Inventory turnover is a key performance indicator for businesses that require to stock products or parts. The higher the ratio, the more quickly inventory is sold or consumed. The business incurs costs for holding and storing inventory. Holding inventory ties up cash that could have been deployed to other areas of the business. A high inventory turnover ratio is a sign of efficiency.
To optimize the ratio, it is useful to look at 3 factors.
First, the supply chain. Your supplier plays a key role in your reorder frequency. When you rely on an overseas supplier, the lead time from order to delivery could be months if not weeks. This means you need to hold more stock. When the production cycle time is long, you likely need to hold higher inventory. The inventory turnover ratio for these cases would be lower.
Second, the demand forecast. Purchase quantity is subject to the demand forecast provided by the sales or the production team. It would be great if the business could consistently move inventory as anticipated. In other words, collaborative efforts across teams such as sales, marketing, production, and purchasing would facilitate an optimal inventory management strategy.
Third, the buffer inventory. Buffer inventory is necessary in the event of a sudden surge in demand. The last thing a business wants is a stock-out situation leading to dissatisfied customers or a halt to production. Estimating the adequate buffer inventory is not an exact science, but a combination of knowledge about demand, lead time, and past performances. Excessive buffer inventory builds cost and increases the risk of obsolescence.
These three factors are tightly linked.
For businesses that carry multiple products, it would be advantageous to categorize products and look at the respective inventory turnover ratio. The breakdown provides more insightful information for effective inventory management.