Inventory Turnover Ratio
Inventory turnover calculates the frequency a company sells its entire inventory within a given financial reporting period. This can be calculated for every type of inventory, including materials used during the manufacturing process, work in progress (WIP), and finished products. There is one exception with finished product inventory because the calculation only applies to service and manufacturing companies.
Healthy Inventory Turnover Ratio
For the most part, the higher your inventory turnover ratio is the better off you are. It’s important to find a healthy balance between too low and too high of a turnover ratio because both can get you into trouble. Here’s why.
Having too low of a ratio means that you have too much inventory on hand, and you run the risk of product spoilage. Too high of a ratio means you may not have enough inventory on hand, and this could potentially lead to shortages and lost sales.
A healthy inventory turnover ratio ultimately comes down to the industry you’re in. Food distributers want to ensure that their inventory turns over dozens of times a year because they are dealing with products that have expiration dates. Electronics manufacturers have a different type of inventory, so their ideal ratio will differ from a food distributor.
How to Improve Your Inventory Turnover Ratio
So how can you get your inventory turnover ratio to the best level possible? This is often overlooked, but first you need to take an end-to-end view in addressing your inventory. You need to optimize your supply chain, and an important thing to remember is to always make sure that the production processes are lean. When you solve inventory turnover issues from a lean perspective your company will benefit in the long run.
You can improve your inventory turnover ratio by using an inventory system such as Fishbowl Inventory. In order to go lean, you need to define the value from a customer’s point of view. Map out your current value stream, the process flows and establish pull by the customer. This will help by eliminating waste from the value stream. It will shrink your lead-time and minimize your inventory at every point. Your margins won’t shrink and will improve as each unit’s cost is reduced.
By following these steps, you will notice an improvement in your inventory turnover ratio, and you will have a leaner inventory system that will save your company money.