Fishbowl HOVC James Shores wants to talk about inventory turnover, which he sadly discovered has nothing to do with pastries.
Hi, I’m James. Welcome to this Whiteboard Wednesday. If I sound congested, I don’t care. Today we’re going to talk about inventory turnover and why that matters for your business.
So a quick breakdown of what that formula is, is a matter of cost of goods sold – or COGS – divided by your average inventory, and this is per year. So that will give you your inventory turnover ratio. Now why that matters we’ll talk about in just a minute.
So as an example, let’s say we have Abe’s here, and he sells medical supply as a wholesale distributor. He sells to a whole bunch of places and he’s able to figure out – in the course of one year – the total cost of goods sold was one million dollars. His starting inventory for that year was three million, and his ending inventory was four million. So let’s plug that into our formula; one million divided by the average of these two equals .29 times.
So what does that number mean, what is that ratio? It essentially is how many times your inventory turns over in a year. How many times are you going to sell all the goods that are at your disposal? Well in Abe’s case, it’s going to take him a little over three years to finally sell his inventory and have turnover – that’s really not the best number. Ideally, you want this number to be much, much higher – four, five times a year. A lot of this will depend on the industry that you work in. But keep in mind the more times your inventory is turning over means that you’re generating more profit and typically can mean that you have less inventory that’s just sitting on the shelf that your cash flow is tied up in.
Now, what can this data also tell us? It’s telling us our annual turnover, as we already mentioned. It also tells us what our ABC’s of our inventory is. Now, if you don’t know what the ABC’s of inventory is, we have a great video on that elsewhere on our Whiteboard Wednesday section, if you want to look that up. It also tells us where our cash is tied up, because we should be able to know what’s sitting on the shelves, what’s moving, what’s not. Because if something is just sitting there, it’s not making us money, and it’s taking up valuable real estate – whether we’re a wholesale manufacturer, a distributor, or so on.
So what does this mean, James? Well, this means that if we want to improve this number, we need to do a few things. And this isn’t just an easy thing, it’s a complicated process. But all these factors can help.
We need to streamline our process, and that means that we need to know as soon as inventory comes in, when it’s going out, how often it’s used. We need to know all that data.
We need to be able to stay lean, which means we need to keep only the amount of inventory on hand that we need for at least two weeks out, sometimes a little bit more. Again, another video on that. Feel free to check that out.
We should make use of auto reorder software so that we’re not having to physically count and constantly keep tabs ourselves. If we have an automated solution, it knows when our levels are low and when to reorder so we can stick to the business at hand.
Also, we should be able to include seasonal reports. What this does is it tells us when there’s certain times of the year that customers are buying more of one particular item or product from us, so that we can plan for that accordingly, annually. Now, there may be shifts every year, but we can be able to predict that with seasonal reports.
Now, where does all of this come from? Well, you guessed it. It’s going to come from an automated software solution. The more that you can incorporate these kinds of things, the faster that we’re going to be able to have inventory turnover, we’re going to bump up that ratio, which means that we won’t have as much cash tied up, we won’t have things sitting on the shelf, and we won’t be losing money to things that aren’t going anywhere.
Again, if you have any questions about some of these other things we’ve discussed, we have a lot of other videos talking about these things. And again, I’m James. That’s this week’s Whiteboard Wednesday. Thanks!