complete line of medical instruments used by plastic surgeons and has experienced rapid growth over the past 5 years. In an effort to make more accurate predictions of its financing​ requirements, Findlay is currently attempting to construct a​ financial-planning model based on the percent of sales forecasting method.​ However, the​ firm's chief financial analyst​ (Sarah Macias) is concerned that the projections for inventories will be seriously in error. She recognizes that the firm has begun to accrue substantial economies of scale in its inventory investment and has documented this fact in the following data and​ calculations:

YEAR	SALES​ ($000)	INVENTORY​ ($000)	​% OF SALES
2011	​$16,000	​$1,230	7.69​%
2012	$19,000	$1,250	6.58​%
2013	$18,500	$1,240	6.70​%
2014	$21,000	$1,260	6.00​%
2015	$26,000	$1,300	5.00%
			Average 6.39​%

a. Plot​ Findlay's sales and inventories for the past 5 years. What is the relationship between these two​ variables?

ANSWER: A LINEAR FUNCTION

b. Estimate firm inventories for 2016, when firm sales are projected to reach $40 million. Use the average percentage of sales for the past 5​ years, the most recent percentage of​ sales, and your evaluation of the true relationship between the sales and inventories from part (a​) to make three predictions.

1. Use the average percentage of sales for the past 5 years to make the prediction. What are the​ firm's projected inventories for 2016 when the sales are projected to reach $40 ​million?

2. Use the most recent percentage of sales to make the prediction. What are the​ firm's projected inventories for 2016 when the sales are projected to reach $40 ​million?

3. Use your evaluation of the true relationship between the sales and inventories from part a to make the prediction. What are the​ firm's projected inventories for 2016 when the sales are projected to reach $40 ​million?

Answer 1

Forecasting of Inventory is generally calculated on the basis of previous year of inventory to sales percentage or through the average percentage of sales. Average percentage of sales can be multiplied with the current year of sales to derive the inventory of the current year.

When using the average percentage method, we can see that the average percentage is 6.39% and if Sales $40,000, inventory would be $2,558 as 6.39%of 40,0000 = 2,558

1)	Year	Sales ($000)	Inventory ($000)	% of Sales
	2011	16,000	1,230	7.69%
	2012	19,000	1,250	6.58%
	2013	18,500	1,240	6.70%
	2014	21,000	1,260	6.00%
	2015	26,000	1,300	5.00%
Average	2016	40,000	2,558	6.40%

2)	Year	Sales ($000)	Inventory ($000)	% of Sales
	2011	16,000	1,230	7.69%
	2012	19,000	1,250	6.58%
	2013	18,500	1,240	6.70%
	2014	21,000	1,260	6.00%
	2015	26,000	1,300	5.00%
	2016	40,000	2,000	5.00%

In the second part, using the most recent percentage of sales method to make the prediction, it would be at 5% and hence 5% of 40,000 = $2,000.

3)	Year	Sales ($000)	Inventory ($000)	% of Sales
	2011	16,000	1,230	7.69%
	2012	19,000	1,250	6.58%	3,000	20
	2013	18,500	1,240	6.70%	(500)	(10)
	2014	21,000	1,260	6.00%	2,500	20
	2015	26,000	1,300	5.00%	5,000	40
		40,000	1,440	3.60%	14,000	140

We can say there is a linear relationship between Sales and inventory, if the inventory decreases sales goes down. Another way to look at it is as Sales decreases, inventory also decreases. When sales has a $2500 increase, there is an increase in inventory by $ 20 while when there is a $ 5,000 increase, inventory increases by $40. following and assuming this trend, when sales jump to 40,000 in 2016 there is suddenly a $14,000 increase which would make the inventory jump by $140 or so. Hence it gives us the inventory of $1,440.