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Inventory insight: Manage and maximize

October 11, 2010
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Inventory is more than just the products available for sale, but rather a financial investment waiting for a return.

Store managers frequently view inventory items — oil filters, motor oil and air filters — as inanimate objects, but in reality:

  • The oil filter should be thought of as $1.50;
  • The quart of oil as $1.14; and
  • The air filter as $3.68.

Once an owner begins thinking in these terms, it is much easier to understand the financial consequences of managing lube inventory.

The inventory impact
Effectively controlling inventory plays a critical role in the operation of a lube center, impacting earnings and the return on your investment.

Managing your inventory at your lube site is easier than ever because of advancements in computer-based inventory controls today. Computer software can even automatically order more supplies or goods for a site, thereby eliminating one more thing on a lube owner’s list of to dos.

The most significant measurement in inventory management is inventory turnover.

Inventory turns are measured by the number of times the average inventory investment turns over on an annual basis.

Inventory turnover is calculated by dividing cost of goods by your average inventory (average inventory can be based on monthly, quarterly or annual inventory levels).

To calculate average inventory using beginning and ending annual inventory:

  1. Add the beginning and ending inventory and divide by two.
  2. Using quarterly inventory levels, add each quarter’s ending inventory, and divide by the number of quarters used to measure the turnover.

An example of average inventory based on monthly calculations is shown in Table 1.

Determining COGS
Cost of goods sold (COGS) is calculated by adding your beginning inventory and purchases and subtracting the ending inventory.

An example of May’s cost of goods is shown in Table 2.

An evaluation must be done on a monthly basis to review the inventory turnover against the inventory investment.

This can be accomplished by dividing the monthly cost of goods by the month end inventory.

Monthly inventory turns should range in the .75 to 1 turn/month.

  • Cost of Goods Sold (May) $11,346
  • Ending inventory (May) $15,532 = .73 Inventory turns/month

Annual inventory assessment
The same principle applies for yearly assessment. To calculate the annual inventory turns, divide the annual cost of goods by the average monthly inventory.

The yearly COGS is calculated in Table 3.

  • Cost of Goods Sold (annual) $135,761
  • Average monthly inventory $15,207 = 8.93 Inventory turns

Inventory turnover goals should be eight to 12 times-per-year based on the store volume. Lower volume stores should be in the lower range and higher volume stores in the upper range.

This particular example shows that the average monthly inventory level is $15,207, yet the average monthly purchases were only $11,238 ($134,856 Purchases/12 months).

Inventory turn ratio
By increasing your inventory turn ratio (see sidebar), you can significantly improve your cash flow.

Maintaining a lower average inventory can increase your inventory turn rate.

However, if the inventory level is too low you will not have items on hand to support your sales.

Buying in bulk and using volume discounts should be evaluated along with your carrying costs and cash flow considerations. Saving five cents per filter but adversely impacting your inventory turns and cash flow quickly will negate any cost savings.

If sales are of sufficient volume, orders should be placed on a weekly or bi-weekly basis.

Quality computer management systems will have functions to assist with usage-based or automatic ordering. Since inventory costs are second only to salaries as a percentage of sales, effective management is crucial to running a profitable business.

Successful management of your cost of goods and inventory turns can make the difference in whether a store is profitable or not.

Howie Loewen, consultant multi-store operations, training/installs for Integrated Services, Inc. (ISI), is a fast lube consultant and an expert in inventory management and theft control issues.

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