Inventory turns: The key metric to making your money work for you
I get a lot of questions about inventory turns
because they can be hard to understand. Even harder to understand
or model is how turns affect cash flow. However, the entrepreneur
who measures turn and appreciates the connection is much more
likely to prosper in the long run.
First, defining inventory turns – how many
times did you turn your inventory? However, there are many ways
to view inventory turns — including financially (at cost or retail)
I will try to make it as simple as possible.
If we buy a widget for $1,000 and we sell
that widget for $3,000 and we sell one every three months, we
have 4 turns annually at retail. (12 months in a year, divided
by 3 months, equals 4 turns).
In the auto salvage business, if we pay $1,000
for a car, and we sell $1,000 in parts off of it in 30 days,
we have 12 turns at cost and 30 days to break even.
Let’s think about cash flow. If we pay $1,000
for a car, and we sell $3,000 worth of parts off of it in a year,
our $1,000 produces one turn at retail, and $3,000 in cash flow.
It also produces $2,000 in gross margin, with a 33 percent cost
of goods sold and a 66 percent gross margin.
If we buy a car, and sell $3,000 off of it
in 90 days, we have 4 turns and the same gross margin of 66 percent
is applicable, but we produce $12,000 in annual cash flow. This
assumes we take our $1,000 and reinvest it every 90 days in another
In both cases we have a 33 percent cost of
goods and a 66 percent gross margin.
So, if you have 4 turns per year, you will
produce $12,000 in cash flow and $8,000 in gross margin (That’s
what you pay bills with or buy momma a new car with!).
But, if you have one turn, you only get $3,000
in cash flow, $2,000 to pay bills with, and in all likelihood,
momma won’t get a new car.
The owner of any kind of small business can
benefit from understanding how quickly inventory is turning,
the different kinds of turns, and how much harder money works
when inventory can be made to turn a little bit faster.
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Remember, only you can make BUSINESS
Ron Sturgeon is past owner of AAA
Small Car World. In 1999, he sold his six Texas locations, with
140 employees, to Greenleaf. In 2001, he founded North Texas
Insurance Auction, which he sold to Copart in 2002. In 2002,
his book “Salvaging Millions” was published to help
small business owners achieve significant success, and was recently
reprinted. In June 2003, he joined the new ownership and management
team of GreenLeaf. He also manages his real estate holdings and
investments. You can learn more about him at WWW.autosalvageconsultant.com
He can be reached at 5940 Eden, Haltom City, TX 76117, email@example.com or
817-834-3625 ext 6#.