SCM1 : Introduction to

Supply Chain Management

MEASURING
SUPPLY CHAIN
PERFORMANCE
The
Importan
ce of
Inventory
20XX 2
 Inventory
FAQs
(Frequently Ask
Questions)
20XX 3
What is inventory process?
An inventory process tracks inventory as companies receive, store,
manage and withdraw or consume it as work in progress. Essentially, the
inventory process is the lifecycle of goods and raw materials.

What is an inventory record?

An inventory record, or stock record, contains data about the items a
company has in stock, such as the amount of inventory on hand, what’s
been sold and reordered, what’s on order, the product’s value, and where
it’s stored. It’s important to keep accurate inventory records to assist with
inventory control and keep accurate balance sheets.
What is demand forecasting?
Demand forecasting is the practice of predicting customer demand
by looking at past buying trends, such as promotions and seasonality.
Accurately predicting demand provides a better understanding of how
much inventory you’ll need and reduces the need to store surplus stock.
Inventory forecasting relies on data to inform decisions, applying
information and logic to guarantee you’ve got enough product on hand to
meet demand while not tying up cash with unnecessary inventory. There
are a number of advanced simulations used, but it typically comes in the
form of trend forecasting, graphical forecasting, qualitative forecasting,
or quantitative forecasting.
What is average inventory cost?
The average cost of inventory is a method for calculating the per-unit
cost of goods sold. To calculate the average cost, get the sum of the cost of
all stock for sale, and divide it by the number of items sold.
This method is also called weighted average cost, and is a valuable
way to determine the value of your current inventory. It works best for
brands that have high volumes of inventory and SKUs that are similar in
cost. One of its benefits over other methods is that it makes it easier to
track and consistently calculate inventory value by using a blended
average.
What is inventory count?
An inventory count is the physical act of counting and checking the
condition of items in storage or a warehouse. An inventory count also
checks the condition of items. For accounting purposes, inventory counts
help assess assets and debts.
Inventory counts help you understand which stock is moving well and
inventory managers often use this information to forecast stock needs and
manage budgets.
The objective of inventory management is to
strike a balance between inventory investment
and customer service.

You can never achieve a low-cost strategy without

good inventory management. All organizations have
some type of inventory planning and control system.
A bank has methods to control its inventory of cash.
A hospital has methods to control blood supplies and
pharmaceuticals. Government agencies, schools, and,
of course, virtually every manufacturing and
production organization are concerned with inventory
planning and control.
• In cases involving physical products, the
organization must determine whether to
produce goods or to purchase them. Once
this decision has been made, the next step
is to forecast demand. Then operations
managers determine the inventory
necessary to service that demand.
Four (4)
Function
s of
Inventor
y
1.To provide a selection of goods for anticipated customer
demand and to separate the firm from fluctuations in that
demand. Such inventories are typical in retail establishments.

2. To decouple various parts of the production process. For

example, if a firm’s supplies fluctuate, extra inventory may be
necessary to decouple the production process from suppliers.

3. To take advantage of quantity discounts, because purchases

in larger quantities may reduce the cost of goods or their
delivery.

4. To hedge against inflation and upward price changes.

Four (4)
Types of
Inventory
1. Raw Materials
Materials that are needed to turn your inventory into a finished product are
raw materials. These inventory items are bits and pieces of component
parts that are currently in stock but have not yet been used in either work-
in-process or finished goods inventory.
There are two types of raw materials: direct materials—which are
used directly in finished goods, and indirect materials—which are part of
overhead or factory costs.

Inventory example: For example, direct raw materials might be leather to

make belts for your company would fall under this category. Or, if you sell
artificial flowers for your interior design business, the cotton used would be
considered direct raw materials, too.
Indirect raw materials might be lightbulbs, batteries, or anything else that
indirectly contributes to keeping your shop running.
2. Work-In-Process
Inventory that is being worked on is Work-In-Process (WIP), just like the
name sounds. From a cost perspective, WIP includes raw materials (plus,
sometimes labor costs) that are still “in production” when the accounting
period ends.
In other words, whatever direct and indirect raw materials your business is
using to create finished goods is WIP inventory.

Inventory example: If you sell medical equipment, the packaging would

be considered WIP. That’s because the medicine cannot be sold to the
consumer until it is stored in proper packaging. It’s literally a work-in-
process.
Another example would be a custom wedding dress that’s not quite
finished when the end of the fiscal year rolls around. That lace, silk, and
taffeta are no longer raw materials, but they’re not quite a “finished goods”
wedding dress, either.
3. Finished Goods
Maybe the most straightforward of all inventory types is
finished goods inventory. That inventory you have listed for
sale on your website? Those are finished goods. Any product
that is ready to be sold to your customers falls under this
category.

Inventory example: Finished goods could be a pre-

packaged fruit salad, a monogrammed bathrobe, or a custom-
built laptop ready for an employee to use.
4. Overhaul / MRO
Also known as Maintenance, Repair, and Operating Supplies,
MRO inventory is all about the small details. It is inventory that is
required to assemble and sell the finished product but is not built into the
product itself.
Depending on the specifics of your business, this inventory might be in
storage, at a supplier, or in transit out for delivery.

