Background

Inventory turnover ratio:

COGS
Inventory turnover ratio=
Average Inventory
This will tell us how many times you roll around your operating capital (in inventory)

Problem:

Operating capital is $100000, all borrowed at 40% interest rate. The market is competitive. How do you
expect to make enough profit to not only pay your interest but also to have good left over margin for
the business?

Suppose using a margin of 20% you roll your capital 3 times per year, but if you were to apply a margin
of 15% you can roll your capital 5 times a year. Which margin will you prefer?

Solution:

Net margin after interest in option 1 is=20%*3-40%=20%

Net margin after interest in option 2is=15%*5-40%=35%

So, instead of focusing high margin per sale, we focus on turning the capital as many times as possible
with a low margin.

This is called inventory turnover ratio where we count everything as cash.

Problem:

Annual revenue is $500,000 and the retailer applies on average 20% markup on cost. The inventory at
beginning of the year was $40000 and at the end of the year was $50000. Do the following

1. Determine inventory turnover ratio (ITR)

2. Assuming that the retailer operates 360 days annually. On average how long does a piece of
inventory takes to sell.

Solution:

COGS
1. Inventory turnover ratio=
Average Inventory
Now Revenue=COGS+20% of COGS

Revenue=COGS+0,2 COGS

Revenue 500000
So COGS= = =416667
1.2 1.2
Average Inventory= (Beginning Inventory+Ending Inventory)/2
=(50000+40000)/2=45000

So inventory turnover ratio=416667/45000=9.25

Basically it means we roll our capital 9.25 times annually.

2.
Average no of days=(annual days of operation)/ITR
It requires =360/9.25=38.91892 days to sell an inventory.

Forecasting (Chapter 3):

Some notation:

t=time tag=time reference depends on the product but it needs to be clearly specified. T=1 begins at a
certain point of time from the calendar. And there after it is always incommented by 1 for every next
period.

Ft is the forecast of period t.

The units must be clearly specified.

At is actually realized value of demand

e t is the error in forecast for period t.

e t = At - F t

If e t is negative then its over estimated demand and if e t is positive then its under estimated demand.

Models that address demand with insignificant or no trend

1. Naïve Model
2. N-period moving average
3. N period weighted moving average.