We work a lot with manufacturers, where inventory can be a blessing on the shelf or a four-letter word. Knowing whether you have too much or too little of this capital-intensive resource can occupy a great deal of a company’s grey matter, trying to strike the right balance.
We are reminded of this in an article by Dave Turbide, CPIM, an independent consultant writing for the current issue of APICS Magazine (July/August, 2016). The discussion usually starts with the word ‘turnover.’ As Turbide reminds us, the APICS Dictionary defines turnover as “the number of times an inventory cycles or ‘turns over’ during the year.” It’s calculated by taking your average inventory level and dividing that by your annual cost of sales. So if you carry $5 million in inventory and your cost of sales is $30 million, your inventory turn is 6 – or six times per year, or about once every two months.
So… is turning your inventory once every two months good? Well, it depends. You have to compare to the levels of other companies similar to yours. Such comparisons can provide insights about how your competitors manage their assets, or whether or not they are able to respond to sudden changes in demand.
One good way to compare to industry averages is to see what the good folks at the U.S. Census Bureau have to say. You can compare your performance in turns to industry averages with the data they provide at www.census.gov/econ/manufacturing.html.
You might also compare your own returns over time, say year over year. Generally, a higher level of returns implies better performance overall as you support more turns (i.e., sales) with a smaller amount of inventory (i.e., cost). On the other hand, you have inventory for a reason, and while too much can be costly or wasteful, too little can mean anything from order shortfalls to manufacturing constraints, lost business or plant (or customer) disruptions – none of which are good.
Performance enhancements can occur not only by reducing inventory (i.e., improving returns) where you’re overstocked, but also from finding ways to shorten lead times (inbound or outbound), changing lot sizes or through packaging allotment changes or other ways of removing variability.
Turbide in his article also reminds us to “keep an eye on turns by inventory type, such as finished goods (in relation to customer service achievement) and raw materials components (relative to production disruptions caused by shortages). Each type of inventory has a different usage profile and thus different service-level expectations and stocking guidelines.”
Finally, note that inventory ‘turns’ is a better indicator than is raw inventory value because it puts the inventory level in the context of the sales volume of the business. When combined with your other key business barometers (historical performance, inventory availability and shortages, and general ‘good business practices’) your turns level will give you a solid gauge of your company’s performance.