Online exclusive! Understanding turns and how to keep track of them.
Published: February 14, 2008
|By Cliff Whitney|
Like the gauges on your car dashboard, successful retailers use ratios to determine the operating efficiency of their store. There are many retail ratios, but few are as important as inventory turns. Inventory turns measure how often your stock is being cycled and is usually calculated at the department level.
Example 1: Mary's Hobby Shop had an average inventory cost of $5,000 for her paint department last year. Her point-of-sale (POS) software reported she had sold $20,000 worth of paint, at cost, last year. Her turns for the year would be four times, or $20,000 ÷
Inventory turns are a general measurement for effective inventory management. If your business plan states a goal four turns per year for a given department and you meet that objective, then you have effectively managed your inventory. If the actual results were significantly higher or lower, it's like a warning light on your dashboard: you need to take a close look at the inventory for that department and take action.
To better understand inventory turns it's necessary to understand several factors and how they relate. The first is average inventory on hand, at cost, for the department. This number needs to be as accurate as possible. The second factor is the cost of goods sold for the period; ordinarily this will be an easier number to find. If the sales period is not a full year, it needs to be annualized by dividing the cost of goods sold by the number of days in the period and multiplying it by 365.
Example 2: Mary's Hobby Store liquidated the slow moving items from
the paint department. The average inventory dropped to $4,000 for the next year. Sales stayed the same, with cost of goods sold at $20,000. Now inventory turns five times a year. Without affecting revenue, Mary freed up $1,000 to use on another department. This is why you unload dead inventory even at or below cost.
Example 3: Mary's Hobby Store wasn't watching the gauges and ended up with only three turns for the year. The average inventory remains at $5,000 but the cost of paint sold is only $15,000 - clearly, not an efficient use of invested funds.
To use inventory turns as a tool you need an effective budget so you know when the warning light might come on. The first place to look is industry averages; many associations publish average benchmark numbers. If not, ask a successful friend, with a similar retail store that is not a competitor. The next place to look is at a store's own numbers. They can give a good idea as to how well the store is doing. If there are two turns a year in a department, it may make sense to set the goal for three turns next year. It's important to set inventory turn goals for each department.
Storewide goals are difficult to get a handle on and react to. Item or category goals may keep a manager on the run dealing with too much detail. In most cases, departments are the right level for setting inventory turn goals and tracking the result.
Here are some scenarios to practice the concept:
1. If, for the paint department, a goal is set for inventory turns to be four in the upcoming year but midyear calculations show the store on track for six turns, is that good?
It sounds good. But, the truth is, a high turn ratio is also a warning. One or more of the following may be true if turns are higher than planned:
Inventory may be too low, meaning selection is limited so customers may not return.
There may be too much time spent placing purchase orders, receiving,
labeling and stocking displays.
Prices may be too low, resulting in higher sales, but smaller margins.
2. You set a goal of four turns per year in the paint department but midyear calculations show you are only on track for two.
Consider the following:
There may be slow-moving or obsolete inventory in the department. These items are like an anchor to the rest of the items in the department. (Run "no sales" or "margin ranking" reports to sort these items out. Merchandise them better or put them on sale in order to exchange bad inventory dollars invested for good inventory.)
Department foot traffic may be low. Customer traffic reports will give the percentage of those customers who buy compared to the total traffic in the store.
The departmental pricing may be high; perform a comparative-price study.
Items in the department may not match the buying habits of the customers.
The products need better marketing or merchandising.
We've come to rely on inventory turns as one of our basic management tools. We set benchmarks for each department, and are serious about maintaining them. We review the turn ratios, at least monthly, and if a warning light comes on, we dig deeper to find out out why.
Cliff Whitney is the owner of Atlanta Hobby in Cumming, Ga., and the president and CEO of Mercury Adhesives.