Module 5

Distribution Planning
Notes

MBA Semester 4
Course – Sales and Operations Planning

Topics Covered
1. Distribution Planning
2. Sales Orders
3. Lead time
4. Inventory analysis
5. Use of ERP

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 Module – 5
Distribution Planning
1. Distribution Planning

Distribution Requirements Planning (DRP)

Distribution requirements planning (DRP) is a systematic process to make the delivery of goods
more efficient by determining which goods, in what quantities, and at what location are required
to meet anticipated demand. The goal is to minimize shortages and reduce the costs of ordering,
transporting, and holding goods.

Also known as distribution replenishment planning, DRP is a time-based approach that

determines when inventory is likely to be depleted and plans replenishment to avoid shortages.
DRP uses a tree-like structure where a central facility, such as a warehouse, supplies regional
facilities which then supply other facilities in the tree. This structure can contain any number of
layers.

A key element of DRP is the DRP table, which usually includes elements that are important in the
process, including:

 forecast demands
 current inventory levels
 target safety stock
 recommended replenishment quantities
 replenishment lead times

DRP distribution works by either a pull or push method. The pull method has goods move up
through the network by fulfilling customer orders. This provides more availability for consumers
because local management controls the availability of the goods. However, managing distribution
inventory can be difficult because every order is new to the supplying location as demand flows
up the network. This is called the "bullwhip effect:" small changes in consumer demand that
generate large swings in demand higher up the network.

In contrast, the push method sends goods down through the network. It generally has lower costs
because shipments are planned globally and stored centrally. However, service levels can suffer if
central planning is too far removed from the actual demand.

DRP ideally combines the service levels of pull with the efficiency of push, but this depends on
accurate forecasts and stable processes to be successful. If both of these exist, DRP produces high
fulfilment performance with minimal inventory. Companies usually try to hedge their bets by
using safety stock, but that can reduce the overall effectiveness of the DRP strategy, resulting in
higher inventory levels or shortages.
A number of vendors include DRP modules in their ERP software.
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2. Sales Orders

Definition of sales order

A sales order is a document generated by the seller specifying the details about the product or
services ordered by the customer. Along with the product and service details, sales order consists
of price, quantity, terms, and conditions etc.

Components of sales order

A sale order usually carries information such as customer’s name, shipping address, transaction
date, products ordered, descriptions, units of measure, quantities, prices, taxes, etc. The key
details of the sales order are listed below:

• Name and contact information of the company (seller)

• Name and contact information of the customer
• Customer billing information
• Customer shipping information
• Information about product or service
• Price before taxes
• Tax, delivery, and shipping charges
• Total price after taxes
• Terms and conditions
• Signature
• Any other relevant information as needed

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Sales order sample format

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Sales order process and procedure

The step-by-step sales order process is explained below:

 The buyer sends a request for a quote from a vendor.
 After receiving the request, the vendor sends back the quote.
 The customer considers the quote reasonable and sends a purchase order.
 The vendor receives the purchase order (PO) and generates a sales order using the details
of PO.
 The vendor sends the sales order to the customer to confirm the terms of the sale.
 The vendor assembles and prepares for delivery of goods and services requested.
 The vendor delivers those goods or services as per the order.
 Using the details of the sales order, the vendor generates the invoice and sends it to the
customer.
 The customer pays the amount specified on the invoice within the allotted time frame.

Automating sales order process

Sales orders play a central role in making sure a sale is well-documented, properly conducted, and
reflective of what both sides are expecting.
When the order is received from a customer for goods to be supplied, the Items, quantities, date
of delivery, etc., details are given with sales order number. Later when these goods are delivered,
this sales order is tracked for the order details either in the delivery challan or in the sales invoice.

Automating the sales order process using accounting software has helped businesses to track the
complete journey right from receiving order till it is fulfilled.
Since the order details recorded in the system and the insights such as pending orders, due dates
etc. has helped businesses in fulfilling customer needs and expectations contributing to better
customer experience. Not just that, since the system knows the anticipated inventory outflows
based on the order details, help you in optimum inventory management.
Overall, accounting software will give your business a centralized system to manage every area of
your business, removing the stress and inefficiency of manual, time-consuming processes.

3. Lead Time

What is Lead Time?

Lead time refers to the time interval or time duration between the commencement and
completion of the project.

To simply put, it is the time-lapse measured from the start to the end of the product.

How to Calculate Lead Time?

Though the lead time seems to be a technical term, the lead time calculation is much more
straightforward.

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Before we get on the calculation part, it's essential to know that the lead time depends on the steps
involved in the supply chain. Based on the sequence of steps, time is calculated to get the exact
lead time.

Lead time formula

As the supply chain management system is inclusive of manufactures and retailers, the following
formula is used:

For manufacturer

Manufacturing Time + Procurement Time + Shipping Time = Lead time

For retailer

Procurement Time + Shipping Time = Lead time

Why is Lead Time central to Inventory Management?

