Turnover analysis is the most basic and fundamental tool for controlling your investment in inventory. Turnover analysis looks at your business's investment in individual items or groups of items making up your entire inventory. Turnover analysis then helps you decide if your investment in an inventory item, or groups of items, isexcessive, too low, or just right. From a cash flow perspective, performing turnover analysis is particularly useful for finding inventory items that are over-stocked. Remember, an excessive investment in inventory results in less cash available for other cash outflow purposes, such as paying bills.
Since turnover analysis focuses on individual inventory items or groups of items, it requires that you make a periodic count of all the items making up your total inventory. Your business probably already takes a physical count of its inventory items, so the information necessary to perform turnover analysis may already be available. If you are just beginning your business, be prepared to make a periodic count at least once a year, if not more often.
Turnover analysis also requires that you know the number of inventory items sold on an individual basis. This may seem like an awful lot of work just to determine if the investment in a particular inventory item or group of items is excessive. However, the information provided by the analysis will make it all worthwhile.
Turnover vs. average inventory. There are some limitations to the information provided by the average inventory investment period calculation. First, as the name implies, the average inventory investment period is an "average." Because it is an average, it assumes that all products are the same, each selling at the same rate, and each costing the same amount. Secondly, the calculation assumes that your inventory only contains one product. Most likely, your business carries a number of different products; some selling faster than others, and others costing you more to purchase.
Turnover analysis goes beyond the average assumptions made by the average
inventory investment period. It does this by requiring you to look at each
product or line individually, taking into account the number currently on hand,
the number sold, and the number on hand in relation to the rate at which each
item sells. So, turnover analysis can be used to pinpoint the specific inventory
items that are creating an excess investment in inventory, thus creating cash