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Profitable Times Newsletter

Inventory Turns

Perhaps the best way to begin the understanding of 'turns' is to define what it is and describe how it is calculated, and then explore its value as a measure of activity for stores.

Turns is commonly accepted to be retail shorthand for 'Inventory Turnover Ratio'. In fact however, it is really a measure of how hard your inventory dollars are working for you; i.e., how often each inventory dollar is used per year to buy merchandise. When we think about turns it is easier to visualize how many times we have reordered certain merchandise than it is to visualize dollars being reused to buy that merchandise.

The measurement of turns is an important calculation. But like so many calculations, if the raw data is inaccurate, or the calculation is wrong or applied inconsistently, the result is useless. Garbage in, garbage out! In fact, the use of inaccurate information will often lead to decisions that are worse than decisions made by 'gut feel'.

There are some variations to how turns should be calculated, but I think the following formula will work for a vast majority of applications.

Annual Cost of Goods Sold

Average Inventory at Cost
 = Inventory Turnover(Turns)

Step One. Gather the information you need to make the calculation.

Annual Cost of Goods Sold $ ____________

The Annual Cost of Goods Sold is the total cost of goods purchased over a twelve-month period.

Average Inventory at Cost $ ____________

Considering the seasonality of many stores, and that inventory is generally taken infrequently, the calculation of an average inventory can be difficult.

  • If you take an inventory at high season and another at low season, average the two.
  • If you take two inventories a year you can actually use three inventories (1. Last year's final inventory; 2. The current year's mid-year inventory; 3. The final inventory from this year) and divide by three.
  • If you take only one inventory a year be true to yourself. Don't use an inventory taken when the stock on hand is extremely low, which will result in an inaccurate, high number of turns, and don't discount your performance by using a large inventory number resulting in a low number of turns. If you are like most stores and take only one inventory a year, adjust that inventory number to reflect your best estimate of your average inventory.
  • If you take only one inventory a year you can also take the ending inventory from the previous year and the most recent inventory and divide by two.
  • If your store is only open nine months a year, then only those nine months should be taken into consideration.
  • If you are open all year long but are busy only seven months (and very, very slow for the remaining five months) then your average inventory should primarily reflect your average inventory levels during the busy season.
Annual Cost of Goods Sold ($150,000)

Average Inventory at Cost ($45,000)
 = Inventory Turnover (Turns)

Step Two. Do the calculation.

This is where the garbage in, garbage out, shows up. If you have gathered the information carefully, the easy calculation results in an accurate and useful number. Simply divide the Annual Cost of Goods Sold($150,000) by the Average Inventory at Cost($45,000)

Annual Cost of Goods Sold ($150,000)

Average Inventory at Cost ($45,000)
 = 3.33 Inventory Turnover (Turns)

The answer, 3.33 inventory turns, indicates that you used your inventory dollars 3.33 times during the twelve months being measured.

Please note two things. First, both numbers used for the calculation are at cost. While it is typical to use cost numbers you can use retail numbers. The important point is that the numbers must have the same base — cost or retail. Second, it is typical to base this calculation on annual numbers. However, if you calculate it on a semiannual, biennial or any other time period, just remember to use the exact same time period for each number in the formula.

As I mentioned earlier, calculating turns is an important tool for measuring retail activity. I counsel my clients however, to primarily use it to build historical data for their own store rather than as a number to compare with other stores. Differences in store goals and objectives, and how the ratios are calculated by different stores, leads me to use this primarily as an internal tool.

Square footage is also a factor affecting turns. A store that is too big may have slower turns because it requires too much inventory to keep the store looking full and inviting. A store that is too small my have elevated turns because it needs to be re-stocked more frequently.

So, how should turnover data be used? I suggest you use it for internal monitoring of segments of your store as well as the store as a whole. The turns of individual items, different product categories, products at various price levels, and the store as a whole can be compared to each other and to their own historical record. By segmenting the turn data you can set different values for each segment. You may well be satisfied with a .5 turn ratio for the highest priced items, 3.2 for the store overall, and 6.0 for souvenir/impulse/novelty items. Unfortunately, in a vast majority of stores turns are too low as evidenced by storerooms (and rest rooms) bulging with product and tired looking merchandise.

In general, the higher the turns the better. High turns mean you are using your inventory dollars efficiently, your stock looks fresher, and you probably need less storage space. On the other hand, rapid turnover can put a strain on personnel who need to process more purchase orders and receiving documents, and deal with all the activity associated with frequent deliveries. Also, if you don't keep up with the work associated with high turnover, you may loose sales because some popular items are temporarily out of stock.

If the turns are too low however, too much capital is being tied up in inventory and the store may be short of cash that can be used to buy newer product.

 
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