Right Inventory Level for Healthy RoI and Customer Service

Inventory is an area for a company which shows its impact on (Return of Investment) RoI. However, maintaining a proper inventory level cannot be done away with as inventory is crucial for reducing Lead Gap Time for a company to offer better service to customers. Inventory reduction helps in better capital utilization and finds itself as an important figure in balance sheet of the company. One way of reduction of manufacturing lead time is by keeping a level of inventory.


Basic questions in Inventory Management


Inventory control is a technique of maintaining a level of Inventory keeping in view best economic interest of the organization. While controlling Inventory, following basic questions to be answered –

  • Should the item be stocked at all?
  • If yes, what is the purpose of stocking?
  • How much to stock?
  • When to order for new stock?
  • How much to order?
  • How to make use of existing stock including disposal option?


Inventory level will be optimized, if these questions are answered on continuous basis. All the techniques developed in controlling Inventory try to answer these basic questions. Technology support like inventory management module of ERP (Enterprise resource planning), MRP I (Material resource planning) and MRP II (Manufacturing resource planning) will provide with proper data to answer these questions better.


Inventory level as company target


If we were to ask what is the single most target for the CEO or the MD of the company, what would be the answer? In my opinion, it would be ROI i.e. Return of Investment. ROI in simplified way is profit divided by the capital employed and expressed as percentage. Capital employed consists of cash, buildings, receivables, equipment and inventory. So, to increase ROI, inventory level should be reduced but not sacrificing customer service.


ROI is also expressed as product of sales margin (profit divided by sales) and asset turnover (sales divided by capital employed). Inventory reduction helps in better capital utilization and finds itself as an important figure in balance sheet of the company.


Basic activities within Inventory Management


Inventory management is not a standalone activity but an integrated one. Many areas should be focused to control the inventory. Many areas or departments have to work together. The key areas are demand management, materials requirement planning, sales and operation planning, production planning and inventory optimization. Everyone working together managing the conflicts among themselves will lead to an optimized inventory level.


Inventory to reduce lead time gap


Lead time to manufacture a product consists of procurement time, manufacturing time and delivery time. All these together are also called as manufacturing lead time.


On the other hand, customer order cycle is the time between receipt of order from the customer and delivery. The customer wants this to be as less as possible. Company wants manufacturing lead time to be as high as possible to plan better at a better cost. The gap between manufacturing lead time and customer order cycle is called Lead time gap. To reduce this gap, either manufacturing lead time should be reduced or customer order cycle should be increased. We can safely assume that the customer cannot be made to wait longer and what in our control is the possibility of reduction of manufacturing lead time. One way of reduction of manufacturing lead time is by keeping a level of inventory. Inventory management is about this decision on level of inventory to be kept in stock.


Wrong reasons for Inventory


  • Poor quality either in in-house manufacture or in supply chain – With this there will be a tendency to manufacture more and stock more. Reliability in quality is one of pre-requisites to minimize inventory level
  • Unreliable supplier – When raw material or pre-part is sourced from outside, unreliability in supply chain adds to inventory. With unreliability, the procurement person tends to order more.
  • Inaccurate demand forecast – When manufacturing plan is based on forecast, accuracy of forecast has a vital link to inventory level. Poor forecast by the marketing will have an impact on inventory. No forecast is accurate. But error of forecast can be reduced by looking at past trends and closer interaction with the customer and market. Another way is, instead of depending on accuracy, have a lean production system to manufacture parts as per the pull of customer.
  • Poor planning –If planning of manufacturing schedule, raw material or parts with the supplier is poor, routing of parts for manufacture, inventory will get affected. Apart from the discipline by the person, taking care of production planning and control, he or she should be provided by a resource to have all data needed for planning.
  • Chasing after machine utilization – There will be a tendency especially in small scale industries, to use the machine fully utilized whether there is any customer order there or not. To fulfill the measurement parameter of machine utilization, persons in manufacture tend to produce more. If we shift the focus to manufacture only what can be drawn by customer even if the machine is to be kept idle, inventory level can be reduced. In manufacturing wastes, this is called as over production.


Link of Inventory to type of flow


The challenge of managing inventory depends on type of flow of goods. Three types of flow can be visualized.


Base flow: Constant predictable flow of goods. For example, milk supply. It is relatively easy to manage inventory here

Wave flow: Here demand is seasonable and can be reasonably predicted based on history. For example-rain coats

Surge flow: Here demand of products is highly unpredictable. For example- fashion products where there might not be a repeat order. It is a real challenge to keep and manage inventory here.


The author P S Satish is Mentor, Capability Developer and he trained thousands of engineers across the country. Mastered in Technology from IIT, Satish heads Bangalore based Saraswati Industrial Service, with 30 years of Industrial experience is serving engineering Industries in the area of capability development (purchase, quality & soft skills), consulting and mentoring. The focus is on overall improvement of the company for 3C-Competitiveness, Core-competency, Customer satisfaction.  You can reach him at gotopssatish@gmail.com; Mob: 9845043202


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