4/12/13 MC44 – Inventory Turnover (1) | SAP Mental Notes

SAP Mental Notes

MC44 – Inventory Turnover (1)

Formula

Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory at value

If you are not familiar with the term Cost of Goods Sold, this is the cost of your revenues.

Average Inventory is measured in value and not in volume.

If you divide both elements you know how often you sold you’re average inventory. “So what?” you ask. I
will explain next.

Concept and use

I will present you with two business scenario’s to point out the significance of the Inventory Turnover ratio.

Scenario 1

You sell one product. You invest 10.000 EUR as starting stock. You run your business for one year and at then
end of the year you are completely sold out. Your revenue accumulates to 12.500 EUR. For simplicity sake
your gross profit is 2.500 EUR (12.500 – 10.000).

Revenue = 12.500

COGS = 10.000

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Average Inventory = 5.000 (10.000 starting stock + 0 end stock / 2 = 5.000 average stock)

Inventory Turnover = 2 (10.000 / 5.000)

ROI = 50% > 2.500 (R-C) earned out of 5.000 (A)

Scenario 2

Again you sell one product. But this time you invest 5.000 EUR in starting stock. After 6 months you sold your
stock and you replenish your stock again for 5.000 EUR. After another 6 months you’re sold out. Your
revenue is again 12.500 EUR. Your gross profit is 2.500 EUR (12.500 – 5000 – 5000).

Revenue = 12.500

COGS = 10.000

Average Inventory = 2.500 (5.000 starting stock + 0 end stock / 2 = 2.500 average stock)

Inventory Turnover = 4 (10.000 / 2.500)

ROI = 100% > 2.500 (R-C) earned out of 2.500 (A)

Conclusion

Looking at the two scenarios the increased inventory turnover means increased operating efficiency: your
ROI increased from 50% to 100%! Obviously you invested half the money in scenario 2 to achieve the same
profits.

This doesn’t mean businesses should try to achieve a maximum inventory turnover per se. Achievable ratios
differ per material type (finished goods, semi or raw), but also per moving speed (ABC class). Last but not
least the type of industry very much determines what ratio you can achieve: process industries typically
have higher inventory turns than, say, heavy equipment manufacturers.

You can find out what the industry standards are by purchasing metrics from data suppliers like Reuters or
Gartner. This will give you an idea how well you are doing compared to your competitors. Or you can just use
inventory turnover as an internal benchmark. In this case you periodically review the inventory turnover for
different sets of materials and set targets that you wish to achieve.

Inventory turnover is typically a financial measurement (see relation to ROI). In order to improve the ratio,
close cooperation with procurement/production planning is required, since they directly influence the stock
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levels.

Again, as with many KPIs and reports don’t judge based on this value alone, but use other stock controlling
reports to minimize your inventory and still have a sound service level.

Finally you can read an interesting business case on how inventory turns made Dell a leader in it’s business.

Kowboyz BV / CC BY-ND 3.0

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This entry was posted in MM, Process and tagged MM, reporting, Stock on February 26, 2009
[http://sapmentalnotes.wordpress.com/2009/02/26/mc44-inventory-turnover/] .

14 thoughts on “MC44 – Inventory Turnover (1)”

Pingback: SAP MM: Inventory Turnover Concept And Use with Real Life Scenarios (MC44)

Shahid zaman
June 26, 2009 at 08:19

Very good side

Kowboy Post author

July 2, 2009 at 17:54

Thank you.

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gova
July 20, 2009 at 07:42

very good explanation…i need to know..how the avarage stock will be claculated

jeyana
August 22, 2009 at 15:25

Yes, by the way, why do you calculate the average inventory as the arithmetic mean between starting and
ending inventory balance? It should be more complicated, if the company purchases the inventory in
unequal amounts or in unequal time periods, for example…

Kowboy Post author

August 22, 2009 at 18:41

Jeyana, you are right when you say the example is oversimplified. That is my intention. I want everyone to be
able to understand the concept that higher inventory turnover means higher ROI. I don’t want to give an
elaborate scientific explanation on how to calculate average inventory in a real life situation. There are other
sources for that PLUS in SAP MC44 transaction will do that for you.

Tommy J.
October 23, 2009 at 14:35

If I am right, most of the times the Inventory Turns is measured over a period of one year (12 months
rolling). In the Consumer Electronics industry we see a lot seasonality. Could this be a reason to change to a
shorter period like 6, 3 or even 1 month turns? What do you recommend and why? Do you have any
literature on this specific subject. Thanks in advance for your help.

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Kowboy Post author

October 24, 2009 at 19:20

Especially with seasonality stick to 12 months rolling. If your seasonal pattern is repeated each 6 months you
could use 6 months rolling. By including the full season you cancel distorted results. Whenever your KPI is
increasing you know you did better. If you exclude part of the season you’re not sure whether you did really
better or that the increased inventory turns is part due to the start of season with higher demand. Also, in
this case it could be possible that procurement is lagging demand and although the inventory turn increased
your service levels may be under pressure as safety stock is consumed. So, stick to 12 months rolling and do
not assume that a higher inventory turn is better per se. Analyze major deviations from the historical
average.

Eric
November 13, 2009 at 05:45

Hi Kowboy,
Here you show turnover for complete inventory, but can we do the same for inventory split by RM, Wip and
FG to explain the differente part of the turnover? Thanks in advance

Kowboy Post author

November 13, 2009 at 09:11

Yes, absolutely. Although with RM and WIP you wouldn’t use COGS, but Cost of Goods “Processed”. For the
obvious reasons that raw materials and components are not sold. In case you are an SAP user: Since I do not
work with SAP anymore I am not sure how SAP handles these material types in MC44. MC44 does offer the
ability to filter on material types (see my other post on inventory turnover).

Franklin
November 9, 2010 at 19:45
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In a general sense, could a product’s market share be a factor on it’s inventory turn (given that the product is
competiviely priced)?

Put another way, is it common to see high inventory turn products (if competitively priced) have high
market share?

Kowboy Post author

November 15, 2010 at 15:41

It could be, but it’s not related.

Josh
December 15, 2010 at 03:38

Could you let me know the formula of AVERAGE INVENTORY?

rita appiah
January 30, 2013 at 11:43

what if the inventory on the income statement is only 1 and not 2 . how do you get the average for one
inventory?

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