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Four Inventory Turns Per Year Doesn't Cut It Anymore!

by Howard Coleman

I may be over estimating the inventory turns of a typical wholesale-distributor, as I recently visited with a few with 2.5 to 3.0 turns per year!

There are large savings as a result of optimizing inventory and improving inventory practices. Just by improving one turn, a typical wholesale-distributor can save hundreds of thousands of dollars! Consider this example:

XYZ Company  
Cost of Goods Sold $20,000,000
Total Inventory Value (average) $5,000.000
Days of Inventory 91
Inventory Turns 4.0
Annual Carrying Cost $1,000,000
Cash Tied Up in Inventory $5,000,000
   
If "XYZ" increased turns by "1"  
Inventory Turns 5.0
Days of Inventory 73
Annual Carrying Cost $800,000
Annual Carrying Cost Savings $200,000
Cash Tied Up in Inventory $4,000,000
One Time Cash Savings $1,000,000

 

 

 

 

 

 

 

 

 

 

 

 

We can illustrate this another way. Let's say you turn inventory four time per year. In effect, you are being paid every 90 days! Would you be OK with getting your paycheck that infrequently?

What Are The Rules Within Your Inventory Supply Chain?
Rules usually evolve over time and often may not be re-evaluated for many years. Sometimes it's because "we've always done things this way." Often, the rules were established to cover flawed processes that lead to excess inventory, excess inventory carrying costs, and the pressure on cash.

Surely, focusing on your processes can yield positive results. The traditional areas of focus – such as eliminating/reducing slow-moving and obsolete inventory, better forecasting and improving your technology utilization – are all good candidates, as are a myriad of other possible initiatives. Yet, improving your supply chain strategy can have the most positive impact. It does, however, require a change in thinking, a plan and a timeline.

What's The "Price" To Be Paid?
Anyone even remotely involved in inventory management knows that increasing inventory turns generates more free cash flow, but comes at a price (increased transaction costs, more receiving, inspecting, put-away, maybe even having to pay more invoices). Consider this extreme example: a company that buys inventory only once per year is getting a cheaper overall price (total cost of acquisition/ownership) than a more frequent buyer. So, I guess there is a point of diminishing returns. But, going back to the first example, there would have to be one heck of an increase in transaction costs to suck-up the annual savings and one-time cash savings. So, the argument, "I'll have to hire more people to handle the additional transaction load" doesn't resonate. Rather, why not "lean" the processes that may be impacted? In other words, improved inventory turns can be obtained and sustained in a truly waste-free "lean enterprise" where "lean" becomes a key tool.

How To Improve Inventory Turnover
First, take an end-to-end view. You need to optimize your inventory supply chain, make your internal processes leaner and optimize your supply chain relationship with your suppliers. Minimize inventory at every point in your supply chain and drive the waste out.

Become more like Wal-Mart (yes, I know, they are different). The point is, through their lean supply chains, Wal-Mart sells product way in advance of having to pay suppliers for it. Maybe you can't be just exactly like Wal-Mart, but I think you get the message as to direction.

What can you do? Take a different approach. As I mentioned earlier, it requires a change in thinking. Many Fortune 500 companies have or are in the process of transitioning to a "Pull" approach to inventory and supply chain management, versus the "Pushing" of inventory into their stocking locations. It's a concept that is only now making its way into smaller enterprises and emphasizes less reliance on demand forecasts (which are not usually very accurate anyway), replenishing inventory based on what was actually sold (the customer's buy signal), reducing replenishment order cycle times (compressing time), and reducing those buffer inventories you maintain to guard against uncertainty. Our thought-leadership white paper "Lean Principles in Wholesale Distribution Supply Chains – Do You Pull or Push?" explains this in more detail.

Supplier Relationships
In recent years, partnership has become a popular term to describe the type of relationship of trust that companies have, or want to have, with their suppliers. But, every good supplier may not make for a good partner, so some criteria must be met.

More specifically, as it regards your focus on improving inventory turns, the ability to develop an understanding of total acquisition/ownership cost and how your supplier can impact total cost and improved inventory turns is surely one of my top criteria. The intention is not a one-way street because there are several ways that a supplier can benefit also. The above mentioned white paper describes this in detail also.

I realize that in your business, too much inventory is or was not part of your strategic plan or a deliberate business decision to tie up too much capital. But inventory does creep in for a variety of reasons related to inventory and supply chain management practices. Four turns per year does not have to be accepted as a way of doing business.

If you are in this category of four turns or less, it took time for you to get to this point. It will require traveling down some new avenues, maybe not often associated with your type of business, to see a new reality in inventory turns.

