Inventory management is a crucial aspect of any business that deals with physical goods. It involves balancing the costs and benefits of holding inventory, such as storage, handling, obsolescence, and opportunity costs, with the revenue and profits generated from sales. A good inventory management system can help optimize inventory levels, reduce costs, improve customer satisfaction, and increase profitability.
But how do you measure the success of your inventory management system? What are the key performance indicators (KPIs) that you should track and monitor? One of the most useful KPIs for inventory management is the Turn Earn Index (T/E Index).
What is the Turn Earn Index (TEI)?
The Turn Earn Index (T/E Index) is a metric that balances inventory turnover and gross profit margin. It is calculated by multiplying inventory turns by the gross margin percentage. Inventory turns to measure how many times you sell and replace your inventory in a given period, usually a year. Gross margin percentage measures how much profit you make from each sale, after deducting the cost of goods sold.
How to Use the Turn Earn Index?
The T/E Index can help you evaluate and compare the performance of different products, categories, suppliers, locations, or segments of your business. You can use it to identify the strengths and weaknesses of your inventory management system and to make informed decisions on how to improve it.
For instance, you can use the T/E Index to:
- Analyze the profitability of your product mix and adjust your pricing, promotion, or purchasing strategies accordingly.
- Identify slow-moving or low-margin items and take action to reduce or eliminate them from your inventory.
- Benchmark your performance against industry standards or competitors, and set realistic and achievable goals for improvement.
- Monitor the impact of changes in demand, supply, or market conditions on your inventory management system and respond accordingly.
The T/E Index can also help you balance turnover and profits. Sometimes, high turnover can come at the expense of low margins, or vice versa. The T/E Index can help you find the optimal balance between these two factors, depending on your business objectives and constraints.
For example, if you sell liquidated goods at a high margin but low turnover, you may have a high T/E Index but also high carrying costs and risks of obsolescence. You may want to increase your turnover by lowering your prices or increasing your marketing efforts. Conversely, if you sell fast-moving goods at a low margin but high turnover, you may have a low T/E Index but also low customer loyalty and differentiation. You may want to increase your margin by adding value or enhancing quality.
Calculating Turn Earn Index with a Formula
The T/E Index reflects both the efficiency and effectiveness of your inventory management system. A high T/E Index means that you are selling your inventory quickly and at a high-profit margin, which indicates a successful inventory management system. A low T/E Index means that you are either selling your inventory slowly or at a low-profit margin, or both, which indicates an inefficient or ineffective inventory management system.
Here is the formula to calculate the Turn Earn Index:
- Inventory Turnover is calculated as: Cost of goods sold (COGS)/Average Inventory
- The Gross Margin Percentage is calculated as Gross Profit/ Net sales x 100
Let’s assume an organization has the following data for the year:
- COGS: $1,000,000
- Average Inventory: $200,000
- Net Sales: $1,500,000
- Gross Profit (Net Sales – COGS): $500,000
First, calculate the Inventory Turnover and Gross Margin Percentage:
Inventory Turnover = COGS/ Average Inventory = 1,000,000/ 200,000=5
Gross Margin Percentage = Gross Profit/Net Sales x 100 = 5,00,000/1,500,000 x 100= 33.33%
Now, plug these values into the TEI formula:
TEI = Inventory Turnover x Gross Margin Percentage
TEI = 5 x 33.33% = 166.65%
The TEI of 166.65% indicates that for every dollar invested in inventory, the company has earned a return of $1.6665 in gross margin.
Using OKRs to Measure Turn Earn Index KPI
Objective and Key Results (OKRs) have transformed the landscape of goal-setting and performance monitoring in Today’s businesses. Combining the precision of the Turn Earn Index (TEI) KPI with the dynamic framework of OKRs can propel a company’s inventory management to unmatched heights. Let’s explore how.
Objective: Improve Inventory Efficiency and Profitability
KR 1: Increase the Turn Earn Index (TEI) from 150% to 180%
Initiative: Implement a more sophisticated demand forecasting tool to predict sales trends.
KR 2: Decrease stockouts from 20% to f 5% to maintain a steady inventory turnover.
Initiative: Review and optimize pricing strategy based on market research.
KR 3: Boost the gross margin from a current rate of 25% to a goal of 35%
Initiative: Collaborate with the sales and marketing team to promote slow-moving stock.
The Turn Earn Index is a useful KPI for measuring and improving your inventory management system. It balances turnover and profits and reflects both the efficiency and effectiveness of your inventory management system. By tracking and analyzing your T/E Index, you can optimize your inventory levels, reduce costs, improve customer satisfaction, and increase profitability.