Pros and cons of ITO

Inventory turnover is the primary KPI in inventory management. In short, it answers the question of how many times (from a statistical point of view) we turn our stock during the year. For example, if on average we have 10 pieces of a given product in stock and we sell it 100 pieces a year, we trade it 10 times a year.

Inventory turnover is typically measured against entire inventories from a value perspective. The formula for the calculation is simple:

ITO = sum of the value of the products sold during the period / average level of inventory in the company during the period

The most common period of the year is used.

The biggest advantage of ITO is the ability to assess whether the value of the inventory we have is a problem or not. Because if we have £100m of stock, but we turn them 40 times a year, that is in most industries, it's a very good result. However, if we have stocks for 50this zł and ITO is 0.2 (that is, we turn the stock once every five years) then this can be a big problem.

The main disadvantage of the ITO is that it is a retrospective indicator. And based on it, we are not able to assess whether the stocks we currently have are "healthy" or not. Because even though our stocks have been trading very well in recent months, that does not mean it will be like that in future periods. Because we could have made an unfortunate purchase of materials because the business environment and demand could have changed because we could have lost/changed a key customer.

Therefore, an important addition to the ITO is DOH (days on hand) which determines for how long we have enough stock. And it is calculated not in classical/financial terms (because it is calculated as standard from historical data and from a value perspective) but broken down by individual SKU and by quantity. That is, for each SKU we should have calculated for how long our stock will last (and this in relation to the planned demand). Such an indicator will help us very easily catch these part numbers for which we have stock for a very long time. And if we go back to the value of this stock, we will have an incredibly good filter, which SKUs we should take care of, when working on reducing inventory. Because it is those with the greatest value and the greatest stock that will pull our ITO down in the future.