Inventory turnover – why measure it?

By | February 5, 2015

Small business owner-managers will tell you [over and over] – “cash is king”.

They are often puzzled why their cash flow is poor but the profit and loss statement is healthy. If the business is growing, then there will be pressure on cash flow.

Why is this? There are lots of reasons but most often the trouble is found in the balance sheet. Such items as accounts receivable blowing out drains you of cash – you need to collect promptly or better still collect when the sale is made.

Inventory is another item in your balance sheet that consumes cash. Without stock you will not have enough to sell. Inventory is required to reach sales targets. But inventory that is not moving impacts heavily on your cash position. Cash is not flowing because inventory is sitting in your store.

What to do? Ideally you want to minimize your inventory. You want inventory to turn-over as rapidly as possible. “Just in time” inventory control has finished goods going into store one day and out the next or within a few days anyway.  Apple do this, I have heard.

What ever happens you need to set a target for inventory turnover for each major product line. Some products may move more slowly than others.

How do you calculate inventory turnover? (The BIC Model of course does it for you each month, by the way.)

Intentory turnover days = Inventory Level $ x 30 (days)/(Sales $ * (1- Gross Margin %))

If you want to determine how much stock you should be holding to turnover in say 45 days, then you can use the formula above backwards.

If you want to discuss how your company is managing its inventory, just give me a call or send a message via the contact page on my web site.

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