There are quite a few KPI’s that managers use to evaluate their inventories in order to keep it under control. One of the most widely used, although not so trivial to assess, is the Inventory Turnover index. It is, roughly speaking, an indicator which tells you how many times, during a year, your inventory is completely replaced – well, of course it is just an index, it does not tell you if a single item is there, unsold, since years and years: for this you need an inventory management system.
Let me give a practical example. Assume you can evaluate the average level of your inventory during the year; the inventory is typically composed of raw material, work in progress, finished goods. The table reports an example:
| item | average numb | unit value | total value | ||
| Raw material | A | 1000 | $50.00 | $50,000.00 | |
| Raw material | B | 2000 | $20.00 | $40,000.00 | |
| Raw material | C | 1200 | $40.00 | $48,000.00 | |
| Work in Progress | X | 200 | $200.00 | $40,000.00 | |
| Work in Progress | Y | 400 | $300.00 | $120,000.00 | |
| Finished goods | F | 60 | $1,200.00 | $72,000.00 | |
| Finished goods | G | 40 | $1,400.00 | $56,000.00 | |
| Finished goods | H | 50 | $1,500.00 | $75,000.00 | |
| Total | $501,000.00 |
So the average (in a year) aggregate (across all items) value of your inventory is roughly half a million dollars. The inventory turnover (or also inventory turns) is defined as the ratio between the cost of all goods sold during the year divided by the average inventory cost. If, for example, the total cost of units sold in a year is 2 million dollars, in this case the Inventory turnover index will be 4:
Inventory turns = (2,000,000/501,000) = 4 turns
Roughly speaking, in order to sell all these goods you are going to completely substitute your inventory four times in a year.
Caution: this is a synthetic measure (an aggregate one) and it is concerned only on value, not on real inventory levels.
The Inventory turnover index is not easy to analyze: is 4 times a year a low value? Or is it too high? One possible answer is: look at the index of your competitors, benchmark towards the top in your market.
By the way: the same index can be seen upside-down: if you divide the average value of the inventory by the cost of sales you end up with the number of “years of supply” granted by your inventory. This is not practical, so multiply by 52 and you get the Weeks of Supply. In this case:
Weeks of supply = (500,000/2,000,000)*52 = 13
This index tells you that, on average, your inventory “grants” 13 weeks of supply. Again: it is a synthetic measure – do not trust it to take replenishment decision. For this we, at Intuendi, have much smarter solutions!
