Page 240 - DMGT501_OPERATIONS_MANAGEMENT

Operations Management

Notes Some of these strategies involve having fewer inventories while others involve owning less of the
inventory. ERP and information technology solutions have been able to provide solutions, not
only for inventory management but also for aggregate planning, material requirement planning
and operations scheduling.
Regardless of which technique or solution one employs, proactive inventory management
practices make a measurable difference in operations. In this supplement, we will cover some of
the important inventory models and their characteristics, which are used in many of these ERP
solutions.

Inventory Metrics

Managing inventory at manufacturing and service companies is critically important. Too much
or too little, or the wrong inventory, all have detrimental impacts on operational and financial

results.
Inventory represents a tremendous capital investment and also is an idle resource. Companies

that can operate with lesser inventory are considered to operate more efficiently. Inventory

measures reflect, in part, the success in structuring supplier relationships to optimize inventory
at the buying company. Several aggregate performance measures can be used to judge how well
a company is utilizing its inventory resources.
1. Average Inventory Investment: The rupee value of a company’s average level of inventory
is one of the most common measures of inventory. The information is easily available and it
is easy to interpret. It represents the average investment of the company. However, it does
not take into account the differences between companies. For example, a larger company
will generally have more inventory than a smaller company, though it could be using its
inventory more efficiently. This makes it difficult for the company to make comparisons

with other companies.
2. Inventory Turnover Ratio: In order to overcome this problem, inventory turnover ratio is
used. This measure allows for better comparison among companies. This is calculated as a
ratio of the company’s sales to its average inventory investment:
Inventory turnover = Annual cost of goods sold/Average inventory investment
This is a measure of how many times during a year the inventory turns over. Because it
is a relative measure, companies of different sizes can be more easily compared. A higher
turnover ratio reflects there are less idle resources in the company, and therefore the

company is using its inventory efficiently. This ratio can only be used in this manner to
compare companies that are similar. For example, even in the same industry depending
on the distribution channels, a retailer would have a much lower inventory turnover ratio
than the wholesaler or distributor.
3. Days of Inventory: A measure that tries to overcome the disadvantage, to a limited degree,
and is closely related to inventory turnover is ‘days of inventory’. This measure is an
indication of approximately how many days of sales can be supplied solely from inventory.
The lower this value, the more efficiently inventory is being used if customer demands are

being met in full. There are two ways of calculating ‘days of inventory’. It can be directly
calculated, or inventory turnover can be converted to days of inventory. Both procedures
are shown below:
Days of inventory = Avg. inventory investment/ (Annual cost of goods sold/Days per
year)

Days of inventory = Days per year/Inventory turnover rate
Detailed measures of inventory accuracy and availability are very important in order to

maximize manufacturing and non-manufacturing efficiency and financial results. In companies

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