If you build it they may not come

If you are a late 80’s movie buff or a Kevin Costner fan you may have seen the movie Field of Dreams where Kevin Costner plays a character who builds a baseball field in the middle of a corn field because he believes that the baseball-great Shoeless Joe Jackson will come back as a ghost and play baseball in his field.  An odd premise for a movie to be sure but it spawned the relatively famous quote, “If you build it he will come.”  


It turns out that you can build something and have no one show up; that’s exactly what is happening at Research In Motion (RIM), the maker of the once-revolutionary Blackberry smartphone.  Like any wholesaler or retailer, RIM carries a certain amount of pre-built inventory on hand, ready to sell at a moments notice.  Grocery stores need milk and eggs, clothing stores need clothes, gas stations need gas.  These are all inventory – product that is intended to be resold.  Inventory is usually a current asset shown on the balance sheet.  Inventory management, that is, determining the correct amount of inventory to carry at any one time is a critical business skill.  Carry too much and the milk goes bad before you can sell it.  Don’t carry enough and you’ll have angry customers that purchase their milk at your competitor’s store.

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In RIM’s latest annual financial statements, inventory has grown from $618 M to $1,027 M, a 66% increase.  That by itself is not necessarily bad.  Businesses experiencing or about to experience strong growth and expansion would likely have similar inventory growth.  In RIM’s case though, the inventory increase is NOT due to growth but completely the opposite.  Inventory increases can also indicate slow-moving inventory; that is, no one is buying your stuff.  RIM’s rapid decrease in the smartphone market share is no secret.  If people stop buying Blackberrys and Playbooks but RIM continues to manufacture them, inventory must grow.

Another way to consider this is with the inventory equation: Closing Inventory = Opening Inventory + Units Manufactured – Units Sold.  If Units Sold decreases faster than Units Manufactured, Closing Inventory will be higher than Opening Inventory.

So, point #1: Inventory growth can be a sign of an unhealthy business.  This is certainly the case for RIM.

Point #2? Obsolete or slow-moving inventory may actually require a write down.  That is, the value recorded on the financial statements ($1,027 M for RIM) may be too high.  If RIM needs to decrease the selling price to encourage sales and that sales price is lower than the manufacturing costs, a write down is likely required.  Why does that matter?  Well for one, RIM’s assets would be smaller than currently shown on the financial statements and two, the write down is also an expense which would further decrease RIM’s net income (loss).

What’s the quick lesson here?  When you read a set of financial statements, look carefully at inventory trends.  If inventory is rapidly increasing and there is no planned business growth in the short term, that inventory growth may indicate that customers don’t like what that company sells.  Never a good position to be in.

Note: this blog was originally posted on my site hosted by Pearson Education (http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

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