why is inventory turns an important metric

Calculate the total value of every product in inventory (quantity on-hand times cost) every month, on the same day of the month.To determine your average inventory investment: Inventory turnover depends on the average value of stocked inventory. Inventory turnover is based on the cost of items (what you paid for them) not sales dollars (what you sold them for).The cost of goods sold figure in the formula includes transfers of stocked products to other branches and quantities of these products used for internal purposes such as repairs and assemblies.Sure, these sales are important, but don’t involve your warehouse stock (i.e. Non-stock items and direct shipments are not included. Only consider cost of goods sold from stock sales which are filled from warehouse inventory.There are several things to keep in mind when calculating turnover rates:

Inventory turnover is calculated with the following formula:Ĭost of Goods Sold from Stock Sales during the Past 12 MonthsĪverage Inventory Investment during the Past 12 Months Here is a list of the turnover rates from our example: The inventory turnover rate measures the number of times we have turned our inventory during the past 12 months.

Investing $2,500 (rather than $10,000) frees up $7,500 that can be used for other purposes… such as stocking other products that have the potential of generating additional profits.Įvery time we sell an amount of a product, product line, or other group of items equal to the average amount of money we have invested in those items, we have “turned” our inventory. Which investment option is better? Selling $10,000 worth of a product (and making $2,500 gross profit) with an investment of $10,000, $5,000 or $2,500? The best option is $2,500. The annual gross profit of $2,500 is now generated with an investment of about $2,500. Sell most of that shipment and then repeat the process two more times before the end of the year. Buy another $2,500 dollars worth of the product. At the end of the year we’ve still sold $10,000 worth of the product, still made $2,500 gross profit, but on an investment of about $5,000.Ĭould we make the same gross profit on an even smaller investment? What if we were to buy $2,500 dollars worth of material. Then, just before running out of stock, we bought an additional $5,000 worth of the product with part of the revenues received from selling the first shipment. If we bought the entire $10,000 worth of the product on January 1st, at the end of the year we would have made a $2,500 gross profit on an investment of $10,000.īut do we have to buy the entire $10,000 worth of the product at one time? What if we bought $5,000 worth of the product on January 1st. Total revenue received from sales of the product is $12,500. Say you sell $10,000 worth of a product (at cost) each year. Instead, we are going to look at the performance of your company’s largest asset: inventory.

This article isn’t about how you are managing your personal investments. How hard is the money you have invested working for you? You’ve probably been asked that question several times by stock brokers or “investment counselors.” No, I’m not going to try to sell you mutual funds.

Why is inventory turns an important metric