December 1997 • Volume 7 • Number 12
Inventory Ownership:
Who Owns What, and When?
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In this month's column, we are going to do something different. We are going to take a break from the stream of thought that has been taking place up to this point, and we will return to a series that ran not too long ago. In that series, we talked about various aspects of inventory. We defined what inventory is and the issues of form, function and position associated with inventory. In response to that column, Michael T. Allen wrote a very interesting and insightful letter to the editor (November 1997, p. 4) about something that was overlooked in the column. One of the columnists called Michael and talked about the issues that were raised. After this discussion, Michael was invited to put his ideas down on paper. The result is this column. We think that it adds some interesting perspectives on the entire issue of inventory. Next month, we return to the discussion of different manufacturing environments. After that, we will turn our attention to misconceptions surrounding the entire issue of cost savings. —Steven A. Melnyk and Chris Christensen |
By Michael T. Allen
This article serves to further expound on the
subject of inventory and its ownership. The reasoning behind
this particular piece was the information written in the
"Back to Basics" column in the July 1997 issue entitled
"Understanding The Nature Of Inventory." The article talked
about the ownership of inventory-in-transit and who, in
fact, was the owner, the vendor (shipper in this case), or
the customer (consignee).
Ownership of inventory-in-transit is based upon one factor: freight terms. Having been associated with the freight industry for some years, I have found that the "true" cost of inventory only starts occurring after the inventory has changed hands. Albeit, "concern" for the inventory-in-transit is still felt by the customer (as the customer needs it for timely production, etc.), but in a lot of cases, the customer still hasn't taken ownership of it until it reaches his dock. In fact, the ownership actually changes hands when it is unloaded and the bill of lading has been signed. This is the exact moment when the inventory has changed ownership from the vendor to the customer.
Now, in many cases, the ownership of the inventory is addressed on the front end during the contract negotiations with the vendor. Purchasing (and any other parties involved) bring to the table the needed requirements, which many times includes the freight terms. This can be a powerful negotiating tool from a total cost standpoint. As many purchasing professionals can attest, freight terms sometimes can make or break the contract ratification. Freight terms totally determine the point at which ownership of the inventory is transferred; and coupled with the freight costs themselves, freight terms can be a major investment in operating capital. The necessary costs of carrying inventory is tempered by the way the freight terms are negotiated. Freight terms are typically stated with F.O.B., which means "Freight On Board" at the beginning, followed by either "origin" or "destination," and then the method of payment, either collect, prepaid, or prepaid and billed. If freight terms are not considered in the negotiation phase of doing business, then you could wind up paying more for the inventory than you originally thought.
With the abolition of the Interstate Commerce Commission (ICC), which previously governed the pricing for freight carriers, it is now even more important that the vendor and the customer come to an agreement on who pays the freight and how ownership is transferred. If your company has a traffic department that handles all negotiations with the freight carriers, then it would be prudent to find out about the "deals" that have been contracted from the traffic department prior to beginning your purchase contract negotiations. Freight carriers now can basically charge whatever they feel is fair and discount however they wish. So it is important from a total cost of inventory and ownership standpoint to include freight terms in your purchase contracts.
If, for example, the contract states the vendor will supply steel at a given price per pound (and the customer knows that steel is incredibly dense material and that his production usages are high) and the freight is stated as F.O.B. origin, freight collect, then the customer will pay for the freight, bear the freight, file any freight claims (if any), and own the inventory-in-transit. The word "origin" is the key word for the ownership transfer. The F.O.B. origin portion of the freight term says simply this, "We, the vendor, will load the freight on board the truck and release the liability of ownership to the customer." This, of course, actually includes the signing of the bill of lading, which bilaterally binds the vendor and the carrier contractually and involves the customer per the payment portion of the freight terms. In this particular example, the customer is involved at the point of shipment due to "origin, collect" stated in the terms. In the case of F.O.B. destination, freight prepaid, the customer wouldn't have any involvement other than the concern of whether or not his freight arrives on time for production, etc.
For a better understanding, see Figure 1 for definitions of the freight terms. These freight terms should clear up any misconception about ownership of inventory and should be considered when negotiating your purchase contract.
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Figure 1. Freight terms
defined. | |
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F.O.B.
origin, freight collect F.O.B.
origin, freight prepaid F.O.B.
destination, freight collect |
F.O.B.
destination, F.O.B.
destination, freight prepaid |
Cash as inventory
Another point I want to clarify is "cash" as a type of inventory from the "Back to Basics" article in the August 1997 issue entitled, "Understanding The Nature Of Inventory: Forms And Positions." Cash is not "truly" inventory, as any controller will tell you. The fifth paragraph under the Forms of Inventory column states, "The final form that inventory can take is that of money. With this form, we recognize that management need not invest in inventories of parts. They can decide that it is in their best interest to keep the resources in cash." This statement is conceptually accurate, but needs to be continued by saying that "inventory will generally not be considered as cash, but cash can be considered as an alternative use of resources and inventory." By definition, inventory denotes being tangible, and in an auditor's eyes, must be able to be touched and seen. Cash, on the other hand, is far from being tangible, unless you go down to the bank and literally put your hands on it! However, in the banking industry, cash would be a form of inventory because that is the commodity used in transacting business.
Simply concluded, the form of inventory as cash really needs to be understood as alternatively using one of your resources.
Mike Allen is materials supervisor for Heatcraft Inc., Advanced Distributor Products in Grenada, Miss. He is responsible for all materials, purchasing, master scheduling and order fulfillment.
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