Tag Archives: Turn

Interpreting Turn Numbers – Part 2

In a previous post I discussed the reasons why a larger turn number is not always considered agrocery-store-2119702_640 healthier turn number.  The first reason involved negative profit margins.  The second reason was high out of stocks.

There is a close relationship between turnover and inventory levels.  Turnover is essentially a measure of how efficiently a retailer is utilizing their inventory in creating sales.  Looking at the turnover equation (Annual Sales/Average Inventory – see Inventory Turnover:  Retail, Cost, or Unit?), it is easy to see that there are only two ways for a retailer to improve their turn numbers.  They can increase sales or lower inventory.  For now, let’s concentrate on the latter.

Smart merchants spend a great deal of time studying their category’s in-stock (aka on-shelf availability) levels.  These numbers tell the retailer whether any particular product is in inventory.  When an item is 95% in-stock, the retailer may assume that 95% of the time that product was in the store and available for the customer to purchase.

Retailers typically lower their inventory levels (and improve their turn numbers) in healthy ways, by cutting excess inventory or dropping SKU’s for which there is little demand.  These changes should not impact the products in-stock levels.

However, when a product’s both a product’s inventory level and in-stock level drops, this is a bigger concern.  This means that for whatever reason – the retailer is not able to keep enough inventory on hand to satisfy customer demand.  In other words, products are not being replaced when they sell out.

The resulting increase in turnover rate is considered unhealthy for two reasons:

  1. If the product had been in-stock, customers could have purchased it and sales would have been higher.
  2. If customers wanted the product but couldn’t find it, they may have decided to purchase it at the competition instead.

 

Interpreting Turn Numbers

No Retail Math number is useful unless you are able to interpret it, 24607796422_e5979e3304_q
and this is just as true for inventory turnover rates as it is for sales or profit figures.

In general, retailers prefer high inventory turnover numbers.  The higher the inventory turnover, the more times the retailer has sold their average inventory.  This means that a higher turnover rate normally correlates with higher levels of sales and profits.

Let’s Calculate!
Retailer #1 carries an average retail inventory of $300,000 and has annual sales of $900,000.  This gives them an inventory turnover of 3.0 ($900,000/$300,000).  If Retailer #1 has no markdowns and a maintain margin of 10%, then they will achieve a profit of $90,000 ($900,000 * 10%).

Retailer #2 carries the same average retail inventory of $300,000, but manage their inventory more efficiently, turning it 4.0 times that year.  This gives Retailer B annual sales of $1,200,000 ($300,000 * 4.0).   If they also have no markdowns and a maintain margin of 10%, they will earn an annual profit of $120,000 ($1,200,000 * 10%).

Is it always true that a bigger turn number is better?  While retailers do generally prefer that their inventory turnover rates increase, there are 2 exceptions to this rule.

The first is when dealing with a loss leader.  If a retailer has a negative initial margin for a particular item, then they may not wish to drive their turnover numbers higher.

The second is when the retailer’s out of stock levels are high.  This situation is one which will be covered in a future post.

photo credit: danielfoster437 <a href=”http://www.flickr.com/photos/17423713@N03/24607796422″>Fresh Produce</a> via <a href=”http://photopin.com”>photopin</a> <a href=”https://creativecommons.org/licenses/by-nc-sa/2.0/”>(license)</a>

Inventory Turnover: Retail, Cost, or Unit?

Periodically I have students who are confused by the idea that there is not one, but three different ways to calculate inventory turnover.  What really confuses them is that when using all three formulas to calculate inventory turnover (turn) for a retailer, each formula provides a different answer.  And, that this happens even though each formula has the same two basic components:  Sales and Average Inventory.

Let’s start with the formulas:
Retail Turnover = Annual Retail Sales/Average Retail Inventory
Cost Turnover = Cost of Goods Sold/ Average Cost Inventory
Unit Turnover = Unit Sales/ Average Unit Inventory

Example:

Retailer Z’s Financials Show:

Total Retail Sales $2,000,000
Cost of Goods Sold $1,200,000
Unit Sales 180,000
Avg. Inventory at Retail $400,000
Avg. Inventory at Cost $220,000
Avg. Inventory in Units 30,000

Let’s Calculate!
Retail Turnover = Average Retail Sales/Average Retail Inventory
= $2,000,000/$400,000  = 5.0

Cost Turnover = Cost of Goods Sold/ Average Cost Inventory
= $1,200,000/$220,000 = 5.5

Unit Turnover = Unit Sales / Average Unit Inventory
= 90,000/ 15,000 = 6.0

While the inputs are similar, they are not identical, due to each one utilizing a different method of measurement.  Typically Retail Turnover will provide you with the most conservative estimate of your turn rate out of the three calculations.  This is due to the fact that the Retail Sales and Average Retail Inventory numbers both have initial margin (or markups) built into them.

Next time we’ll look at interpreting and using these numbers.