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What Is ERP And How Does It Work?

The ERP definition is incomplete without “integration” as its component. It’s the key to Enterprise Resource Planning software. It destroys organization silos by creating a single repository that employs multiple modules and integrates different departments carrying out varied business functions. In the next paragraph, let’s define ERP and see how an ERP functions.

Table Of Contents

What is ERP ?

Enterprise Resource Planning systems are software systems that are used to manage various business processes. These include inventory management, resource planning, financial management, transportation, human resource management, accounting, marketing, sales, distribution, manufacturing, service and maintenance, and e-business. So essentially, what is ERP software?

An ERP software contains various modules that facilitate the transparent integration of modules and allow information to flow independently from one department to another.

Vendors offer ERP solutions

What Is ERP And How Does It Work?

As described above, an ideal ERP software is one that contains a single repository where data is controlled through multiple modules. Following are the various modules that facilitate the flow of information:

1. Manufacturing Module: This module contains functions such as workflow management, bills of material, engineering, capacity, manufacturing process, quality control, etc.

2. Human Resources Module: This module contains functions such as time and attendance, training, benefits, payroll, mandatory compliance, etc.

3. Supply Chain Management Module: This module contains functions such as inventory, supply chain planning, supplier scheduling, claim processing, order entry, purchasing, etc.

4. Financial Module: This module contains functions such as fixed assets, accounts receivable, accounts payable, cash management, general ledger, etc.
5. Project Module: This module contains functions such as Time and expense, costing, activity management, billing, etc.

6. Data Warehouse Module: This module helps different stakeholders — the organization’s customers, suppliers, and employees — to communicate with each other and to access business-critical information.

7. Customer Relationship Management Module: This module contains functions such as sales and commissions, marketing, calls center support, service, customer contact, etc.

ERP offers you

ERP Systems Provide Benefits to Small, Medium, & Large Firms, like-


Reduces labor Costs


Improves accounting controls

Decreases cost of materials

Betters customer service

1. Reduce Labor Costs: ERP software leads to less rework and fewer shortages. Typical studies reveal that they save about 10% of direct and indirect labor costs. It provides better visibility to supervisors that help them achieve set schedules. It also provides them enough time to evolve better methods and enhance throughput.

2. Improves accounting controls: ERP software improves cash availability by developing better collection procedures that decrease the days required for outstanding receivables. It does this by expediting invoice creation, credit checking during order entry, and enhancing the handling of customer inquiries.

3. Decreases cost of materials: ERP software helps decrease the cost of materials by refining the procurement process and improving vendor negotiations.

4. Betters customer service: ERP software helps manage customer contacts, reduce ship lead times, and handle customer grievances appropriately. They check the reasons of demand fall and suggest tried and tested ways to fix them. Typical studies indicate that ERP systems lead to an increase in actual sales by 10% or more.

The data is updated the data in real-time and various departments can access this data through a single software with personalized dashboards. This will minimize the communication required between two parties and maximize the productivity.

ERP to cut costs

Evolution Of ERP

Full form of ERP is Enterprise Resource Planning. Since its introduction in the 1960s, it has evolved into a flexible tiered client-server architecture. The following points describe how ERP systems have evolved over the years.

The 1960s:

The 1960s:

The first version of an ERP system was known as Inventory Management and Control (IMC). It was a combination of information technology and business processes that ensured that warehouses always had an adequate level of inventory. It helped identify inventory requirements, monitor item usages, implement replenishment techniques and options, fix targets, regulate the inventory balances, and report inventory status.


The 1970s:

The next decade saw the rise of Material Requirement Planning (MRP) that helped schedule production processes. They allowed the generation of reports for the purchase of raw materials according to the production requirement of manufactured products. They also monitored inventory levels and the lot-sizing procedure for each operation.


The 1980s:

The 1980s saw an improved version of MRP — the MRP 2. It employed software applications for regulating manufacturing processes — from material acquisition, product planning, inventory control to product distribution.expanded the reach of MRP to SMEs through flexible disk drive.


The 1990s:

This was the decade when Enterprise Resource Planning or ERP, as it's widely known, came into existence. It used a multi-module application software for enhancing the performance of the internal business processes. It had all the abilities of MRP (the 1980s) with added software functionalities to support integration within the business silos.

Today, ERP systems are proving useful to different types of businesses including for-profit and non-profit organizations, non-manufacturing businesses, and governmental departments. ERP has become an all-round software package as it provides Supply Chain Management (SCM), Customer Relationship Management (CRM) along with modules. The ERP system can be modeled keeping in mind the requirements of the company. For example, if a two-wheeler manufacturing company wants to expand its business by making four-wheelers, it can remodel the ERP system quickly and at a low cost.

