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July 25, 2006 Turning Over Inventory = Turning Over Savings Inventory turnover is very simply defined as the number of times that inventory “turns over” or goes though your warehouse in a year. For example, if a company’s inventory has an inventory turnover of 12 that means that it takes them one month to sell their entire inventory. (12 months in a year ÷ 12 turnovers per year = 1 turn per month) Simply put, inventory turnover is a measure of tracking how fast or slow your inventory is moving though your warehouse. Slower moving inventories will have to be kept in your warehouse longer, which in turn raises your Carrying Cost!! To quote our friend Mr. Jon Schreibfeder from issue 63, “Typically an annual carrying cost ranges from 21% to 25%. That means that it costs anywhere from 21 cents to 25 cents to maintain a dollars worth of inventory in your warehouse for an entire year.” Since inventories are usually the biggest investment in a company these numbers can be pretty big. Keep Inventory Moving
Calculating inventory turnover is also very easy to do. All you have to do is take the total cost of products that were sold though your warehouse and divide that by the average inventory investment: Total Cost of Products Sold (1 Year) ÷ Average Inventory Investment (1 year) = Inventory Turnover Let’s look at an example to see how this can really save you money: Cost of Goods Sold for the year of$1,800,000 and they have an average inventory investment of $300,000 for the year. With these numbers you can calculate how many times this company turns their inventory: $1,800,000 Cost of Sales ÷ $300,000 of Average Inventory Investment = 6 Turns per Year For this example, the company turns their inventory 6 times a year or every 2 months. Next we are going to assume the company has a carrying cost of 25%. This number means that 25% of your investment in inventory is contributed to carry cost. With this info we can now find the annual carrying cost: $300,000 Investment X 25% carrying cost = $75,000 Annual Carrying Cost This company spent $75,000 just to have items sit in the warehouse. Now let’s assume that $75,000 a year to carry inventory is way too expensive for this little company. Let’s also say that their 25% carrying cost can not be changed. The company’s best bet to lower their annual carrying costs is to lower their inventory investment. Let’s assume that they want to invest only $200,000 into their inventory instead of the original $300,000 this can be accomplished through better Inventory Management and Purchasing: $1,800,000 Cost of Sales ÷ $200,000 of Average Inventory Investment = 9 Turns per Year As this shows, if they were to turn over their inventory faster at 9 turns per year instead of the original 6 turns a year they will avoid an additional $100,000 dollars in Inventory Investment. This then carries down and saves them money in Annual carrying cost : $100,000 Investment X 25% carrying cost = $25,000 Annual Carrying Cost THAT’S A SAVINGS OF $100,000 OF INVESTMENT IN INVENTORY & $25,000 IN ANNUAL CARRYING COST!! This company could save thousands of dollars in inventory investments and carrying costs simply by increasing their inventory turnover rate (moving their inventory through the warehouse at a quicker pace). This example clearly shows how inventory turnover is a great way to assess how effective your inventory management is. Research has shown that most distributors who have 20%-30% gross margin should try and achieve an overall turnover rate of five or six. The higher your gross margins are, the more you can afford to turn your inventory less. Most food guys especially the distributors work under less margin and then its an absolute necessity they have higher turns. The key to this system working and being efficient is that your Average Inventory & products sold numbers NEED to be ACCURATE!!
THE FASTER YOU TURNOVER YOUR INVENTORY THE MORE MONEY YOU SAVE To Unsubscribe
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