Inventory Turnover Analysis: How to Maximize the Benefits

  • Richard Thelwell
  • August 14, 2015

inventory turnover analysisAt first glance, Inventory Turnover Analysis isn’t difficult to understand. Usually expressed as the ratio of the cost of goods sold to average inventory over the same period, it’s a measure that seemingly isn’t difficult to calculate, and yet which provides valuable insight as to where inventory-related problems are lurking.

That said, Inventory Turnover Analysis isn’t without its problems. Peer into the detail, and it isn’t long before potential difficulties are spotted. Just because Inventory Turnover Analysis is simple, it doesn’t necessarily mean that it’s also straightforward.

Similarly, for businesses wanting to improve their inventory turnover, there isn’t a ‘one size fits all’ strategy for using Inventory Turnover Analysis to drive inventory management improvements.

Manufacturers will probably pursue a different strategy from distributors and retailers—and even among manufacturers, or distributors, different techniques will be appropriate in different individual circumstances.

So here’s our take on how best to use Inventory Turnover Analysis correctly, and use it to deliver sustainable inventory management improvements.

Inventory Turnover Analysis: garbage in, garbage out

As with any business metric, it’s important to make sure that the data you’re using isn’t just correct, but that it’s also sensible, and appropriate.

Your data warehouse and Business Intelligence application can usually be relied upon to make sure that the data you’re using is correct. But only you can make sure that you’re using it sensibly, and that it’s appropriate.

inventory turnover analysis garbage in garbage out
When it comes to inventory turnover analysis, you need to ensure the data is reliable

To start with, when looking at the cost of goods sold, it’s important to only take into consideration the sale of goods that were actually sold from stock, and for which inventory was held.

So if you make to order as well as sell from stock, then it’s important to only count the goods that are sold from stock—otherwise, you’ll think that your inventory is turning over faster than it actually is.

Similarly, from an accounting point of view, you’ll want to make sure that inventory is held at a value that is appropriate for analysis in the context of present day sales. So if you’re holding on the books some old semi-obsolete inventory at a written down value, you’re actually fooling yourself and making your Inventory Turnover Analysis look better than it really is.

Inventory Turnover Analysis: granularity = visibility

Likewise, you’ll want to carefully consider the data that you’re going to use for the ‘average inventory over the period’, which is the denominator part for the Inventory Turnover Analysis ratio.

If sales are flat over the period, then it might be perfectly adequate to take the opening inventory position, the closing inventory position, add them together, and divide by two—and use that figure for your Inventory Turnover Analysis.

But if sales are seasonal, or otherwise skewed to particular times, then a daily or monthly average is probably the way to go. Again, you’ll want to think carefully about how to reflect planned stockbuilds for sales outside the current period, which can be a feature of some industries—think distributors and Christmas, for instance.

inventory turnover analysis seasonal
seasonal sales must be accounted for when conducting inventory turnover analysis

Finally, while it’s tempting to use Inventory Turnover Analysis to arrive at one single number, one single number can actually turn out to be of not much use when attempting to use Inventory Turnover Analysis to drive inventory management improvements.

It’s generally better to take a more granular approach, and conduct separate Inventory Turnover Analysis calculations for each sales category (or even product). That way, you’ll see more quickly—and more clearly—where the problems are.

Inventory Turnover Analysis: getting results

So finally, let’s turn to what to do once you’ve actually carried out your Inventory Turnover Analysis, and identified where the problems are.

At its simplest, there are three ways to boost inventory turnover:

  • Increase sales, but without increasing inventory
  • Decrease inventory, but without decreasing sales
  • Increase sales and decrease inventory at the same time

In many businesses, the option that combines aspiration with realism is to aim to increase sales, but without increasing inventory. How? Pricing adjustments, for one approach. And special promotions, for yet another.

Simply taking the axe to inventory—aiming to decrease inventory levels while not decreasing sales—is another option. How? Try reviewing lead times and inventory-holding policies, for one approach. Look at improved forecasting techniques. Or see if suppliers can deliver more frequently.

But generally, most businesses would prefer to focus on the third option: increasing sales at the same time as decreasing inventory. That isn’t always achievable, or even realistic—but it’s almost always the most rewarding approach.

A successful Business Intelligence solution can help your business conduct Inventory Turnover Analysis. To find out more, download our free guide below