Page 249 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 11: Inventory Management

11.4.4 Use of Control Ratios Notes

1. Input-output ratio: Inventory control can also be exercised by the use of input-output
ratio. Input Output ratio is the ratio of the quantity of input of material to production and
the standard material content of the actual output. This ratio enables comparison of actual
consumption and standard consumption, thus indicating the usage of material is favourable
or adverse.
2. Inventory Turnover ratio: It is computed as follows:

Cost of materials consumed during the period
Inventory turnover ratio =
Cost of average stock held during the period
Average Stock = ½ (Opening Stock + Closing Stock)
Computation of turnover ratios for different items of materials and comparison of the turnover
ratio provides a useful guidance for measuring inventory performance. Therefore, it is possible
to know which is fast moving and which is slow moving. On this basis, attempt should be made
to reduce the amount of capital locked up and prevent over-stocking of the slow moving items.

11.4.5 Just-in-Time (JIT) System

The Just-in-Time (JIT) system is used to minimize inventory investment. The philosophy is that
materials should arrive exactly the time they are needed for production. Ideally the firm should
have work-in-process inventory. Because its objective is to minimize inventory investment, a JIT
system uses no (or little) safety stock. Close coordination among the firm’s employees, its suppliers
and transporters must exist to ensure that material inputs arrive on time. Failure of the materials
to arrive on time results in a shutdown of the production line until the material arrives. Further,
JIT system should ensure quality parts from the suppliers to ensure uninterrupted production.

11.4.6 Material Requirement Planning (MRP) system

Many companies used a Material Requirement Planning (MRP) system to determine what materials
to order and when to order. MRP applies EOQ concepts to determine how much to order. By
means of a computer, it stimulates each products bill of materials, inventory status and
manufacturing process. The bill of materials is simply a list of all the parts and materials that go
into making the finished product. For a given production plan, the computer stimulates materials
requirements by comparing production needs to available inventory balances. On the basis of
the time it takes for a product that is in process to move through the various production stages
and the lead time required to get materials, the MRP system determines when orders should be
placed for the various item on the bill of materials.
The advantage of an MRP system is that it forces the firm to consider its inventory needs more
carefully. The objective is to lower the firm’s inventory investment without impairing production.

Self Assessment

Fill in the blanks:
6. ………………..indicates the lowest figure of inventory balance which must be maintained
in hand at all times.
7. ………………is the ratio of the quantity of input of material to production and the standard
material content of the actual output.

LOVELY PROFESSIONAL UNIVERSITY 243