Inventory turns plus#
the Cost of Goods Sold (COGS) includes the purchasing costs of the raw materials, plus the manufacturing costs if there has been a transformation prior to selling the end product for a given time period.Inventory Turnover = Cost of Goods Sold / Average Inventory at Cost The purchasing perspective is reflected by: Inventory turnover formulaThe inventory turnover ratio is classically defined either from the purchasing perspective or from the selling perspective. Other factors like batch sizes, MOQ (Minimal Order Quantity), or EOQ (economic order quantity) also affect these ratios.
Indeed, distant suppliers (possibly oversea suppliers) entail high stock levels, as the stock needed to cover the whole lead demand is higher, which mechanically lowers the inventory turnover ratios. In practice, lead times are usually the driving force behind the observed inventory turnover ratios. While high ratios are frequently considered as the manifestation of good inventory management, they may also hint at insufficient safety stocks or insufficient protection against supply chain risks. Furthermore, low ratios increase the pressure on working capital requirements.Ĭonversely, high inventory turnover ratios are generally associated with goods being sold rapidly, and a healthy state of inventory, with few depreciation and obsolescence problems. Indeed, SKUs associated with low inventory turnover ratios are frequently associated with excessive inventory, or even dead inventory and inventory write-off. Thus, while inventory rotations do not equate profitability levels, they are correlated to a large extent.Īlso, when analyzing the inventory turnover ratios down to the SKU level, outliers are typically of prime interest from a Supply Chain Management (SCM) perspective. Yet, the two companies have roughly the same working capital requirements as far as their inventories are concerned. Overview of inventory turnover ratiosAll things considered equal, a company that manages to buy a unit of product for $1 and then resell it for $2 while performing this cycle 20 times a year will generate twice as much gross profits than a competitor performing the same cycle only 10 times a year. Methods to improve inventory turnover ratios
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