Inventory Management with Financing Decisions: Theory and Evidence | Weatherhead

Inventory Management with Financing Decisions: Theory and Evidence

Inventory Management with Financing Decisions: Theory and Evidence

Authors

  • Qi Wu
  • Kumar Muthuraman
  • Sridhar Seshadri

Published

Production and Operations Management

Abstract

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