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How to Manage Inventory Turnover in Wholesale

Topics: Wholesale & Distribution, Management

There's a fine line that wholesale distributors must walk when it comes to inventory turnover. Too much turnover will increase cost and drain resources. Companies that aren't prepared for an increase in turnover might see their inventory management spin out of control.

While an increase in turnovers can result in the company getting paid more often, overstocking items can result in more massive carrying cost. Knowing how much to stock is the key to winning at inventory turnover.

Providing excellent customer service can't be overlooked either. In fact, B2B customers are demanding better customer service from their distributors.

In this article, we'll look at different techniques for improving inventory turnover as it applies to wholesale distributors.

Hitting A Moving Target

Determining the right amount of inventory to have on hand is like hitting a moving target. As customers and suppliers change, so does forecasting of inventory.

One technique is to keep more on hand than you need simply. This handles current customers' needs, periodic spikes in demand and can also take care of the occasional customer who unexpectedly pops in once per year. In other words, you're able to create a buffer between current and unexpected demand.

While overstocking is likely to meet customer demand, it can lead to high inventory. Meaning, even after all demand has been met, you're left with unsold products. In this case, you've simply bought too much product. This increases carrying cost.

Carry cost are all costs associated with holding inventory. This includes space in the warehouse, movement of product in the warehouse, insurance, utilities, depreciation, decay, damage, and pilferage. 

On the opposite end of overstocking is JIT (Just-In-Time) management of inventory. This technique strives to order just enough inventory to meet customer demand. JIT can work well when your customers' and suppliers' ordering behavior is well defined and predictable. The JIT supply chain needs to be reliable and work consistently every time. Otherwise, JIT can cause lots of problems.

Just in time inventory turnover management.jpgImage Source

For companies who aren't prepared for JIT and try to implement it, they can quickly find that they're running into inventory shortages, suppliers who aren't able to get products to them quickly enough, increased cost from suppliers for short-notice orders, and incre ased management of inventory as customers orders and demand vary.

To implement JIT successfully requires lots of up-front planning.

There is a middle ground between the extremes of over-stocking and JIT that companies can strive to meet.

A Happy Inventory Turnover Medium

Knowing your current inventory turnover ratio is a great starting point in more efficient management of inventory turnover. You can calculate this ratio using the following simple formula:

    sales / inventory = inventory turnover

Another way to express this same formula is:

    COGS / Closing inventory = turns per year

Where closing inventory can also be average inventory during a period, which is usually one year. As an example, let's say the cost of goods sold (COGS) was $500,000 during the past year, and at the end of the year, inventory was valued at $125,000. That provides a turnover ratio of 4, which means the company was paid four times on its inventory during the year.

Some companies will have room for improvement on their inventory turnover. A number of one or two turnovers per year can probably be improved to three or four. Maybe even five. Here are a few quick wins you can start implementing now to increase your turnover.

However, there is a point at which a company will reach diminishing returns on the number of times it can turn over inventory per year. Transaction cost and demand for resources both go up as turnover increases. By slowly improving turnover, a company will know its most efficient inventory turnover ratio.

Knowing your turnover ratio will put your company in the middle of overstocking and  JIT. You'll likely find your business is using a mixture of the two but not slanted all the way to one side or the other.

Improving The Supply Chain

Inventory is just one piece of the puzzle when it comes to improving inventory turnover. The entire supply chain has to be taken into consideration. This means vendors/suppliers to inventory management to paying customers.

Starting with suppliers, trying to negotiate better payment terms is one of the first steps. If you can close the gap between paying suppliers and getting paid by customers, cash flow will improve. Here's an example of what we mean:

    Supplier1 requires payment in 30 days

    Customer invoices on those goods have net 45 terms

This creates a potential 15-day gap in cash flow. Meaning, the company's cash flow is negative during this time. Money has to come from somewhere to cover paying the supplier. This gap can be closed by changing customer payment terms to net 30, which means customers should be able to pay for COGS fully.

A more aggressive strategy might be net 25 for customers. In this case, the company has a five-day gap to their advantage in cash flow.

Management Of Inventory Based On Demand

A reconfiguration of the warehouse can help improve inventory turnover. This requires reclassifying inventory based on how quickly it turns over.

Inventory that turns over the fastest should go near the shipping area, allowing quick access to the trucks and distribution. Further away from the loading dock and further back into the warehouse is slower moving inventory. Meaning, inventory with a slower turnover. The last classification is inventory that is considered excess stock and obsolete. This inventory should be completely out of the way of active inventory (i.e., fast and slow). This last classification of inventory will go all the way to the back of the warehouse.

This type of inventory classification allows personnel and equipment to move more efficiently throughout the warehouse. It's easier to physically identify inventory as well.

If excess and obsolete inventory start to accumulate at an increasing rate, there is room for improvement. Understanding what is causes the increase in this classification can show that the company is ordering stock that is no longer in demand and costing the company money with every sale (i.e., no profit is being made). This can lead to trimming products lines that are not profitable.

Using Software To Manage And Forecast Inventory

There are various categories of software that help companies manage their inventory. These include:

  • Enterprise Resource Planning (ERP)
  • Warehouse Management System (WMS)
  • Inventory Optimization Software

An ERP is used for full management of company operations. Inventory management is one part of an ERP system. If you want to create more efficiencies and measure performance across the company, an ERP can help you accomplish that.

A WMS manages logistics of inventory within the warehouse. Meaning, movement, stocking and other essential statistics in real-time.

Inventory optimization software is focused just on optimizing inventory turnover. It provides excellent insights into what is happening with your inventory in real-time and can yield excellent results on inventory efficiency.

Keep in mind; these products require intensive integration processes. ERPs are the most intensive. You'll be working with consultants, employees will be tied up, and the cost will be high during the integration period. There is also cost to maintaining such systems. If your inventory needs are noncomplex and straightforward, you probably don't need such elaborate systems. But as complexity increases, a management system should be considered.

Conclusion

It's important to not approach inventory management by focusing only on excessive stocking or only on JIT. Finding a middle ground that uses a mixture of the two can yield the best results and provide a path for scalability. 

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