Page 212 - DMGT551_RETAIL_BUSINESS_ENVIRONMENT

Unit 11: Physical Distribution and Inventory Management

cost decreases increasingly with the increase in inventory, as this cost is relatively fixed with Notes
respect to the value of the inventory.
Frequently, the assumed shortage cost is little more than a guess, although it is usually possible
to specify a range of such costs.

11.3 Inventory Metrics

Managing inventory at manufacturing and service companies is critically important. In
manufacturing, material accounts up between 60–85 percent of the revenue from sales, depending
upon the industry. In the electronics sector, it would is about 85 percent, with overheads of about
12 percent, and direct labour of around 3 percent. All these figures point in the direction of
Inventory.
Inventory is by far the single greatest cost that needs to be examined. Too much or too little, or
the wrong inventory, all have detrimental impacts on operational and financial results as
inventory represents a large capital investment. It also is an idle resource. Companies that can
operate with lesser inventory are considered to operate more efficiently.
Though there are many factors that determine the level of inventory in an organization.
A cursory study reveals the main factors that contribute to these huge expenses. The most
common factors on which the levels of inventory depend are the following:
Production Rate: The production rate can be defined as number of units manufactured over a
period of time.

Production Rate = No. of Units Manufactured/time.
The time can be measured in days, weeks, or on an annual basis. Production rate is also influenced
by the demand for the product, which could be either periodic (seasonal/cyclic) or a constant.
Lead-time: Lead-time is defined as time period from initiating of an activity to its completion.
For inventory management we need following lead times: Purchase lead-time, Manufacturing
lead-time, Delivery lead-time.

Rework/Scrap Rate: This rate is dictated by the efficiency of the manufacturing process. It
involves knowing the number of defective units that are produced by a manufacturing unit. This
is a highly empirical rate and very much depends upon the skill of the labour operating the
machine and the accuracy offered by the machine.
Excess inventory is the quantity of material in stock or on order that is greater than the anticipated
demand for an agreed time period.
Obsolete inventory on the other hand is the inventory that results from an unanticipated demand.
This inventory typically occurs due to model run outs, engineering change notes, or supplier
minimum/multiple order quantities. Companies tend to be reluctant to write off this value as it
is a loss in the books of accounting, and so affects the profit.

Inventory Measures

Inventory measures reflect, in part, the success in structuring systems to optimize the production
rate, the lead time and the scrap rate. Several aggregate performance measures can be used to
judge how well a company is able to control these factors and utilizing its inventory resources.
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

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