As we discuss lead time concerning inventory management, you can say that lead time is
necessary to run your inventory smoothly. It is the most critical aspect and a sign of an efficient
inventory management system.

Well, this is not the only reason. To understand in-depth about the topic, let's take a look at the
following importance to unlock the reasons as to why Lead Time is considered as an essential part
of Inventory Management:

1. Demand Estimation and Forecasts

2. Order Management

3. Management of Suppliers

Components of Lead Time

The components of lead time can be divided into six major components. All of these components
are crucial and are presented in chronological order. The details to which are as follows:

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1. Preprocessing Time

Preprocessing time includes receiving the request, understanding it, and then creating it as a
purchase order. The term is alternatively known as the planning time, referring to making an
order for the product/item that one wishes to buy.

2. Processing Time

After preprocessing, the time taken to procure or produce the order based on the previous request
is known as processing time.

3. Waiting Time

Waiting time means the time taken to procure necessary items or raw materials until the
production process commences.

4. Storage Time

Storage time is the amount of time taken for the items to stay in the warehouse waiting for
delivery

5. Transportation Time

Transportation time is simply the time taken by the item to reach the final customers.

6. Inspection Time

Inspection time is the final component that refers to the time taken to check the products for any
defaults or shortcomings before delivering to the customers.

Lead Time = Preprocessing Time + Processing time + Waiting time + Storage time +
Transportation time + Inspection time

Factors that affect Lead Time

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Benefits of Calculating Lead Time

1. Meeting the deliveries consistently and effectively

2. Reduces the problem of overvaluation and undervaluation of the stock

3. Enhances the customer's trust, support, and loyalty

4. Builds brand value and sets you apart from your competitors

5. Unlock the doors for innovation to improve lower lead time

6. Increase in the cash flow of the business by ensuring timely payments

7. Increases the flexibility in Procurement, shipment, and final delivery of good

4. Inventory Analysis

What Is Inventory?

Inventory is the accounting of items, component parts and raw materials that a company either
uses in production or sells. As a business leader, you practice inventory management in order to
ensure that you have enough stock on hand and to identify when there’s a shortage.

The verb “inventory” refers to the act of counting or listing items. As an accounting term, inventory
is a current asset and refers to all stock in the various production stages. By keeping stock, both
retailers and manufacturers can continue to sell or build items. Inventory is a major asset on the
balance sheet for most companies, however, too much inventory can become a practical liability.

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What Is Inventory Analysis?

Inventory analysis is the study of how product demand changes over time and it helps businesses
stock the right amount of goods and project how much customers will want in the future.

A well-known method for performing inventory analysis is ABC analysis. To perform an ABC
analysis, group goods into three categories:

 A inventory: A inventory includes the best-selling products that require the least space
and cost to store. Many experts say this represents about 20% of your inventory.

 B inventory: B items move at a similar rate to A items but cost more to store. Generally,
this represents about 40% of your inventory.

 C inventory: The remainder of your stock costs the most to store and returns the lowest
profits. C inventory represents the other 40% of your inventory.

Benefits of Inventory Analysis

Inventory analysis raises profits by lowering costs and supporting turnover. It also:

1. Improves Cash Flow: Inventory analysis helps you identify and reorder items you sell
often, so you don’t spend money on inventory that moves slowly.

2. Reduces Stockouts: When you understand which inventory customers want most, you
can better anticipate demand and prevent stockouts.

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 3. Increases Customer Satisfaction: Analyzing inventory offers insight into what and how
customers purchase goods.

4. Reduces Wasted Inventory: Understanding what, when and how much people buy
minimizes the need to store obsolete products, as well as when products expire so you can
have a strategy behind using them.

5. Reduces Project Delays: Learning about supplier lead times helps you understand when
to reorder and how to avoid late shipments.

6. Improves Pricing From Suppliers and Vendors: Inventory analysis can lead you to order
high volumes of products regularly rather than small volumes on a less reliable schedule.
This regularity can put you in a stronger position to negotiate discounts with suppliers.

7. Expands Your Understanding of the Business: Reviewing inventory provides insights

into your stock, customers and business.

Techniques / Methods of Inventory Control

(1) MODERN TECHNIQUES

(a) Economic Order Quantity (EOQ)

(b) Re-Order Point (ROP)

(c) Fixing Stock Levels

(d) Selective Inventory Control

(i) ABC Analysis

(ii) VED Analysis

(iii) SDE Analysis

(iv) FSN Analysis

(2) TRADITIONAL TECHNIQUES

(a) Inventory Control Ratios

(b) Two Bin System

(c) Perpetual Inventory System

(d) Periodic Order System

(a) ECONOMIC ORDER QUANTITY (EOQ)

The optimal size of an order for replenishment of inventory is called economic order quantity.
Economic order quantity (EOQ) or optimum order quantity is that size of the order where total
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inventory costs (ordering costs + carrying costs) are minimized. Economic order quantity can be
calculated from any of the following two methods:

• Formula Method

• Graphic Method

Formula Method: It is also known as ‘SQUARE ROOT FORMULA’ or ‘WILSON FORMULA’ as given below:

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Note: ROL – Re Order Level, ROQ – Re Order Quantity, ROQ is also known as EOQ (Economic
Order Quantity)
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DANGER LEVEL

Danger level refers to the level below the minimum stock level. The following factors should be
considered to determine the danger level:

 Causes for failure of regular supplies

 Easy and quick sources of supply
 Rescheduling of work- order in the light of such exigencies
 Quickest means of transportation
 Emergency period of procurement

Formula

Danger Level = Minimum rate of consumption x Emergency delivery period.

