Inventory turnover as a key performance indicator Part Two
In part one (here) we looked at the importance of Inventory Turnover as a key performance indicator - in this part we'll look at the meaning of a low ratio
So what does this mean for organizations with low turnover? Where an organization has excess inventory, it’s often argued that the finances consumed funding the stock could generally achieve better returns invested elsewhere. In “Upstart Guide Owning & Managing Bar Or Tavern” Roy Alonzo states that in the food and drink business that 10 dollars of sales are required for each dollar of poor purchasing. There is also an associated administrative cost of managing excess stock (warehouse space, labor etc) – coupled with the risks of stock becoming obsolete and un-saleable. A clear indicator then that low inventory turnovers are to be avoided – well perhaps.
Inventory turnover results taken at face value can be (like many ratios) be misleading, they can vary according to many factors. Many businesses utilize inventory to mitigate risks such as obsolescence and seasonal fluctuations. Many also take account of bulk buying to secure better long term value, while these may be viable business strategies they have the possible impact of producing a lower inventory turnover result. Closer inspection of business practices should be prescribed for businesses that have a low ratio before we can say they have poor processes etc as a result.
Many organizations couple inventory turnover ratio with Inventory Turnover Days (calculated by dividing 365 by the Inventory turnover result). Inventory Turnover is usually described by way of a chart showing movement year on year as shown below.
Without doubt, inventory turnover is an important and powerful business measure – widely used the ratio can be indicative of slick processes and controls. Whilst requiring correct interpretation, most businesses will find benefit from having it established within their corporate KPI system and monitoring closely with trend analysis.