Tuesday, August 12, 2008

Inventory turns

by George Matyjewicz

With any distribution business, the less money you have tied up in inventory in order to fill your distribution channels, the more money you will have to do all the other things a company needs done -- marketing, advertising, research and development, acquisitions, expansions, and so on. You need to turn your inventories as often as possible during the year in order to free up that working capital to do other things.

The “official” calculation to figure out how you are turning inventory, is to first find out the Cost of Goods Sold (COGS) for the past 12 months. Then take the current inventory and divide it by the Cost of Goods Sold and you get the number of times you have turned inventory.

Retailers, who used to work on the "Retail Method of Accounting", traditionally calculated the number of turns of inventory by adding beginning RETAIL value of your inventory to the RETAIL value of your purchases then subtracting the RETAIL value of the ending inventory, then divided that value by your total sales. This method has been used in the past because the retailers, on the advice of their accountants, used retail values as it was too difficult to calculate costs manually. But that assumes that everything you sell will be at the retail value. Now, with a good Inventory Control system you will obtain a true Cost of Sales. Hence, you should use the COST instead of Retail to produce a more accurate picture of your inventory turns:
((Beg.Inv.at Cost) + (Purchases at Cost) - (Ending Inv. at Cost)) / (Cost of Sales)

If your Inventory system also has a method of tracking adjustments for shrink or scrapped items, then the more accurate formula would be: ((Beg.Inv) + (Purchases) - (Ending Inv.) - (Cost of Scrapped and Lost items)) / (Cost of Sales)

No comments: