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As with most things in life if you don’t measure it you don’t know where you are or if you need to improve. While this can be bothersome in your personal life with measurements such as how much you weigh or your waistline it’s a necessity in business. So we’re going to talk about several of the most common measurements regarding inventory and supply chain and their definitions. While some are optional some are vital to understanding your inventory position. There are also some that provide the same basic measurement just from different perspectives.
The first one that comes to mind and one that everyone wants to know is inventory turns. Everyone from operations to finance wants to know the inventory turns, usually from very different perspectives. The definition is obvious, it’s how many times you have “turned” or sold through your inventory within a given time frame. The formula is the cost of goods sold for the time period divided by the average inventory value for the same period. So, if the CoGS was $1,000,000 and your average inventory was $250,000 the calculation would be 1,000,000 divided by 250,000 which equals 4. The inventory turns in this example is 4. There is only 2 ways to increase your turns; increase sales (without increasing inventory) or decrease inventory. There is another way to view this measurement as days of inventory. If the above example was for a four week period instead of saying you have 4 inventory turns you have 1 weeks worth of inventory. You can calculate turns using retail value, cost value or units as long as the unit of measure is constant.
Another common measurement is quantity on hand. This can be broken down to raw materials, WIP, components, replacement parts and finished goods. This could also include available to promise which is the uncommitted portion of your inventory or the inventory that isn’t needed for current customer orders.
The next measurement is inventory value. We’ve discussed this in past episodes but it fits in here as well. You can measure the inventory value either at cost or retail value. Some companies like to value inventory at cost to represent their investment while others like to value inventory using the retail cost to capture the total value of the inventory including their profit. Because value changes over time a valuation method will need to be employed to capture this change or to standardize it such as FIFO, LIFO and standard costing.
Inventory accuracy is measured by performing cycle counts and is reported in 3 different ways. The first is overall accuracy; this is the number of locations counted without discrepancies divided by total number of locations counted. As an example, if you count 50 locations and 49 of them are without discrepancies (the counted item matches the perpetual inventory) your inventory accuracy is 98%. The other two ways are by number of units and by cost. Both of these measurements should be measured using absolute numbers. In other words, no negative counts. Whether you’re short 3 units or over 3 units the variance is 3. If you take into account if a variance is positive or negative opposing variances will cancel each other out. It reminds me of the old joke of the 3 accountants that go bow hunting together; the 1st accountant sees a buck in the distance, he draws his bow and fires missing to the left of the buck. The 2nd accountant draws his bow and fires missing to the right. The 3rd accountant exclaims, “You got him!”
There are other measurements but we can cover them later. If you have questions about what we’ve discussed here today or if there is another measurement you would like to know about please send us a message at www.cashflowabc.com.