ADS Solutions Wholesale Distribution Software Blog

How to Improve Inventory Turns with Specialized Distribution Software

Just by improving one turn, a typical wholesale distributor can save hundreds of thousands of dollars. The less money you have tied up in inventory, the more money you will to accomplish other things in your business. Here’s an explanation of why it’s important to optimize your inventory.

improve inventory turnsImproving inventory turns is one of the most prudent things a distributor can do. While it is a given that some segments of your product line naturally move faster than others, actively optimizing your inventory as a whole for rapid turns can make or break your distribution business. Given two similar companies, with two similar product lines competing in the same market, the one with the better inventory management system is the one that will grow faster. Poor inventory turn is a bottleneck for growth and a drain on profitability.

“Turns” refers to the number of times your inventory is flushed through your sytem per year, per month, or over any desired reporting period. Inventory turn rate can be calculated for your entire inventory or just a segment of it, such as a product grouping or particular SKU family, and gives you a picture of how you are doing relative to last week, last month, or last year, or even compared to your competitors. Our last blog talked about ABC inventory stratification; classifying your inventory this way allows you to drill-down and calculate turns on each stratum.

Aside from improved ROI, what are the other benefits of high turns? With any distribution business, the less money you have tied up in the inventory you need for order fulfillment, the more money you will have for working capital to do all the other things a company needs to grow — marketing, advertising, research and development, consulting, acquisitions, expansions, and other investments that fuel your business. Caveats of poorly buffered safety stock aside, the higher your number of turns, the better, and the harder your investment in inventory is working for you (aka ROI).

Calculating Inventory Turns

The “official” calculation to figure out how you are turning inventory, is to take your Cost of Goods Sold (COGS) and divide by your average cost of inventory during that period. For example, if your COGS during the month is $10,000, and the cost of your inventory for that period was $1,000, then your inventory turnover rate is 10 (which would be very good!). If you are evaluating turns over a longer period of time, or if your inventory costs fluctuates during your reporting period, it might be more accurate to calcualte your average inventory cost, using:

(Beginning Inventory Balance + Ending Inventory Balance)  /  2

Don’t make the mistake of using the “Retail Method of Accounting”, which adds the beginning RETAIL value of your inventory to the RETAIL value of your purchases then subtracting the RETAIL value of the ending inventory, then divided that value by your total sales. This method has been used in the past because some distributors, on the advice of their accountants, used retail values because it was too difficult to calculate costs manually. But that assumes that everything you sell will be at the retail value. With a good inventory control system like ADS Soltuions Advantage distribution software, you will obtain a true Cost of Goods Sold. Hence, you should use the COST instead of Retail to produce an accurate picture of your inventory turns:

(( Cost) + (Purchases at Cost) – (Ending Inv. at Cost))  /  (Cost of Sales)

If your inventory management system also has a method of tracking adjustments for shrink or scrapped items, then the more accurate formula would be: ((Beg.Inv) + (Purchases) – (Ending Inv.)  –  (Cost of Scrapped and Lost items))  /  (Cost of Sales).

There is a fine line between a high number of turns and running out of product because your inventory quantity is too close to what you are actually selling AND having too much inventory in relation to your sales. Every distributor’s dream is to get their inventory to the correct levels so they have achieved “Just-in-Time Inventory”. Find that perfect balancing point where your amount of inventory on hand earns the best return. If this balance point, invest in a good software system, and it will become clear.

For example, if you had $500,000 in inventory, and you only had sales of $50,000 in a month, you would have too much inventory and paltry turns. On the other hand, if you had $5,000 in inventory and $50,000 in sales, you would be buying too often and wasting money on shipping, receiving, and labor required to process frequent purchasing. The ideal point is to turn inventory 5-6 times, and it is many companies have used their ERP software to help them turn 10-12 times.

Your goal is to keep your inventory investment at target levels with as wide a selection as possible, and avoid both finished goods sitting in your warehouse, and lost sales opportunities due to insufficient safety stock.