Inventory example: For example, gloves to handle the packaging

of a product would be considered MRO. Basic office supplies such as
pens, highlighters, and paper would also be in this category.
Summary
Raw material inventory - Materials that are usually
purchased but have yet to enter the manufacturing process.

Work-in-process (WIP) inventory - Products or

components that are no longer raw materials but have yet to
become finished products.

Maintenance/repair/operating (MRO) inventory -

Maintenance, repair, and operating materials.

Finished-goods inventory - An end item ready to be sold,

but still an asset on the company’s books.
Assets
Committed
to Inventory
 Supply chain managers make scheduling and
quantity decisions that determine the assets
committed to inventory. Three specific
measures can be helpful here:

a)Percentage Invested in Inventory

b)Inventory Turnover
c)Weeks of Supply
Percentage Invested in Inventory
The first is the amount of money invested in
inventory, usually expressed as a percentage of
assets.

FORMULA:
EXAMPLE
TRACKING HOME DEPOT’S INVENTORY INVESTMENT
Home Depot’s management wishes to track its investment in
inventory as one of its performance measures. Recently, Home
Depot had $11.4 billion invested in inventory and total assets of
$44.4 billion.
APPROACH: Determine the investment in inventory and total assets
and then use formula.

SOLUTION: Percent in invested inventory=(11.4/44.4)× 100 = 25.7%

INSIGHT: Over one-fourth of Home Depot assets are committed

to inventory.
LEARNING E X E R C I S :
If Home Depot can drive its investment down to
20% of assets, how much money will it free up for
other uses?
Inventory Turnover & Average inventory period

• Inventory turnover is the rate that inventory stock is sold, or used, and
replaced. The inventory turnover ratio is calculated by dividing the cost
of goods by average inventory for the same period. A higher ratio tends
to point to strong sales and a lower one to weak sales.
• The inventory turnover ratio is the number of times a company has sold
and replenished its inventory over a specific amount of time.
• Use to evaluate average inventory period or how long it
will take to sell the inventory currently on hand
• Ultimately, the inventory turnover ratio measures how well the
company generates sales from its stock and helps businesses make
smarter decisions in a variety of areas, including pricing, manufacturing,
marketing, purchasing and warehouse management.
FORMULA:

Cost of goods sold is the cost to produce the goods or

services sold for a given period.
Inventory investment is the average inventory
value for the same period. This may be the
average of several periods of inventory or
beginning and ending inventory added together
and divided by 2.
Average inventory period refers to a financial ratio
used to compute the average number of days a
company takes before they sell all their current stock
of inventory. In other words, AIP is the duration goods
are sitting on the shelves for before they're sold.
EXAMPLE:
INVENTORY TURNOVER AT PEPSICO, INC.
PepsiCo, Inc., manufacturer and distributor of drinks, Frito-Lay, and
Quaker Foods, provides the following in a recent annual report (shown
here in $ billions).

Determine PepsiCo’s turnover ration and compute

average inventory in annual period.
APPROACH: Cost of goods sold is $14.2 billion. Total inventory is the
sum of raw material at $.74 billion, work-in-process at $.11 billion, and
finished goods at $.84 billion, for total average inventory investment of
$1.69 billion.
SOLUTION
Inventory turnover = Cost of goods sold/Average inventory
investment
= 14.2/1.69
= 8.4 (8)
INSIGHT: We now have a standard, popular measure by which
to evaluate performance.
Using the latter data compute the average
inventory period of PEPSICo. We already
know the inventory turnover ratio is 8. To
calculate how many days it will take to sell the
inventory on hand at the current rate, divide
365 days in the year by 8, which equals 45.63
days.
LEARNING EXERCISE:
If Coca-Cola’s cost of goods sold is $10.8 billion
and inventory investment is $.76 billion, what
is its inventory turnover ratio?, How long they
could sell the remaining stock in a annual
period?
Weeks of Supply
Weeks of supply, may have more meaning in the wholesale and retail
portions of the service sector than in manufacturing. It is computed
below as the reciprocal of inventory turnover:

Weeks of supply = Average inventory investment /

Average weekly cost of goods sold

*Average weekly cost of goods

sold=
Annual cost of goods sold
52 weeks
DETERMINING WEEKS OF SUPPLY AT PEPSICO
Using the PepsiCo data in Example 3, management wants to know the
weeks of supply.

APPROACH: We know that inventory investment is $1.69 billion and

that weekly sales equal annual cost of goods sold ($14.2 billion) divided
by 52 =$14.2/52 = $.273 billion.

SOLUTION:
Weeks of supply = (Average inventory investment/Average weekly
cost of goods sold)
= 1.69/.273 = 6.19 weeks
LEARNING EXERCISE 
If Coca-Cola’s average inventory investment
is $.76 billion and its average weekly cost of
goods sold is $.207 billion, what is the
firm’s weeks of supply?
Supply chain management is critical in driving
down inventory investment. The rapid
movement of goods is key. Businesses would
resupply every other week. Economical and
speedy resupply means both rapid response to
product changes and customer preferences, as
well as lower inventory investment. Similarly,
while many manufacturers struggle to move
inventory turnover up to 10 times per year,
Supply chain management provides a
competitive advantage when firms effectively
respond to the demands of global markets and
thank
you