Use Quantities instead of Money for Inventory KPIs

The accounting formula of Inventory Turnover is Cost of Goods Sold / Average Inventory. To find the COGS you have to use the following equation: Cost of Goods Sold = Beginning Inventory + Inventory Purchases – End Inventory

While this makes perfect sense, in real word the calculation of COGS is little more complex and
several inventory valuation methods are used, such as FIFO, LIFO and Average Cost. In FIFO we assume that the oldest units of inventory are always used first. In LIFO we assume that the newest inventory is always used first. In the Average cost method, the beginning inventory balance is used and the purchases all over the year in order to determine an average cost per inventory unit.

This might still sound easy but remember that in most cases, the repeated purchases of a material, take place with different prices all over the year. So you cannot just divide the inventory balance with the last price because you’ll get a wrong result. In addition, if you don’t purchase but produce a material, estimating its cost is a far more complex procedure and many things should be taken into account such as the Cost of the Raw Materials, the Cost of Labor, the Manufacturing Overhead and the Depreciation Cost.

Most ERP systems do not provide these values “on the fly” but only at the end of the year, when the Balance Sheet is created and the Costing Process is executed.

If you are a Manager who needs to track the Inventory’s KPI, the easy way out is to use Quantities instead of Money.

• Inventory Turnover= Sales in Quantities / Average Inventory in Quantities
• Average Days to Sell Inventory= 365 / Inventory Turnover