Supply Chain

• Inventory is the lifeblood of most manufacturing organizations. Just-in-time (JIT) inventory is the inventory method that attempts to have inventory ready for assembly or sale as soon as it's needed. In other words, demand for inventory always meets supply in terms of both time and price points. Another inventory method called just-in-case inventory focuses on having an oversupply of stock available.
  
  

Inventory Cycle

• Different industries have different inventory needs. Those companies that need just-in-case inventory may have lower inventory turnover than companies that practice just-in-time inventory. In other words, inventory turnover measures the speed at which inventory moves through the company, and companies with an inventory policy that promotes oversupply may have a longer inventory cycle.
  
  

Negative Sign

• Inventory turnover also can be a sign of product deterioration. When the inventory cycle decreases, it usually indicates increased demand, which can lead to improved performance. When inventory levels increase and inventory turnover decreases, it is a sign of weakness from an operational perspective. Look for increases in debt to confirm that is the case.
  
  

Example

• In general, companies that sell highly perishable goods and/or goods with a low profit margin per item, such as grocery stores, have a higher turnover ratio. Analysts use the average inventory [(Year 1 inventory + Year 2 inventory)/2] to calculate turnover. This helps to account for seasonal affects. So if Y1 inventory is $10,000 and Y2 inventory is $20,000, average inventory is $15,000. If the cost of goods sold is $45,000, the stock turnover ratio is $45,000 divided by $15,000, or 3.