Understanding Inventory Velocity – Business Acumen 101
One of the most important keys for a company’s profitability and cash generation is Inventory Velocity. If you understand this relationship you will be on your way to financial success. So what is inventory velocity?
“Inventory Velocity – How many times during the year does the inventory turn over? Total sales divided by the value of inventory is the equation used to determine the velocity of inventory turnover.”
While the financial people will understand this definition, how well do the sales people and inventory buyers understand this rule? Here is the rule of thumb: the higher the number of inventory turns during the year – the better. The question your sales people must ask is how does my customer benefit from buying from me? Does my product or service increase their inventory turns and thus their profits increase? Do your buyers focus on getting products that turn over rapidly or do the products just sit on a shelf or in a warehouse?
Okay, some more things to think about regarding inventory velocity.
First, the higher the velocity coupled with a profit margin equals the true return on sales. So a company’s success is dependent upon the combination of turns and profit margin on the products sold. The higher the turns the greater the total profit or return on sales. This simple formula is one of the less understood concepts used to insure profitable growth.
Second, sales people that understand this formula will make an effort to increase the turnover rate of products. They work to increase the turns of the entire product mix therefore limiting the number of products that unprofitable due to lack of movement from inventory. They also take this formula a step farther. They use this formula to show their customers how the salesperson can increase their inventory turns. This action translates into a customer seeing either greater profits due to higher total returns; lower costs due to just in time inventory deliver (which has the effect of increasing inventory turnover) so less cash goes to finance inventory; or due to just in time inventory delivery – warehouse space can be reduced or converted into manufacturing space for increased productivity and higher sales. A win-win situation for sales person and customer.
Third, have your buyers of inventory analyze the rates of turnover on all products purchased for either manufacturing or for sellable inventory. Use this information to forecast an optimum inventory level for each product or product line. The company will benefit from this performance matrix with either lower inventory investments or maximized sales opportunities. The optimum mix of inventory for sale is a minimum inventory level that allows for all possible sales during a period of time (daily, weekly or monthly) or simply stated as product is always available for every sales opportunity, therefore, no lost sales. The creation of optimum inventory levels can be time consuming at first, the long term payback is very high.
An example of a company that has focused upon this third point is WalMart. They created an infrastructure system for tracking inventories and coordinated their entire supply chain system to support the optimum inventory levels. Their goal was to always have an item a customer wanted without investing in excessive levels of inventory. Using this system, WalMart was able to catch and past KMart in total sales and market share. A great strategy and execution of strategy.
Finally, inventory turns is a guide to show just how productive a sales team or an operations group are effective. This is a matrix that can be measured and should be top of mind for all the key personnel responsible for managing inventory levels or moving inventories to customers. When you examine the importance of the supply chain group in the determination of inventory turnover, new systems and measurement practices become an easy decision. Focus on how to improve the turnover of inventory and watch your profitability soar!