# Inventory turnover rate

Also see:

A way to measure how quickly materials move through a factory or an entire value stream, calculated by dividing the cost of goods by the amount of inventory present at the time.

Probably the most common method of calculating the turnover rate is by using the annual cost of goods sold (before adding overhead for selling and administrative costs) as the numerator and dividing that by the average amount of inventory present during the year. Thus:

Using the cost of goods instead of sales revenue captures one source of variation unrelated to the performance of the production system: fluctuations in sales prices due to market conditions. By assuming an annual average of inventories rather than year-end conditions, another source of variation is captured: an artificial drop in inventories at the end of the year as managers try to look good.

The turnover rate can be calculated for material flows through value streams of any length. When making comparisons, however, remember that the velocity decreases with the length of the value stream, even if performance across the entire value stream is equally 'Lean'. For example, a plant that performs only assembly operations may have a velocity of 100 or more, but if the parts suppliers that supply the assembly plant are included in the calculation, the velocity will often drop to 12 or less.

And when counting all the way from the first processing of materials - steel, glass, resin and so on - the rate often drops to four or less. This is because the cost of goods sold at the very end of the value stream does not change, while the amount of material in inventories grows steadily as we add more factories to our calculation.

Turnover rate provides a great metric for a Lean transformation when the focus shifts from the absolute rate at each plant or across the value stream to the increase in turnover rate. If turnover rate is accurately calculated using annual averages of inventory, it can even become that one number that never lies.

Turnover rate for the U.S. economy:

Although most companies measure inventory by turnover rate, the workbook Building a Lean Fulfillment Streamuses the Average Days on Hand (ADOH) indicator for this purpose. ADOH represents inventory in the form of the number of days a process can continue to operate by consuming its stored inventory. An advantage of ADOH is that it allows managers to visualize how much inventory they have in relation to the work to be done in a day. For example, if the lead time from order to delivery of a delivered item is four days, but there is an ADOH of twenty, it is clear at a glance that there is five times as much inventory as needed.

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