Published June 2001

Pay attention to inventory: Its ‘turns’ say a lot

For most business people, the word “inventory” by itself is usually enough to bring on some sort of negative reaction. It might range from minor frustration to body sweats, heart palpitations and a full-blown anxiety attack.

Inventory often is the focal point of a company’s shortcomings as well as an open drain down which profitability escapes. The “inventory problem,” though, often isn’t the inventory itself but the way we business owners and managers react to it.

Let’s face it, it’s big, and it’s ugly, and we don’t want to think about it, let alone start wrestling with it. Instead, we begin to avoid and ignore it — and bury its real costs.

And when it comes to the true costs of inventory in our businesses, we tend to think first of what it costs to bring the stuff in the door and then what it costs in interest to borrow the money needed to pay for it.

In reality, though, that’s just the beginning. When the real costs are tallied up, for example, the inventory that’s not there can cost you as much as the stuff that is. The only real reason for inventory is to respond to customer orders, and when you don’t have the goods to meet an order, only two things can happen, both of them bad.

The first is that you pay extra money to have the items shipped to you on an expedited basis and, often, reshipped to the customer the same way — often eating up your profit margin in the process.

The other is that the customer finds another supplier or another product to meet his or her needs.

Inventory you don’t have is expensive enough, but the inventory you don’t need is even more so. Even at a modest $5 per square foot, storing unnecessary inventory represents a significant cash outlay. And if you have borrowed the money to pay for your inventory, the longer it sits there, the more money you have to send off to the bank every month.

We figure the cost of inventory, and the effectiveness of our inventory management, with a calculation called “turns” or “inventory turns.”

If you divide annual sales by your average inventory, you will get the number of “turns.” A $100,000-a-year business that, on average, keeps $25,000 in inventory would have four turns. (When people talk about inventory turns, it’s usually understood that they are referring to “turns per year.”) Four turns translates into an average of 90 days an item sits on your shelf before it gets purchased and delivered to a customer.

Depending on your own credit terms, that can mean a total financing time for you of those 90 days plus the 30 to 50 days that it takes for your customer to pay you. And the longer that financing time, the more the carrying costs eat into your profit margin.

The number of turns varies widely industry by industry and, within an industry, by the size of the operation.

Turn calculations reflect the average, though, and the typical inventory contains items that move considerably faster or slower than that average. And, often, the way to improve the profitability of your company lies simply in concentrating your management efforts on the high-turn stuff and dumping the products that sit around for months waiting for someone to place an order.

In one sense, that is an oversimplification, but in another, it is precisely what we have to do. A good inventory system will tell us which are the high-turn products and which are parked there on the shelves.

Management’s job is to take that information and transform it into a marketing plan that will redirect the company’s efforts to the existing and potential customers for the high-turn items. This can involve some surprisingly major strategic decisions.

Our inventories may seem to be just sitting there on our shelves, soaking up money and swapping jokes with bad punch lines like “one good turn deserves another.” But they are really trying to tell us something.

If we care about the bottom line, we should listen.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by e-mail to otisrep@aol.com.

Back to the top/June 2001 Main Menu