Dynamic inventory control with limited capital and short-term financing

Abstract

For most firms, especially the small- and medium-sized ones, the operational decisions are affected by their internal capital and ability to obtain external capital. However, the majority of the literature on dynamic inventory control ignores the firm's financial status and financing issues. An important question that arises is: what are the optimal inventory and financing policies for firms with limited internal capital and limited access to external capital? In this article, we study a dynamic inventory control problem where a capital-constrained firm periodically purchases a product from a supplier and sells it to a market with random demands. In each period, the firm can use its own capital and/or borrow a short-term loan to purchase the product, with the interest rate being nondecreasing in the loan size. The objective is to maximize the firm's expected terminal wealth at the end of the planning horizon. We show that the optimal inventory policy in each period is an equity-level-dependent base-stock policy, where the equity level is the sum of the firm's capital level and the value of its on-hand inventory evaluated at the purchasing cost; and the structure of the optimal policy can be characterized by four intervals of the equity level. Our results shed light on the dynamic inventory control for firms with limited capital and short-term financing capabilities.Copyright © 2014 Wiley Periodicals, Inc. Naval Research Logistics 61: 184–201, 2014