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. 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 your costs of goods sold, or CGS, divided by your average inventory. This is per year. So what that will do is 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 got Abe’s here, and he sells medical supply as a wholesale distributor. Sells to a whole bunch of places, and he’s able to figure out in the course of one year, he’s sold—the total cost of goods sold—one million dollars. Now his starting inventory for that fiscal year three million, his ending inventory was four million.
So let’s plug that into our formula: One million divided by the average of these two equals point two nine times (.29). So what does that number mean, what is that ratio?
What it essentially is how many times your inventory turns over in the year, how many times are you able to sell all the goods that are in 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 his number to be much, much higher, four, five times a year.
A lot of this will depend on the industry you work in, but keep in mind, the more time your inventory is turning over means that you’re generating more profit, and typically, it can mean 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 tells us? It’s telling us our annual turnover, as we’ve already mentioned. It also tells us what our ABCs of our inventory is. Now if you don’t know the ABCs of inventory is, we have a great video on that elsewhere on our Whiteboard Wednesday section, go and 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, it means that if we want to improve this number, we need to do a few things. And this isn’t just an easy thing, this is a complicated process, but all these factors can help.
We need to streamline our process. That means that we need to know as soon as our 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 we have another video on that, feel free to check that out.
We should make use of auto reorder software, so 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.
But 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 we can incorporate these kind of things, the fast 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 that we have 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.