BUS606: Operations and Supply Chain Management

When accurate inventory records are kept, it is possible to use the data in the records to determine the inventory turnover rate. The inventory turnover rate shows the number of times in a given period (usually a month) that the inventory is turned into revenue. Inventory turnover of 1.5 means that the inventory turns over about 1.5 times a month, or 18 times a year. In this case, you would have about three weeks of supplies in inventory at any given time (actually 2.88 weeks, which is 52 weeks/18). Generally, an inventory turnover every one to two weeks (or two to three times per month) is considered normal.

A common method used to determine inventory turnover is to find the average food inventory for a month and divide it into the total food cost for the same month. The total food cost is calculated by adding the daily food purchases (found on the daily receiving reports) to the value of the food inventory at the beginning of the month and subtracting the value of the food inventory at the end of the month.

That is,

average food inventory = (beginning inventory + ending inventory)/2

cost of food = beginning inventory + purchases – ending inventory

inventory turnover = (cost of food)/(average food inventory)

Example

A restaurant has a beginning inventory of $8000 and an ending inventory of $8500. The daily receiving reports show that purchases for the month totaled $12 000. Determine the cost of food and inventory turnover.

Cost of food = $8000 + $12 000 – $8500 = $11 500

Average food inventory = ($8000 + $8500)/2 = $8250

Inventory turnover = $11 500/$8250 = 1.4

The turnover rate in the example would be considered low and would suggest that the business has invested too much money in inventory. Having a lot of inventory on hand can lead to spoilage, high capital costs, increased storage space requirements, and other costs.

Inventory turnover rates are not exact, for a few reasons. One is that in many food operations, accurate inventory records are usually kept only for more expensive items. Another is that the simple food cost used in the calculation does not truly reflect the actual food cost. (Food costs are discussed in another chapter in this book.) In addition, not all inventory turns over at the same rate. For example, perishables turn over as quickly as they arrive while canned goods turn over more slowly.

Even though turnover rates are not exact, they do give managers at least a rough idea of how much inventory they are keeping on hand.