I hope that you have enjoyed the PurchTips article “Buyers: Know Your Inventory Turnover Ratio!“
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While inventory turnover ratio seems like a pretty straightforward calculation, there are some things you need to consider when evaluating it, including:
- Inventory turnover ratio must be evaluated alongside of stockout statistics. If your inventory turnover is really high, but your number of stockouts are too, that’s not good inventory management. That’s putting your organization at a competitive disadvantage.
- A common mistake when calculating the inventory turnover ratio for the entire inventory is to use the price of the inventory when you sell it, rather than your cost.
- You’ll often see the denominator of the inventory turnover ratio expressed as “average inventory” in either quantity or monetary figures. In the article, I used an expanded denominator to show you how average inventory is calcualted. This helps prevent “guesstimates” that can distort your true inventory turnover ratio.
- There is no “one-size-fits-all” ideal inventory turnover ratio. It varies from company to company and from item to item. While you may be able to find benchmarking statistics for your industry from an industry or supply chain trade association, most often organizations compare their inventory turnover ratio to past performance and look to increase their inventory turnover ratio from the previous year while reducing the number of stockouts.
Inventory turnover ratio is a very important and widely-used metric. Use it wisely and avoid some common mistakes and you can sell your value to management.
To Your Career,
Charles Dominick, SPSM
President & Chief Procurement Officer
Next Level Purchasing, Inc.
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Comments
Inventory turns are such a multi layered topic. One powerful way to view it is from the accounting and finance perspective. Inventory is considered a current asset, BUT, only if it is convertible to cash in 30 days, the definition of a current asset. This would mean a minimum inventory turn of 12.
Therefore, when supplier finance is in question and inventory skews the current assets, it is wise to apply the Acid test which eliminates all inventory with turns greater than 12.
An example helps to make the point.
• Quick Ratio (or Acid Test) is similar to Current Ratio BUT it excludes inventory.
• Inventory, classified as a Current Asset in accounting practice, may indeed not be current if the inventory turn is greater than 12
• The Acid Test removes the value of inventory from the calculation for the purpose of analyzing a firm’s cash resources.
• Example:
a. Current Assets (CA)= $2,000,000
b. Inventory (I) with turns greater than 12 = $500,000
c. Current Liabilities (CL) = $1,000,000
d. Current Ratio is CA/CL or $2,000,000/$1,000,000 = 2.00 or healthy
e. Acid Ratio is [(CA – I)/CL] or [$2,000,000 – $500,000)/ $1,000,000 or 1.5
Robert Menard, CPP, CPPC,
author of”You’re the Buyer – You Negotiate It!”
Dallas, TX 214.513.8484
Robert Menard, CPP, CPPC,
author of”You’re the Buyer – You Negotiate It!”
Dallas, TX 214.513.8484
http://bit.ly/25ww6H
http://bit.ly/3ICwUN
“Working with clients worldwide to save money through professional purchasing and negotiation”
Sell for a dollar, earn a dime – Save the same dollar, earn ten dimes
http://bit.ly/25ww6H
http://bit.ly/3ICwUN
“Working with clients worldwide to save money through professional purchasing and negotiation”
Sell for a dollar, earn a dime – Save the same dollar, earn ten dimes
Thanks for your comment, Robert. However, your definition of current asset appears to be different than the most commonly used one which refers to a current asset as “cash and other assets expected to be converted into cash, sold, or consumed either in one year or in one operating cycle.” I’ve never seen 30 days used to differentiate a current asset from a noncurrent asset.