Inventory Turnover As Indicator of Health of Inventory and Business

Inventory management as well as Supply chain operations are often overlapping and hold the key to the success of sales operations. In all of the businesses be in automobile, manufacturing, pharma or retail industry, status of inventory reflects the health of the business.

Inventory operations have two key elements namely Inventory System and Physical operations. Today inventory systems have replaced the book keeping and financial accounting that was being practiced earlier. Current inventory systems not only do the book keeping but are linked to upstream as well as down stream activities including procurement, sales processing, financial accounting.

In terms of measuring a sales performance in relation to Inventory, we often use the term Inventory Turnover. Inventory turnover simply refers to the number of times the inventory is sold or used in a period of one year. Inventory turnover is also termed as stock turn, or stock turnover.

Inventory Turnover is calculated by taking the Total Cost of Goods Sold, divided by Average Inventory. Adding together Beginning inventory and ending inventory and dividing the figure by 2 in turn calculate average Inventory.

The inventory turnover as a measure of health of sales and business is used extensively in Retail, textile as well as FMCG segments. A higher inventory turnover does indicate a healthy trend of increased sales and indicates the need to maintain adequate inventory levels to avoid stock outs. In adequate stocks can result in loss of business opportunities and is something that the management needs to keep watching closely. On the other hand a lower inventory turnover shows that either the sales of the said inventory is slowing down or that the unused inventory is building up clogging the system somewhere. A slow inventory turn can help the inventory manager focus on finding non-moving, obsolete and slow moving inventory items and thereby steps can be taken to deal with them appropriately.

Inventory turnover also reflects the holding cost that is incurred in managing inventory. Increased inventory turns reduce the holding costs. The costs especially fixed costs like rent and cost of operations get distributed over higher inventory throughput and thereby the cost of inventory transactions reduces.

Inventory turnover is also indicative of the health of inventory operations. When the inventory turnover is higher, the inventory operations efficiency will also be high to meet with the increased operational requirements thereby good house keeping and increased responsiveness to market requirements.

Inventory turn in some cases or some systems is also calculated based on the numbers sold rather than the average value of inventory. In such a system the Inventory turn is calculated by dividing the Number of Units Sold divided by the Average number of Units inventory held in a given period of time.

Over a number of years, each industry has developed methods to check inventory turnover and industry standards have been standardized. So whenever a new business venture is set up, they are able to have the industry standard as benchmark to be achieved and use it as a guide to streamline operations.