Think of inventory turns as a measure of how well a company's products are doing in the market and how well its inventory is managed.

The term basically captures the number of times per year businesses such as retailers and manufacturers are able to sell off or use up their complete inventory of raw materials or finished goods.

The more often a company is able to turn over its inventory, the better. The reason is simple: Businesses like to convert merchandise and materials into cash as quickly as possible.

In addition, holding on to inventory costs a lot of money, both in terms of the capital tied up in unsold products and in the expenses associated with warehousing them.

So, the quicker a company is able to push its inventory out the door, the higher the return on its inventory investment and the better its cash flow.

"Anytime you have products sitting in inventory it means your resources are not producing cash flow," says Andy Chatha, an analyst at ARC Advisory Group Inc., a manufacturing consultant in Dedham, Mass. "Ideally, you want zero inventory" if you want to maximize cash flow, he adds.

Do the Math

Inventory turns are calculated by dividing annual sales by the average value of the inventory. For example, if a company had sales of $100,000 last year and the average retail value of its inventory over the past year was $50,000, then the number of inventory turns equals two.

In other words, the manufacturer replaced its inventory every six months, on average.

But if the manufacturer were to increase its turn rates to 10, those same sales would be generated by just $10,000 worth of inventory.

This would generate a lot more cash to invest in other aspects of the business, such as the option to buy "new equipment, build a new sales organization or to give stockholders a bigger payback," says David Monroe, an analyst at Plant-Wide Research Group, a North Billerica, Mass.-based manufacturing consultant. "It's almost like having a free loan, except you never have to pay it back."

The average number of inventory turns varies greatly by industry and by companies within industry segments. For instance, the ratio is particularly critical in industries that face significant pricing and competitive pressures, low margins and fast obsolescence rates, Chatha says.

These include companies in the automobile, consumer electronics and computer industries plus retailers of all types, say analysts. Companies in these sectors all have high inventory turnover rates because the cost of holding on to goods in hypercompetitive, fast-evolving areas can be unacceptably high.

Some firms, like Dell Computer Corp. -- considered by many experts to be one of the leaders in inventory management -- have turnover rates that range from 30 to 40 times per year.

Companies stand to benefit from improving inventory turns, even with relatively low-volume or slow-moving products, because of the same cost factors that drive companies with fast-moving products, says Monroe.

"In fact, the only industries where it doesn't always help is in aerospace and defense," where the need to maintain inventories of parts for longer periods of time is part of the business model because of slower obsolescence rates, says Monroe.

Getting Better All the Time

A study published in December 1999 by the management firm Pittiglio Rabin Todd & McGrath in Waltham, Mass., found that U.S. companies have dramatically improved their inventory turns during the past few years.

U.S. inventory turns rose by more than 12% from 1994 through 1998 to an average of 5.4 annual turns, according to the report. During the same period, the average cash-to-cycle time -- the number of days between paying for raw materials and getting paid for the product -- improved by 10% to 100 days, the report stated.

Driving much of those inventory turns was the need to address falling margins and slowing annual growth, the report said. In addition, many big U.S. companies have also invested millions of dollars over the past several years to automate their inventory management processes using sophisticated supply chain management tools.

The continuing move away from traditional build-to-forecast manufacturing models to more flexible models such as build-to-demand, build-to-order and flow manufacturing are also changing the way companies look at inventories, says Monroe.

The increasing emphasis on a fully integrated supply chain means that inventories barely spend any time sitting unused.

"I've seen some practitioners of flow manufacturing who move inventory so quickly that they utilize materials, ship products and bill customers before their suppliers even bill them," Monroe says.

Companies are also becoming increasingly aware of the need to improve inventory management and to move toward build-to-demand models at a time when the overall economy is slowing, says Chatha.

Many high-tech companies, including giants such as Cisco Systems Inc. and Murray Hill, N.J.-based Lucent Technologies Inc., recently got stuck with excess inventories when the economy slowed more abruptly than they had anticipated, reflecting how even well-managed build-to-forecast models can sometimes cause problems.

» posted by ITworld staff

Computerworld

• Email
• Print
• Share
  • Slashdot
  • Digg
  • Stumble
  • Reddit
  • Newsvine