Use this simple tool for identifying areas of potential improvement in the business to create an effective inventory management process. This type of measurement allows for more widespread understanding of the nature of inventory and fosters action to prevent a build-up of non-value-adding “drag”.
What are the possible pitfalls when using inventory turnover as a measurement for effective inventory management?
For most businesses, effective inventory management involves measuring inventory turnover.
Inventory turnover measures how quickly inventory moves off the shelf. This measurement relates to the cost of holding inventories. This type of inventory tracking and measurement can be done using an inventory management software.
The longer inventory is held, the more it ties up investment in an asset, adding no value to the customer. The more inventory held, the higher the investment in warehousing, material handling systems, and labor. In addition, taxes and insurance costs rise, as well as incremental costs in data processing (Monks, Joseph G., Operations Management: Theory and Problems, McGraw Hill, 1977). Worst of all, holding products in inventory increases the risk that it will spoil or become obsolete.[Read more: Inventory Planning Methods & Tips for Optimizing Your S&OP Process Today.]
Identifying Inventory Categories
Unconsciously, one assumes all inventory is likely to be ordered by customers or is immediately ready for shipment. However, a closer look would most likely identify some inventory falling into one or more categories listed below. If the entire inventory fell into these categories, turnover would approach zero:
- Damaged: Product not fit for use due to material handling, storage, etc.
- Recall: Material suspected to be out of specification
- Rework: Material partially defective, yet repairable
- Outdated: Product beyond its date of expiration (may still function, but can be shipped only in specific cases)
- Short-dated: Product soon to reach expiration (may soon become outdated)
- Obsolete: Product superseded by new product (last year’s style, model, etc.)
- Non-Moving: Product with very minimal order demand for a time period significant to the business
The inventory turnover ratio masks the effectiveness of the inventory since it assumes that all inventory is equally subject to “turning” in the short term. By separating inventory into the above categories and measuring their total, a business will become aware of a “drag” caused by maintaining inventories within these categories. Without some plan for action, the dollars tied up in these categories will add to the cost of doing business. Considering the time value of money, the longer it takes to act, the more it costs. The costs of carrying this inventory may be surprising.
How does one determine the size and priority of a problem and ensure that it receives the proper attention from management? As is true in most business areas, the key to identifying, recognizing and accepting a problem or an opportunity is an ongoing measurement that highlights the opportunity when it occurs and points it out to the proper level of management.
In my next blog, I’ll share some tips on how to get started with measuring inventory effectiveness.[Whitepaper: How to measure inventory health and improve service levels.]