The prime motivation for this practice is the reluctance of companies to share their fine-grained gross margins. Panelists and compilers of industry data frequently use net sales as the numerator in the inventory turnover equation. When considering the stock levels associated with parts, components or raw materials, the notion of inventory selling price is somewhat fuzzy as only the prices of the finished goods are ever observed directly. In a more abstract way, it can be said that the inventory turnover tries to capture the ratio flow over state.Īs a rule of thumb, the purchasing flavor of inventory turnover tends to be more prevalent among most verticals. Most of these variants are acceptable as long as the ratio is homogeneous, with aligned units for both values. The numerator always represents the flow of inventory, while the denominator always represents the state of inventory. Indeed, as soon as the goods are ordered, the company carries the risk associated with those quantities, and thus those quantities negatively impact the company’s supply chain agility. This includes the stock on hand but also the stock on order. the Average Inventory at Selling Price follows the same valuation metric as the one used for the net sales, but is applied to all the stock currently held by the company, as above.īoth perspectives require the whole inventory to be taken into account in the calculation.the Net Sales represent the revenue generated by the units sold for a given time period, not including taxes (like VAT) and temporary rebates or discounts. The selling perspective is reflected by: Inventory Turnover = Net Sales / Average Inventory at Selling Price This cost does not include inventory carrying costs. the Average Inventory at Cost follows the same costing definition as the one used for the COGS but is applied to all the stock currently held by the company, either available on hand, or on order.This cost does not include selling costs (like advertising), or general administrative costs (like human resources). the Cost of Goods Sold (COGS) includes the purchasing costs of the raw materials, plus the manufacturing costs if there has been a transformation prior to selling the end product for a given time period.The purchasing perspective is reflected by: Inventory Turnover = Cost of Goods Sold / Average Inventory at Cost The inventory turnover ratio is classically defined either from the purchasing perspective or from the selling perspective. Other factors like batch sizes, MOQ (Minimal Order Quantity), or EOQ (economic order quantity) also affect these ratios. Indeed, distant suppliers (possibly oversea suppliers) entail high stock levels, as the stock needed to cover the whole lead demand is higher, which mechanically lowers the inventory turnover ratios. In practice, lead times are usually the driving force behind the observed inventory turnover ratios. While high ratios are frequently considered as the manifestation of good inventory management, they may also hint at insufficient safety stocks or insufficient protection against supply chain risks. Furthermore, low ratios increase the pressure on working capital requirements.Ĭonversely, high inventory turnover ratios are generally associated with goods being sold rapidly, and a healthy state of inventory, with few depreciation and obsolescence problems. Indeed, SKUs associated with low inventory turnover ratios are frequently associated with excessive inventory, or even dead inventory and inventory write-off. Thus, while inventory rotations do not equate profitability levels, they are correlated to a large extent.Īlso, when analyzing the inventory turnover ratios down to the SKU level, outliers are typically of prime interest from a Supply Chain Management (SCM) perspective. Yet, the two companies have roughly the same working capital requirements as far as their inventories are concerned.
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