At a very basic level, inventories are merely the by product of a universal accounting law" of material flow:

inventory = cumulative supply - cumulative demand.

In other words, if we draw a "black box" around a piece of our supply chain and measure the total amount of product that flows into the box (the supply) and then subtract the total amount that we observe leaving the box (the demand), the result (assuming no product is destroyed along the way) is the inventory in the box.

What does a negative unit of inventory look like?

Well, a lot like a back-order. If consumers of our output are willing to order without receiving product, then we can allow demand to exceed supply and inventory can become negative, in which case, it represents the total quantity on back-order. Think of a positive inventory as a pile of goods waiting for orders and a negative inventory as a pile of orders waiting for goods.

## Sunday, August 17, 2008

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