Hello Beets! My name is Helen King. I am the newest member of the Supply Chain Insights team. I am very excited to join the team. I look forward to interacting with the Beet Fusion community. I will be posting a Metrics Blog here weekly so be sure to come back each week to see what we have for you.
Before I get into all of the facts and figures of this post, allow me to give you a little background on myself. I am a recent graduate of Tuskegee University with a Bachelor’s degree in Sales and Marketing with an emphasis in Supply Chain. During my four years at Tuskegee, I developed an interest in supply chain management and took extra courses to get a better understanding of the vast field and how it works. I attended panel discussions, roundtables, and conferences that were hosted by my college and began networking in the supply chain world. In my senior year, I was introduced to Lora Cecere during her visit to Andrew F. Brimmer College of Business and Information Sciences. The rest is history.
A Closer Look at Inventory Turns: An Important Measurement
In any kind of research, it is important to understand the why and how of the measurement. In the past, at Supply Chain Insights, when calculating the Supply Chain Index rankings, we used financial information from YCharts. The methodology used by YCharts is to calculate inventory turns as Inventory Turnover = Revenue / Average Inventory where Average Inventory is equal to the average of the last two reported inventory levels of the specified frequency.
In an ideal world, companies want to turn inventory faster The faster the turns, the greater the contribution to market valuation.
It was recently brought to our attention by an independent researcher in the pharmaceutical industry that the standard for calculating inventory turns is: Inventory Turnover = Cost of Goods Sold/Inventory. We find that it is calculated both ways in the industry. However, for companies the use of cost/goods methodology normalizes the data for a more supply chain-centric view.
As can be seen in Tables 1 and 2, the calculations yield very different results. It is for this reason, that we are adapting the Supply Chain Index methodology to use the cost of goods sold method.
Table 1: Inventory Turns Using Revenue/Average Inventory
Table 2: Inventory Turns Using Cost of Goods/Inventory
Looking at Trends
We use orbit charts to track and depict changes in year-over-year results at the intersection of certain metrics that we measure, below are two orbit charts which compare Operating Margin to Inventory turns. The first chart is a reflection of the calculation as Inventory Turnover = Revenue /Average Inventory and the second depicts Inventory Turnover = Cost of Goods Sold/Inventory.
As you can see, the difference in the number of inventory turns between the the observed timeframe (2006-2015) were 7.60 turns and in the new method, average inventory turns over the observed timeframe were 6.27.
Next Step for the Supply Chain Index and the Supply Chains to Admire
Pharmaceuticals is a unique industry in that compared to other industries margins are extremely high, so when the methodology for calculating industry turns was adjusted, we found the inventory turns were overstated when using YCharts data. This drastic change can explained by the difference in using revenue versus using cost of goods sold in calculating inventory turns because the large revenue margins that pharmaceutical companies are able to realize skew the ratios when cost is not taken into account.
In our countdown for the Supply Chain Insights Global Summit, we will be publishing a series of reports on the Supply Chain Metrics That Matter by industry. In this series, we will use the cost of goods definition for inventory turns.
Let us know what you think. I look forward to hearing from you.