Inventory Performance Measurement

Inventory performance management or supply chain management has emerged as an important business activity these days. The idea is to apply a total systems approach to managing the entire flow of information, materials and services from raw materials suppliers through factories and warehouses to the end customer. The efficiency of the supply chain can be measured based on the size of the inventory investment in the supply chain. The inventory investment is measured relative to the total cost of the goods that are provided through the supply chain.

Two common measures to evaluate inventory efficiency are:

• Inventory Turnover
• Weeks-of-Supply

These essentially measure the same thing and mathematically are the inverse of one another.

Inventory Turnover = Cost of goods sold / Average aggregate inventory value

Here, cost of goods sold is the annual cost for a company to produce the goods or services provided to customers; it is sometimes referred to as the cost of revenue. This does not include the selling and administrative expenses o the company. The average aggregate inventory value is the total value of all items held in inventory for the organization value at cost. It includes the raw material, work-in-process, finished goods, and distribution inventory considered owned by the company.

Good inventory turnover values vary by industry and the type of products being handled. At one extreme, a grocery store chain may turn inventory over 100 times per year. Values of six to seven are more typical.

In many situations, particularly when distribution inventory is dominant, Weeks-of-Supply is the preferred measure. This is a measure of how many weeks’ worth of inventory is in the system at a particular point of time. The calculation is as follows:

When company financial reports cite inventory turnover and weeks of supply, we can assume that the measures are being calculated organization wide. In some very low inventory operations, days or even hours are a better unit of time for measuring supply.

An organization considers inventory an investment because the intent is or it to be used in the future. Inventory ties up funds that the intent is for it to be used in the future. Inventory ties up funds that could be used for other purposes and a firm may have to borrow money to finance the inventory investment. The objective is to have the proper amount of inventory and to have it in the correct locations in the supply chain. Determining the correct amount of inventory to have in each position requires a thorough analysis of the supply chain coupled with the competitive priorities that define the market for the company’s products.