Inventory turnover as a key performance indicator Part One
There are a vast array of possible business metrics – from those that are operational, financial, to those based on productivity. While most businesses have some form of key performance measurement system – many struggle with tens if not hundreds of individual measures in an endeavor to monitor their activity. Many businesses that fit this profile fail to distill their business into a manageable number of indicators that not only provide the basis to monitor progress but which provide meaningful information about performance.
Inventory turnover is increasingly being considered one of these key business measures, in “Supply Chain Management on Demand Strategies, Technologies, Applications” Chae An, and Fromm Hansjörg consider that Inventory turnover has become a measure on the effectiveness of internal business processes. Incorporated into a balanced scorecard the measure provides insight into the performance and effectiveness of an organizations processes and increasingly indicates how “lean” an organization is.
So what signifies a good inventory turnover, what is considered world class? The ratio is generally calculated by dividing the cost of goods sold by the value of the average inventory value and in “Lean Manufacturing: Tools, Techniques, and how to Use Them” William Feld considers that a stock turn of 50 or higher is world class. However research by Industry Week shows that the top 25% of manufacturers only achieved 25 inventory turns a year – a clear disparity portraying room for improvement.
A quick look around corporate annual reports suggest that many organizations are analyzing their inventory turnover closely and are monitoring trends and changes (whilst highlighting improvements to shareholders). A look at the following links show a range of corporate results quoting Inventory Turnover as a KPI as part of their investor relations package (http://www.toshiba.co.jp/about/ir/en/finance/indicators.htm, http://www.tthd.com/english/ir/indicator.html) – indicative that businesses are taking notice.
Clearly organizations and financial institutions place a level of importance on Inventory Turnover so what does it imply on the underlying business? A high turn rate is indicative of fast stock consumption and replacement and as we stated earlier, high inventory turnover is increasingly aligned with lean organizations – symptomatic of this are low levels of inventory, effective processes and satisfied customers all of which are typical business targets. Being able to describe year on year improvements in the ratio is therefore indicative of an improving business with an efficient supply chain delivering value to both customers and shareholders alike. An important business goal!
In part two of our article we'll discuss the impact of a low inventory turnover click the following link to jump to part two Inventory Turnover as a Key Performance Indicator - Part Two