Back to Basics: Inventory Control and Cost of Goods Sold
A basic rule of business overlooked by the typical lube store manager: Inventory is not product available for sale but a financial investment waiting for a return.
Far too often I talk with store managers who view inventory as an inanimate object. They think of inventory as an oil filter, a quart of oil, an air filter, etc. In reality, the oil filter should be thought of in terms of $1.68, the quart of oil as $2.80 and the air filter as $3.68. Once we begin thinking in these terms, it is much easier to understand the financial consequences of managing inventory. Effectively controlling inventory plays a critical role in the operation of a lube center, impacting earnings and the return on your investment.
The most significant measurement in inventory management is inventory turnover. Inventory turns are measured by the number of times your 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, add the beginning and ending inventory, and divide by two. Using quarterly inventory levels, add each quarter ending inventory, and divide by the number of quarters used to measure the turnover. To calculate cost of goods sold, add your beginning inventory and purchases and subtract the ending inventory.
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 (from the stores P&L) by the month end inventory.
Monthly inventory turns should range in the .75 to 1 turn/month. 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. Inventory turnover goals should be a minimum 8 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.
By increasing our inventory turn ratio, we can significantly improve our 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 10 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. Monitoring your bulk oil is critical. Receiving emergency deliveries of oil that is shipped in drums or case products can cost you a 20 to 75 cent per quart premium. Your cost of goods can be severely impacted if oil is shipped in these capacities.
Cost of Goods Sold
It is also important to understand the various increments of merchandise by category, and how each will impact the overall cost of goods sold.
Slight adjustments to the increments of merchandise can have major effects on your cost of goods sold, and thereby on your inventory turns. Management of your cost of goods and inventory turns can make the difference in whether a store is profitable or not. Since inventory costs are second only to salaries as a percentage of sales, effective management is crucial to running a profitable business.