Dynamic Inventory Management with Inventory-Based Financing

Abstract

This paper considers a stochastic inventory management problem where a capital-constrained firm can obtain additional working capital through an inventory-based financing facility by pledging its inventory to obtain loans from a lender. We show that it is optimal to deploy a state-dependent base-stock policy through which the firm may order new inventory up to or salvage existing inventory down to certain levels in each period depending on whether it has an initial net capital or debt defined as the on-hand capital minus all outstanding loans and interests. Through analytical and numerical studies, we offer a number of new insights regarding the optimal inventory management for a capital-constrained firm with access to inventory-based financing. In particular, we find that when the firm anticipates a shortage of capital with which to meet high demands in a future period, it may strategically over-stock its inventory in earlier periods in order to secure the necessary capital. Through extensive numerical experiments, our paper also demonstrates how some of the key parameters may affect the optimal inventory and financing decisions and the associated profits. Finally, we discuss three model extensions that allow finite storage capacity, per-unit inventory holding cost, and demand backlogging.