How Much is Increasing Inventory Turns by One?
Thursday, November 11, 2010 at 1:20PM There has never been a good answer to this question.
We have asked our partners in finance and they just gave us a blank stare and did what finance people always do. They asked “Why do you want to know that?” They followed back with their other stock answer “We do not track that.” This last comment is Finance talk that in truth means, “Why are you bothering me with this ridiculous question. Get lost and let me get back to work.”
The question is valid. It deserves an answer. If we are at 7 turns, how much cash will be generated if we get to 8 turns? It seems this would be something worth knowing. Besides the business value of answering such a question, getting to the answer allows us to do a bit of math in our blog which we have put in the appendix of this posting. In that way, only those who really want to read it can do so.
Basically, if we set:
- T=current level of inventory turns
- I=current quarter or year end inventory
- V=Value,savings,or cash generated by increasing T to T+1 turns
We are assuming that the Cost of Goods Sold (COGS) on which turns are calculated remains fixed.
- T=COGS/I
- V= I/(T+1)
The calculation could not be any easier or after having seen it, anymore intuitive. We believe that Finance and Supply Chain folks generally have the opinion that a turn accounts for a fixed or set amount of savings or cash generation. In fact, as turns increase the savings diminish.
Let’s look at some numbers. Let us assume you run a business with $50M in inventory. The table below shows the value of an additional turn:
| Current Inventory $M | Current Turns | Turns + 1 | Savings | New Inventory |
| $50 | 1 | 2 | $25.0 | $25.0 |
| $50 | 2 | 3 | $16.7 | $33.3 |
| $50 | 3 | 4 | $12.5 | $37.5 |
| $50 | 4 | 5 | $10.0 | $40.0 |
| $50 | 5 | 6 | $8.3 | $41.7 |
| $50 | 6 | 7 | $7.1 | $42.9 |
| $50 | 7 | 8 | $6.3 | $43.8 |
| $50 | 8 | 9 | $5.6 | $44.4 |
| $50 | 9 | 10 | $5.0 | $45.0 |
| $50 | 10 | 11 | $4.5 | $45.5 |
| $50 | 11 | 12 | $4.2 | $45.8 |
| $50 | 12 | 13 | $3.8 | $46.2 |
| $50 | 13 | 14 | $3.6 | $46.4 |
| $50 | 14 | 15 | $3.3 | $46.7 |
| $50 | 15 | 16 | $3.1 | $46.9 |
If we are one turn per year, increasing to two turns would generate a whopping $25M in cash. If we were at 11 turns currently at the same base of $50M in inventory, the cash benefit diminishes where an additional turn would generate $4.2M in cash.
Let us consider a realistic scenario. Our company has $50M in inventory. We are turning it 6 times a year. Management has challenged us to get to 12 turns. What are the savings for each incremental turn? Again we are assuming that COGS are fixed.
| Inventory Progression | Turns Progression | Turns + 1 | Incremental Savings | New Inventory |
| $50.0 | 6 | 7 | $7.1 | $42.9 |
| $42.9 | 7 | 8 | $5.4 | $37.5 |
| $37.5 | 8 | 9 | $4.2 | $33.3 |
| $33.3 | 9 | 10 | $3.3 | $30.0 |
| $30.0 | 10 | 11 | $2.7 | $27.3 |
| $27.3 | 11 | 12 | $2.3 | $25.0 |
| $25.0 | 12 | 13 | $1.9 | $23.1 |
| $23.1 | 13 | 14 | $1.6 | $21.4 |
| $21.4 | 14 | 15 | $1.4 | $20.0 |
| $20.0 | 15 | 16 | $1.3 | $18.8 |
Here is a graphic version of this progression:
In closing, as Supply Chain professional in general and Inventory Planners in specific we need to know our turns but the value that each successive turn will bring in terms of cash generation.
As usual, we encourage and welcome your comments.
Reader Comments (1)
I'm a finance person who does not find this question at all ridiculous! Efficient and effective working capital management can add tremendous value to a business, not least because it frees up cash to 1) invest in more productive uses, like sales and marketing or product development; 2) pay down debt, which adds immediate value; or 3) distribute to the shareholders as a return on investment. Cash tied up in working capital is a necessary evil; it earns no return. When business owners tell me they need more capital, this is the first place I tell them to look.