Inventories are short term assets held as part of an organisation’s core business operations. Inventory management is an important part of working capital management. Where inventory levels are significant, a good model should show the impact on cash of holding such significant levels. We will look at how to model three types of inventory: raw materials, work in progress and finished goods.

2. Financial modelling should be collaborative. Collaboration reduces error, speeds up development time and lowers cost. The Financial Modelling Handbook is a collaborative, crowd-sourced guide to building better financial models using the FAST Standard.

3. Mayank Jain is a financial modeller at F1F9 based in Delhi.
He has worked on projects across a variety of sectors including marine and transport, enterprise reporting and infrastructure.

4. Inventories are short term assets held as part of an organisation’s core business operations.
Inventory management is an important part of working capital management. Where inventory levels are significant, a good model should show the impact on cash of holding such significant levels.
We will look at how to model three types of inventory: raw materials, work in progress and finished goods.

5. We will begin by calculating cost of goods sold. This figure is reported in the income statement (“IS”).
The formula is cost per widget x widgets sold x CPI escalation. CPI escalation is currently marked as a placeholder (a temporary modelling solution).
Check out the modelling guide on placeholders to see how escalation factor would be modelled in full.

6. Next we will estimate finished goods required at the end of each period. Our estimate is based on the average days a widget spends in a finished goods warehouse before it is sold.
The formula is: average days / days in model period x cost of goods sold.
Note the use of a last forecast period flag to reduce our requirement to zero at the end of the project.

7. In our finished goods warehouse, inventory levels are reduced by finished goods that are sold. Inventory levels are increased by finished goods issued from production.
Since we have a target finished goods balance, we can estimate how much in finished goods we need to demand from production.
The formula is: target finished goods balance plus what we expect to sell less beginning balance.

8. The finished goods balance is modelled in a corkscrew.
The balance increases with finished goods received from production; it decreases with finished goods sold.
Check out the modelling guide on modelling balances to find out more about corkscrews.

9. Next we will estimate work in progress required at the end of each period. Our estimate is based on the average days a widget spends in production before it is issued to the finished goods warehouse.
The formula is: average days / days in model period x cost of goods sold.
Note the use of a last forecast period flag to reduce our requirement to zero at the end of the project.

10. In our production facility, inventory levels are reduced by widgets ready to issue to the finished goods warehouse. Inventory levels are increased by raw materials issued by our raw materials department.
Since we have a target work in progress balance, we can estimate how much in raw materials we need to demand from our raw materials department.
The formula is: target WIP balance plus what we expect to issue to finished goods less beginning WIP balance.

11. The WIP balance is modelled in a corkscrew.
The balance increases with raw materials received from the raw materials department; it decreases with widgets issued to the finished goods warehouse.

12. Finally we will estimate raw materials required at the end of each period. Our estimate is based on the average days raw materials spends in the raw materials warehouse before it is issued to the production.
The formula is: average days / days in model period x cost of goods sold.
Note the use of a last forecast period flag to reduce our requirement to zero at the end of the project.

13. In our raw materials warehouse, inventory levels are reduced by raw materials ready to issue to production. Inventory levels are increased by raw materials purchased.
Since we have a target raw materials balance, we can estimate how much in raw materials we should be purchasing.
The formula is: target raw materials balance plus what we expect to issue to production less beginning raw materials balance.

14. The raw materials balance is modelled in a corkscrew.
The balance increases with raw materials purchased; it decreases with raw materials issued to production.