Effect of Financing Costs and Constraints on Real Investments: The Case of Inventories | Weatherhead School at Case Western Reserve University

Effect of Financing Costs and Constraints on Real Investments: The Case of Inventories

Effect of Financing Costs and Constraints on Real Investments: The Case of Inventories

Authors

  • Qi Wu
  • Kumar Muthuraman
  • Sridhar Seshadri

Published

Production and Operations Management , vol. 28, issue 10

Abstract

Research on inventory theory has primarily focused on the cost tradeoffs within the inventory<br>system and overlooks the effect of a firm’s financial decisions. This paper emphasizes on jointly<br>analyzing a firm’s inventory and financing decisions. We first show that, even under a deterministic<br>model, it is always optimal to use both cash and credit for financing inventory, even when<br>one is cheaper than the other. Next, with a stochastic model, we show that a firm would not only<br>use cash and credit, but they would use them at the same time. This provides an explanation<br>addressing the recent controversy on, why firms borrow while holding cash. We also analyze the<br>impact of the credit line on its inventory management. Amongst other insights, we show that<br>making strategic use of credit allows larger inventory orders and reduce ordering volatility. Even<br>a small amount of credit can reduce significant amounts of cash needed. Finally, we collect a<br>unique dataset on firms’ cash, inventory, and credit availability to check the testable hypotheses<br>based on our analytic model. We reinforce the insights and provide empirical evidence that fills<br>in the gap between empirical literature and classical inventory theory.