Inventory turns vs. Inventory velocity

Corporate management and investors understand the concept of "inventory turns" as a key financial measure that is constantly monitored and improved.  This metric broadly signifies how a company uses its cash effectively. For example, "lower turns" means a company needs more operating capital and therefore less money available for funding growth. The good news about inventory turns is that it can be easily computed at the corporate level. The bad news is that it is difficult to control or improve it.

The reason for this disparity is because inventory comprises so many variations (beyond the categories of finished goods, work in process, and raw materials), such as high-priced, fast-moving, slow-moving, one-off, long lead time, long transit time, standard, custom-made, etc.  Layering the company's business model variations on top of this - engineered to order, build to order, made to stock, selling through distribution, direct to OEMs, moving goods through retail channels, local customers, global customers - it becomes virtually impossible to monitor, control and manage the inventory purely by corporate mandates.

The top-down approach of telling the plants to reduce inventory by X percent becomes impractical if they are not accompanied with detailed guidance on how to do it. What is advisable and has proven to be effective is to put together a best practices template that helps identify potential inventory optimization opportunities.

This leads us into the domain of inventory velocity. Management consultants have been emphasizing that if one can measure, one can improve. So, what is the single most important measurement of inventory? It is the speed at which the inventory is being churned into cash. The factors that affect this speed are consumption rate, lead times, product lot sizes and replenishment frequency.  The fastest speed can be accomplished when the consumption rate synchronizes with replenishment frequency, and lead times and lot sizes are kept at a minimum.

The challenge that most manufacturing corporations face -- therefore not making it a common practice -- is that most systems do not have this data readily available. Understanding the current state of these factors for all the parts in the manufacturing (finished goods, work in process, raw materials) will help companies assess the improvement opportunities.

Why are these factors relevant? Synchronizing replenishment frequency with consumption will ensure that the speed of material movement is fluid and therefore minimizes on-hand inventory stagnation. Long lead times can have a multiplier effect on inventory.  Not only does this lead to higher inventory in the pipeline, but it increases the computation of the safety stock.  Large lot sizes have a similar impact on the on-hand inventory.

Example: Imagine you are consuming 50 pieces of a raw material every day and the lead time to get it from the supplier is 5 days. If the lot size is 500 pieces, then each order cycle will be carrying up to an additional 5 days of inventory. Changing one of the factors can easily lead to improvement in inventory velocity, while changing all three can lead to substantial inventory savings.

It is important for corporate management to drive the plant level materials, procurement, purchasing and logistics managers to work together to identify parts where such discrepancy exists. This data will allow the corporate team to set inventory goals and accomplish them with some level of consistency.

Measurement vs. Execution

Currently, most business systems in large corporations do not provide this level of detail. The information stored in ERP/MRP/supply chain systems is largely after the fact. These systems carry the inventory data but not the inventory cycle data. Since the materials, purchasing and logistics functions act as silos, it is not easy to extract raw data and perform analytics to identify the improvement areas.

A recommended approach would be to build or use a collaborative real- time system that can store and track this data.  It should consist of master and transaction data sets for inventory cycle information. Actively engaging the supply chain partners to transact data in real time is a vital step in gathering this valuable information.  Starting small by taking one type of inventory (finished goods or raw materials) is advisable. If the raw-material inventory is the first to be tackled, then it is essential to identify key suppliers of high-value parts and engage them in this process.

Once the measurement is done, the parameters for improvement should be identified (examples: reduction in lead time or smaller lot sizes or frequent delivery) and desired goals should be set. The collaborative system should be capable of making these changes in parameters and enforcing them. The system should provide for continuous improvement rather than treating this exercise as a one-off project.

With this approach, companies can successfully measure, identify and set goals, and improve and sustain their inventory turns over a period of time.

Source: Ultriva


Keywords warehouse management, supply chain management, supply chain management IT, SaaS, inventory management systems, inventory control