Operations Management Basics: Inventory turns

One other important indicator for the evaluation of business organisations (not processes) is the inventory turnover rate (or number of inventory turns). The turnover rate answers the question of how much time a Dollar (or Euro) bill actually spends inside an organisation with the organisation being seen as a black box of sorts. A company has a competitive advantage if it can turn its inventory faster then the competitors can.

inventory turns = cost of goods sold (COGS) / average inventory

The inventory turnover rate is especially important because inventory creates costs. A business has to invest money in order to produce or buy an item and store it over a period of time, especially if the item might also loose value over time. The important indicator here are the inventory costs per unit, which are calculated as average inventory costs over inventory turns per unit time. If, for example, the annual inventory costs are 30% and there are 6 inventory turns per year, the per unit inventory costs are at 5%, meaning that for every unit sold the company has to calculate 5% inventory costs sort of as an internal tax rate. Inventory turns are therefore a good indicator on how productive an organisation uses its capital.

These lecture notes were taken during 2013 installment of the MOOC “An Introduction to Operations Management” taught by Prof. Dr. Christian Terwiesch of the Wharton Business School of the University of Pennsylvania at Coursera.org.