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Rebalancing Your Inventory Like Your Retirement Accounts

Most financial advisors recommend rebalancing your retirement accounts on a yearly basis. The goal is to maintain the target mix of investments to achieve optimal performance. If it works for your retirement accounts, maybe it can be applied to your inventory investment also: Analyzing the individual items in your inventory investment, and adjust/refine the mix to achieve optional performance. So where do you begin?

Start the process by analyzing your inventory and identifying underperforming items. There are several metrics you can use for this purpose, including: turns, turn and earn, or gross margin return on investment (GMROI)-just to name a few. The differences between the metrics are illustrated as follows using the generic Item-X, with an annual sales of $100,000, cost of goods sold (COGS) of $80,000, gross margin percentage of 20 percent, and average inventory of $20,000.

"Turns" measures the number of times you sell or turn the average inventory. The calculation is COGS divided by the average inventory over a given time period. Another way of looking at turns is the number of opportunities you had at earning margin. For Item-X, with annual COGS of $80,000 and average inventory of $20,000, the number of turns is four-80,000 ÷ 20,000 = 4. In other words, there were four opportunities to earn margin on the inventory investment. While this information is valuable and it allows you to compare items, it does not take into consideration the margin you actually earned. To factor in margin, consider turn and earn or GMROI.

"Turn and earn" helps you balance turns and gross margin. The calculation is number of turns multiplied by the gross margin percentage. Using Item-X as an example, with turns of four and the average gross margin of 20 percent, the calculated turn and earn would be 0.80 (0.20 x 4 = 0.8). This metric takes turns to another level, and enables you to easily compare items with low turns and high margin against items with high turns and low margin.

GMROI is similar to turn and earn in that it balances turns and gross margin, but the formula is different. The calculation is gross margin dollars divided by average inventory. Using Item-X again, with gross margin of $20,000-sales less COGS-and average inventory of $20,000, the calculated GMROI would be 1.

Both turn and earn and GMROI-which factor in both turns and gross margin-provide the most accurate view of underperforming inventory items. However, turns alone will also allow you to identify underperforming items. Ideally, you'll have multiple metrics available to analyze inventory, as two items with the same low GMROI or turn and earn can have wildly different reasons for the low mark.

Now that you have a metric or metrics to analyze, you can start to identify underperforming items. This can be a combination of science, art, and gut feel, as the definition of what an underperforming item is debatable. Instead of debating, it might be easier and more productive to simply rank your items and focus how to improve the performance or discard the bottom 20% of your inventory. Future articles will discuss ways to accomplish that.

By the way - If you haven't done so already, you might want to consider rebalancing your retirement accounts too!

Tony Corley is a Sr. Product Marketing Manager at Epicor. Connect with him on LinkedIn.


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