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Lesson 11 - Inventory Turnover
What response would you get when asking your employees what inventory turnover means? A blank expression? A grunt? By saying “I have no idea”? By saying “It’s our opportunity to make a profit”?
If you hear that last answer then you are probably a very good businessperson because that is exactly how inventory turnover should be thought of…an opportunity to earn a profit. The concept is best illustrated by using an example.
Say you sell $10,000 worth of product (at cost) over the course of a year and receive total revenue from those sales of $12,500. If you bought the entire $10,000 worth of product on January 1st, at the end of 12 months you would have made a return of $2,500 on an investment of $10,000. But do you have to buy the entire $10,000 of material at one time? What if you bought $5,000 worth of product on January 1st and then, right before running out of that stock, you bought an additional $5,000 worth of product with part of the revenues received from selling the first shipment. At the end of the year you’d still have sold $10,000 worth of product, still made $2,500 gross profit, but would have only had a maximum $5,000 invested in inventory. Could you do the same by buying $2,500 of inventory every 90 days and buying $2,500 just before you ran out of that until at the end of the year you would have made an annual $2,500 in gross profit with an investment of only $2,500 at any one time but done it four times during the year?
The better option is obviously investing $2,500 at one time to make the same amount of annual gross profit and using that $7,500 that was tied up in inventory on the first example to either buy more profit producing products, using it to market your company or investing it in your people.
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