By Vijay Virmani, Senior Principal Customer Success Specialist
In an increasingly competitive landscape, businesses need to constantly analyzing their data to see where they can get ahead. Inventory turnover is a simple measure that when compared against competitors and companies outside of industry can bring a competitive advantage. The ratio highlights opportunities to learn best practices, reflects on overall business management, and can lead to cost saving opportunities.
Inventory turnover is the number of times a company sells and replaces its stock of goods during a period. It provides insight as to how the company manages costs and how effective their sales efforts have been.
Do you know how quickly your inventory is being moved at any given time? If not, you should, and you can easily find this information by calculating your inventory turnover.
Inventory turnover = Cost of goods sold/ Average on-hand inventory* value for a period
*On-hand inventory includes raw materials, sub-assemblies, finished goods or stock keeping units (SKUs).
What do the numbers mean?
Inventory turnover is most commonly measured over a year. A higher number generally means strong sales and low inventory levels at any given time period.
Efficient inventory turnover help to ensure:
However, carefully managing the benefits and risks of higher turnover should be top of mind, as it increases the risk of lost sales opportunities due to stock out and customer complaints.
Lower inventory turnover most likely mean poor sales and an excess of inventory on-hand.
Different areas of your organization play a role in inventory requirements. Here are some things to consider when trying to improve inventory turnover:
Inventory turnover optimization requires strategy that involves organization and cannot be achieved through the efforts of the inventory/material planning group alone.
Let’s look at how different groups in an organization interact on business strategy and can impact the inventory turnover.
Sales and Marketing
Sales and marketing decide on what products and variation of products to offer in the market to meet target revenue. The end products offered to customers are commonly as SKUs. The number of SKUs offered in the market directly impact the inventory value on-hand.
Sales and Product Owners
Lead time expectations are set by sales and product owners.The finished goods need to be available on-hand for shorter lead times.To the other extreme, customer orders can be shipped directly by suppliers without carrying any inventory on-hand at all.The lead time for the customer orders shipped by suppliers can be managed by partnerships with suppliers and system capability to process drop ship orders
Product development teams develop structure and details on how to build SKUs.The number of components/sub-assemblies required and lead time to assemble or manufacture the SKUs play a role in inventory value in a given time period. Inventory value of raw materials and sub-assemblies are less compared to finished goods inventory. Make to order, configure to order or assemble to order business models reduce the need for finished goods inventory but may increase lead time. Product development is not required in a pure business model where goods are purchased and sold (e.g. retail store model).
Supplier qualifications and contract negotiations play a vital role in the procurement process.The purchasing execution becomes easier with qualified suppliers with pre-negotiated prices and terms. Good quality materials with short lead times lower the inventory level required to fulfill open orders. Consigned goods and vendor managed inventories are good examples of reducing inventory value on-hand.Vendor managed inventory is one of the best to reduce the inventory value and lead time as the ownership of the goods are transferred at a point of sale and level of inventory is managed by the suppliers.
Partnership with suppliers is important.Suppliers can help with reducing lead times and inventory levels if they are engaged in material planning and execution process.Suppliers can plan and deliver quality supply periodically to meet the demand plan using Just in Time (JIT) or Kanban techniques.
Customer order capture to shipping process impacts the inventory on-hand.The shorter order cycle results in higher inventory turnover. Order definition, order booking, order promising, manufacturing execution, shipping method, shipping location, and shipping terms (e.g. ship and bill) are components of order cycle time that impact inventory turnover.
You can improve inventory value to some extent with localized efforts. However, all areas of the business need to do their part for achieving significant improvement towards the desired inventory turnover outcome. Holistic business strategy and execution across the entire business processes are critical for achieving the most desired outcome in inventory value and turnover.
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