Howard ColemanHoward Coleman, principal of MCA Associates, a management consulting firm since 1986, works with wholesale distribution and manufacturing companies that are seeking operational excellence. Our staff of Senior Consultants provides operational excellence – idea leadership - and implements continuous improvement solutions focused on business process re-engineering, inventory and supply chain management, sales development and revenue generation, information systems and technology, organizational assessment and development, and succession planning. MCA Associates may be contacted at 203-732-0603, or by e-mail at hcoleman@mcaassociates.com. To learn more, visit  www.mcaassociates.com.

COMMENTS: 11
Financial management
Posted from: Vivian Shellmire, 2/15/16 at 11:05 PM CST
Goods source for helping students who are future accountants to understand the importance of reporting COGS and Inventory costing, management, and turnover.
Inventory
Posted from: stuart emmett, 1/28/16 at 5:09 AM CST
Good piece and for my "General Truths on Inventory" please see: https://www.linkedin.com/pulse/general-truths-inventory-stuart-emmett-msc-ba-hons-?trk=mp-reader-card
4 Turns per year doesn't cut it anymore
Posted from: Turns Will Come, 11/6/15 at 10:22 AM CST
Inventory turns are an outcome of responsible supply chain management. Consignment, LTA's, stocking programs, lead time agreements, etc. are the methods that, once employed CORRECTLY will lean out the supply chain and subsequently increase turns. Less money tied up in inventory. It is important to note that thorough analyses need to be done to determine with materials are good candidates for which method of replenishment. Liability can grow with supplier inventory if the proper process is not followed.

This was a great article. Thank you.
Inventory turns
Posted from: JoAnn Steward, 3/9/14 at 2:10 PM CDT
I enjoyed reading the comments here, but no one mentioned the special circumstances that must be considered when dealing with minimum order quantities, 4 - 6 month lead times, and transportation costs of imports. My company is considering calculating turns separately for domestic and import inventory. I would love to read some comments on these points. Thank you.
Canvas Bags
Posted from: Canvas Bags, 7/3/12 at 6:37 AM CDT
Hi. Just a quick note to let you know that I truly appreciated this post. I have been looking for this kind of information. Keep up the good work!
New Zealand Grocery Merchandising
Posted from: New Zealand Grocery Merchandising, 2/6/12 at 11:18 PM CST
Higher inventory turns mean that the business keeps lower levels of inventories on hand relative to their overall production activity during the period and translates more of the produced goods into sales. Lower values mean that higher proportions of production expenses are getting ‘stuck’ in inventory.
<a href="http://www.strikeforcenz.co.nz/results.php">New Zealand Grocery Merchandising</a>
Posted from: Jimmy Walker, 11/5/10 at 2:13 PM CDT
Howard, I agree with a lot of your thoughts here but I have also seen what too many turns can do to a company as well. There is a happy medium to the turns. Some companies will take this a little to far and think that more turns are going to help them when, in turn, they are just running out of inventory and not able to fulfill orders in a timely manner. Too many drop ships and the vendor begins to wonder if they really need distribution!!!
I blogged about your article
Posted from: Robert Lockard, 10/13/10 at 10:17 AM CDT
Excellent article! Thank you for sharing such a well-thought-out discussion of inventory turnovers' effect on a business' bottom line. I just published a blog post about your article on the QuickBooks Manufacturing Blog. It's entitled "Want to Save Money? Increase Your Inventory Turnovers," and you can read it here: http://quickbooksmanufacturing.wordpress.com/2010/10/13/save-money-increase-inventory-turnovers/

Have a great day!
Four Inventory Turns per year doesn't cut it anymore
Posted from: Frederic Flis, 10/6/10 at 9:43 AM CDT
I know that you are looking at the overall inventory which is made up of many individual items. Several things to keep in mind: Transaction costs are higher for low-cost items. Therefore, purchasing more inventory for low-cost and small cube items makes sense. These items do not have much effect on total inventory nor turns. Also, high-volume items that have a lower cost for larger purchases need to be analyzed to see if purchasing more really is a benefit.

The best way to reduce inventory is to monitor slow to medium-selling items with higher costs. Sometimes factory pack size can effect this, but paying more to buy one at a time from another distributor may be best. Each supplier and each item needs to be reviewed to determine what is best.
4 Turns Per Year Doesn't Cut I Anymore
Posted from: Howard Coleman, 9/29/10 at 2:14 PM CDT
Stuart: Thanks for your comments. Well stated. My intent here was also to focus on supply chain relationships and a change in thinking regarding "pulling" vs. the customary "pushing" of inventory.
Posted from: Stuart Rosenberg, 9/29/10 at 11:29 AM CDT
Good article, Howard. However, I would like to take it a little further. While inventory turns are an important indicator it is not the only one that should be used to determine inventory well being. These are "Dynamic Inventory Turnover Ratio," "Projected Inventory Turnover ratio," "Weeks of Sales on Hand." Inventories exist for future requirements. If errors in projection of future inventory is relatively small and the ITR is lower than the PITR %, then changes in the COGS are the problem area, not inventory management.

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