Costs Of Implementing An ERP System

ERP implementation costs can be divided into two parts — Annual costs and one-time costs. These costs can be divided into multiple factors including hardware, consulting and training, and time. The major factor responsible for deciding the cost of an ERP system is the number of concurrent users — the number of people who use it at any given time.

  • Hardware: The vendor specifies which hardware should be used for the ERP system. From time to time, the hardware should be improved to protect the ERP from wear and tear. Also, with improvements in technology, new hardware components reduce lag, increase data-transfer speed, and improve connectivity.
  • Consulting and Training: To make full use of enterprise resource planning software, employees working in a company need extensive training. But it’s on the company to decide the amount of training needed. It depends on the following factors: Knowledge of employees working in the company, the complexity of the ERP package, and to what extent external personnel will be required to implement the system. The typical time required to implement ERP in small businesses is about 4-6 months whereas, in the case of large enterprises, it’s 9-24 months.
  • Implementation Time: This factor determines the time required by the implementation project team to implement the ERP system. Also, it includes the time needed to train various stakeholders — including the Management Information System (MIS) team, executives, and users in different departments — to producing customized reports, developing data, and organizing meetings with consultants.

How Can a Company Calculate One-Time Costs?

It’s fairly easy to calculate the One-Time costs. They are calculated using ratios with ERP software costs. Some of them are described below:

  • Inventory Turnover costs: Low inventory turnover means overstocking inventory whereas high turnover symbolizes superior materials management. It’ calculated using the formula = Cost of Sales/Inventory.
  • Days of Receivables: It denotes the average time in days that receivables are outstanding. It’s calculated using the formula = (365 * 1/ (Sales/Receivables)).
  • Return on Assets: It gauges the effectiveness of management in using the resources accessible to it. It’s calculated using the formula = (Profit before Taxes/Total Assets).

How Can a Company Calculate Annual Costs?



These costs will be specified by the ERP vendor to run the software.



It depends on the annual customer support agreement — including software upgrades, telephonic, and face-to-face support — with the vendor.

Consulting and Training

Consulting and Training:

These costs depend on factors such as improving business processes, training new personnel throughout the year, upgrading software functionality, etc.

Implementation time:

The number of MIS experts required in the facility will depend upon the nature of the ERP software package. For a micro-based ERP package, less number of MIS experts will be required. Whereas for a mainframe ERP package, a large group of MIS experts will be required.

Multi-Tier ERP Systems

ERP implementation is a rigorous exercise. If it’s implemented successfully in a business, it can boost the revenues, control costs, and increase employee efficiency. The best measures of success of ERP implementation are its impact on the bottom line and business performance. The degree to which the ERP system is used in a company is yet another measure of successful ERP implementation. The following points make it clear.

1. Class A User: When all the business-critical functions are managed by an ERP, it is known as Class A user. The products are built according to the manufacturing database and efforts are taken to ease business processes and factory designs. The enterprise resource planning software prepares Sales & Operating (SoP) plans that determine the market-demand, develop realistic sales graphs, and coordinate supply chain activities. The most important feature of a class A Enterprise Resource Planning software is that it updates accounting, gives useful management information, and updates according to the latest release from the software vendor.

2. Class B User: When the enterprise resource planning software is used to partially run the business, it’s termed as a class B user. They prepare the SoP plans that don’t have a company-wide agreement. The schedule of a majority of supply chain activities is created by the ERP, but some of them are kept outside its purview. There exist some informal and parallel systems to manage exceptions that lie outside the formal system. Also, the manufacturing database of the ERP contains the exact model of how products are built. But the quantity of reasonable exceptions is also high. Moreover, enterprise resources planning software updates accounting functions but also raises many exceptions that attract suspecting eyes.

3. Class C User: When the enterprise resource planning software is used only partially, it’s termed as a Class C user. The basic function of ERP includes recording information related to shipments, accounting, sales, purchase orders, etc. The manufacturing database of ERP doesn’t show an accurate model of how products are built. The SoP plans don’t virtually exist and most sales orders make inaccurate delivery promises. The accounting applications of the ERP are not updated. And what about the version of ERP? Most of the time, the ERP reflects an older version.

4. Class D User: What is a Class D user and how does it differentiate from these above? The basic difference is that of ERP and its usage. In this, the ERP system is either not used at all or used to run only in the management information system (MIS) function. Most of the business systems are managed through informal and parallel systems. Moreover, there are no SoP Plans as well.

Class A User

Class B User

Class C User

Class D User


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