Danger Level = Maximum rate of consumption x Emergency delivery period.

(d) SELECTIVE INVENTORY CONTROL

Controlling all inventory in the stock is a very difficult task especially where huge inventories are
maintained of variety of items. In such circumstances, following smart techniques for managing
and controlling the different types of inventories held are as follows:

(i) ABC Analysis: ABC analysis may be defined as a technique where inventories are analyzed
with respect to their value so that costly items are given greater attention and care by the
management. Three categories are created namely A, B and C. Following table represents the
approximate classification of items along with their value and quantity.

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Self-Assessment Questions

Q.1. Kuber Enterprises require 2, 70,000 units of a certain item annually. The cost per unit is Rs.
3, the cost per purchase order Rs. 100 and the inventory carrying cost Rs.6 per unit per year. What
is the economic order quantity?

Q.2. Explain the factors affecting the level of inventory in an organization.

Answers to Self-Assessment Questions

1. Here, R = 2, 70,000, O = 100, Unit Price = 3, C = 6

EOQ = √2RO / C

= √2(270000)(100) / (6) = 3, 000 units

2. Some significant factors affecting the level of inventory are explained as follows:

1. Nature of business: The level of inventory will depend upon the nature of business whether it
is a retail business, wholesale business, manufacturing business or trading business.

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2. Inventory turnover: Inventory turnover refers to the amount of inventory which gets sold and
the frequency of its sale. It has a direct impact on the amount of inventory held by a business
concern.

3. Nature of type of product: The product sold by the business may be a perishable product or a
durable product. Accordingly, the inventory has to be maintained.

4. Economies of production: The scale on which the production is done also affects the amount of
inventory held. A business may work on large scale in order to get the economies of production.

5. Inventory costs: More the amount of inventory is held by the business, more will be the
operating cost of holding inventory. There has to be a trade-off between the inventory held and
the total cost of inventory which comprises of purchase cost, ordering cost and holding cost.

6. Financial position: Sometimes, the credit terms of the supplier are rigid and credit period is
very short. Then, according the financial situation of the business the inventory has to be held.

7. Period of operating cycle: If the operating cycle period is long, then the money realization from
the sale of inventory will also take a long duration. Thus, the inventory managed should be in line
with the working capital requirement and the period of operating cycle.

8. Attitude of management: The attitude and philosophy of top management may support zero
inventory concept or believe in maintaining huge inventory level. Accordingly, the inventory
policy will be designed for the business.

Model Questions

Q.1. Jaidev enterprises manufacture a product ‘EMR’. The following particulars are collected for
the year 2016:

1. Annual demand of EMR- 1,000 units

2. Cost of placing an order Rs. 100

3. Annual carrying cost per units Rs. 10

4. Normal usages 100 units per week

5. Minimum usages 50 units per week

6. Maximum usages 150 units per week

7. Re-order period 2 to 6 weeks

Calculate the following:

a. Re-order Quantity

b. Re-order level

c. Minimum Level

d. Maximum Level

e. Average stock level

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Q.2. A manufacturing company will require 1, 00,000 units of a product during the next year.
The cost of processing an order is Rs. 40 and the carrying cost per unit is Rs.2 per year. Lead
time of an order is 5 days and the company will keep a safety stock of two days usage.

You are required to calculate the following:

1. Economic order Quantity

2. Re-order Point

3. Minimum Inventory
4. Maximum Inventory

5. Average Inventory.

5. Use of ERP

Enterprise Resource Planning (ERP) is a computer system that integrates application

programs in accounting, sales, manufacturing and other functions in the firm. This integration is
accomplished through a database shared by all the application programs

Advantages

 Standardise and improve processes

 Improve the level of systems integration
 Improves quality of information
 Sharing of information - quick decisions, less admin
 Schedule production, utilise capacity
 Guides staff through processes
 Less IT maintenance

Challenges

Enterprise Requirements Planning (ERP) in practice is extremely difficult to implement. A

number of prerequisites exist. These include:

 accurate bottom up forecasts

 open lines of communication
 flexible manufacturing and distribution systems
 improved communications with suppliers and customers
 accuracy in the collection of data, i.e. Bill of Material (BOM) and Inventory Records
 a high level of management commitment

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