If you asked 50 executives how they measure inventory turnover or turns you will most likely receive 50 different answers. Ironically, most of the answers will be based on a process that has been used for several years and is referred to as the accounting method. This method is a ratio showing how many times a company’s inventory is sold and replaced over a period. The days in the period can then be divided by the inventory turnover formula to calculate the days it to sell the inventory on hand or “inventory turnover days.”
Generally calculated as:
= Cost of Goods Sold/Average Inventory
With today’s technology, executives and managers have the ability to see more than the holistic view of the total inventory and these views along with the improvement of forecast accuracy can significantly change the decision processes concerning inventory management.
What if you were able to see your current inventory investment in dollar and units separated in layers? Would seeing the inventory on hand that was purchased for current or future promotions change your perspective on inventory turns? How about inventory that was purchase from a forward buy opportunity? Would that impact the carrying cost considerations given the carrying cost was considered to determine the purchase quantity?
This visibility provides additional data that would not be considered when decisions are being made in regards to inventory management and performance. If you were able to remove certain layers of inventory from the turns formula how would that effect your results?
Imagine using the current turn’s process at the beginning of 2010 as the market is starting to rebound and forecast are adjusted for the projected increase is demand. If you were comparing the average inventory value to the previous month sales you would not be seeing a very favorable inventory turns result.
Now consider this. This view of inventory layers can be considered a forward looking approach because you are able to consider the inventory that has been purchased and received into inventory for upcoming events or seasonal demand. Does the other part of the formula still apply? If we can support the current forecast accuracy for the items in inventory can we change to a forward looking projection of sales at cost instead of looking back in history? Using this approach in combination with specific layers of inventory could provide improved accuracy in the inventory metrics and user performance reporting.
This detailed analysis can also be valuable when considering the impact to other departments related to sale and operations. These will be topics for the upcoming weeks.