What is the difference between planned and unplanned inventory accumulation? Write down the relation between change in inventories and value added of a firm.
The stock of unsold goods (finished and semi-finished), which a firm carries forward from one year to another year is termed as an inventory. Inventory accumulation can be planned or unplanned. The planned inventory accumulation refers to the inventory that a firm can anticipate or plan. For example, a firm wants to raise its inventory from 1000 to 2000 units of denims and expects sales to be 10000 units. Thereby, it produces 10000 + 1000 units, i.e. 11000 units (in order to raise the inventory by 1000 units). If, at the end of the year it is found that the actual sales that got realised were also 10000, then the firm experiences the rise in its inventory from 1000 to 2000 units. The closing balance of inventory is calculated in the following manner:
Final Inventory = Opening Inventory + Production – Sale
= 1000 + 11000 – 10000
= 2000 units of denims
In this case the inventory accumulation is equal to the expected accumulation. Hence, this is an example of a planned inventory accumulation.
Unplanned inventory accumulation is an unexpected change in an inventory. There is an unplanned accumulation in an inventory when the actual sales are unexpectedly low or high. For example, let us assume, a firm wants to raise inventory from Rs 1000 to 2000 and expects sales to be 10000 and thereby produces 11000 units of denims. If, at the end of the year, the actual sales realised were 9000 units only, which were not anticipated by the firm and therefore the inventory rose by 3000 units. The unexpected inventory accumulation is calculated as:
Final inventory = Opening inventory + Production – Sale
= 1000 + 11000 – 9000
= 3000 units of denims
Hence, this is an example of unexpected inventory accumulation.
The relation between value added and the change in inventory is shown by the given Gross value added by a firm = Sales + change in inventory – Value of intermediate goods.
It implies that, as inventory increases, the value added by a firm will also increase, thus confirming the positive relationship between the two.
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