Leading ERP Vendor ADS Solutions Is Here to Help

Although ADS Solutions competes as leading ERP vendor of wholesale distribution software, we are always happy to discuss your questions about inventory optimization and inventory stratification. Please feel free to call our staff at 800-423-8268 ext. 835: we’re here to help.

How to Find EOQ with Your Distribution Software Solution

“EOQ sits at the heart of inventory control, and good use of EOQ intelligence affects many areas of your business – namely cash flow, growth potential, and profitability.”

EOQ, or economic order quantity, is a powerful tool for distributors. ADS Solutions’ distribution management system allows distributors to manage inventory purchasing and stock levels based on desired service levels for specific products. Higher desired service levels typically require higher levels of stock and greater inventory carrying costs. Similarly, lower service levels are associated with lower levels of customer satisfaction. EOQ gives the distributor the ability to systematically set service level inputs and to generate recommended purchasing reports that optimize inventory levels.
“Optimizing your inventory levels” means that for each product and your chosen service level, you keep enough stock on hand to fulfill your customers’ orders in a timely fashion, yet keep your overhead costs to a minimum. The fewer goods you can stock for the shortest amount of time, but still manage to ship all your orders on-time, the better. EOQ sits at the heart of inventory control, and good use of EOQ intelligence affects many areas of your business – namely cash flow, growth potential, and profitability. In its most simplistic form, the equation looks like this:

Where D is your demand; S is your setup, or ordering cost; and H is your holding cost. The kind of EOQ calculated by sophisticated ERP software for distributors is based on a slightly more complicated mathematical equation that takes your safety stock levels, your vendor lead time, the product’s usage rate, multiple contributors to your carrying costs, and your transaction costs into consideration, and generates an optimal (or “economic”) order quantity. That said, the principle is the same as in the mathematical expression above.

Accurate EOQ Depends on Good Historical Data

The more accurate the historical data is that you use to substantiate lead times and usage rates, the more reliable your suggested EOQ-generated order quantity becomes. Properly used, EOQ can be a critical driver of profitability and growth in your business. Volumes have been written about EOQ, and a simplified summary such as this will hardly scratch the surface of this powerful facet of inventory optimization. As with all such tools, though, the better the information inputs, the better the value of the output.
Most ERP vendors like ADS Solutions distributors software will automatically track the transaction data that automatically feeds your EOQ algorithm. If your distribution management system doesn’t do this automatically, here are a few practical tips about how to most accurately track and record some of the information integral to an accurate EOQ calculation. Also remember that EOQ is a tool, a sophisticated and very powerful tool, but a tool nonetheless, so don’t overlook the importance of human interaction and input to the process.

Location, Location, Location

Record the sale and fulfillment of products in the proper location. If you have to move products from warehouse X to satisfy demand in region Y, be sure to associate the sale of this item in your distribution management system with region Y. You can see that if the demand is recorded as having come from warehouse X, then warehouse Y is likely to experience stock-outs in the future.

Note Date of Request – Not Just Delivery Date

Record when the customer wanted the product, even and especially if that date varies from the actual delivery date. Use the features on your distribution management system to help you keep track of seasonal requests that were lost to competitors because of your low inventory. Be sure to track ebbs and flows of orders tied to other predictors, too, like sales of ‘sister’ products.

Start Tracking Unfulfilled as Well as Fulfilled Requests

Record usage for what the customer actually orders. If you are out of stock, then you need to note that, even if you fill the order with another product. If all you record is record fulfilled order, you may not purchase enough to satisfy customer demand in the future.

EOQ Differs With Every Distribution Management System

Many of the more sophisticated ERP distribution software programs available today offer some type of demand forecasting or EOQ functionality; however, each will operate in its own unique way, and none are 100% foolproof. The application of human judgment to a distribution management system’s EOQ recommendation is the last part of this equation – and a critical one at that. Your ERP software should provide sound, logical, suggested economic order quantities, but your buyers need to overlay their professional experience and sound judgment to adjust recommendations based on your own unique business and specific industry, and have the ability to adjust or override system suggestions.