Inventory Management with Asset-Based Financing

Abstract

Most of the traditional models in production and inventory control ignore the financial states of an organization and can lead to infeasible practices in real systems. This paper is the first attempt to incorporate asset-based financing into production decisions. Instead of setting a known, exogenously determined budgetary constraint as most existing models suggest, we model the available cash in each period as a function of assets and liabilities that may be updated periodically according to the dynamics of the production activities. Furthermore, our models allow different interest rates on cash balance and outstanding loans, which is an enhancement over most traditional models in that inventory financed by a loan may be more expensive than that by out-of-pocket cash. We demonstrate the importance of joint consideration of production and financing decisions in a start-up setting in which the ability to grow the firm is mainly constrained by its limited capital and dependence on bank financing. We then explain the motivation for asset-based financing by examining the decision making at a bank and a set of retailers in a newsvendor setting.production/inventory management, asset-based financing, loan limits, supply chain management

Is Operating Flexibility Harmful Under Debt?

“…These rates (i.e., "hair-cuts") are chosen by the lender as additional risk controls, reflecting the riskiness of each asset class. Our assumption that cash and inventory have advance rates of 1 and α, respectively, is consistent with common practice, where accounts receivable advance rates are often 90%-100%, while inventory rates range from 50% to 90% (Buzacott andZhang 2004, CH 2014). Most secured contracts include contingencies requiring the borrowing base to exceed the size of the outstanding debt throughout the life of the loan.…”

“…However, this may also act as an additional risk shifting lever, exacerbating agency conflict with the lender due to the firm's tendency to over-order once it is leveraged (see, e.g., Buzacott and Zhang 2004). Fortunately, a contract with a borrowing base covenant and a non-zero withdrawal limit is again able to fully alleviate agency issues and restore optimality, as formalized in our next result.…”

Joint logistics and financial services by a 3PL firm

“…The existing literature has focused on the budget-constrained firm's production, inventory, capacity, and debt decisions, and seeks to demonstrate that it is important to incorporate financial decisions into operational decisions. For example, Buzacott and Zhang (2004) consider a production/inventory control model and investigate the interplay between inventory decisions and asset-based financing.…”

“…Moreover, as the focus of our model, the retailer is budget-constrained and would borrow capital, either a cash loan or trade credit, from the bank, the 3PL firm, or the supplier. To be in line with Buzacott and Zhang (2004) and Dada and Hu (2008), we assume the retailer has limited liability. We use superscripts S, R, BK, and 3P L to denote the supplier, the retailer, the bank, and the 3PL firm, respectively.…”

“…Although recent studies (e.g., Buzacott and Zhang, 2004;Dada and Hu, 2008;Jing et al, 2010) on bank financing and trade credit are significant and promising, the extant literature has been silent on the influence of 3PL financing on a budget-constrained supply chain. A research question naturally arises: How would a 3PL firm with ILFS impact the supply chain with a budget-constrained retailer?…”