It is therefore inevitable to discard inventory with low turnover rates because the above fixed costs will have to be paid for whether or not the product has been sold.
Asset management is a very important concept in finance. Any businessman should practice better working capital management. The levels of stock, debtors and cash must be balanced appropriately. From the above, for instance, it is practicable to invest $2,500 compared to $10,000 because when the stock is converted into cash, it could have generated some interest.
But even though by going with the last option i.e. buying $2500 worth of inventory would be preferable as the approach suffers from one setback. I.e. the purchaser will have to forgive quality discounts by virtue of buying in bulk.
However, consistently, we may apply the inventory turnover formula, as its usefulness will depend on how we have cost/valued our inventory. Stock can be valued on FIFO, LIFO or weighted average method. To get a reliable rate, then we must be consistent on how we value of inventory as some methods will over cash them while others will under cash the stock making the resulting conclusions to be misleading.
The inclusion of the cost of goods sent to branches is also tricky if those other branches are in foreign states and operate in foreign currencies and yet the financial operators need be reported in reporting entity. Translations will then have to be made for the foreign operation back to the reporting entity's currency.
But despite the criticism to this technique, inventory turnover is a very instrumental tool for decision making. One will be able to gauge on where to invest and disinvest in case of a low inventory turnover rate.
Ajax Chemical's Existing Inventory
A problem would arise when the vendor gives the consumer some money in advance before the products are sold. The products would either fetch low returns or no returns at all.
The customer's inventory would again require to be maintained, distinguishing them from the other stock. This would mean additional labor costs. The return on this investment would then be too low for the vendor.
May be it could be advisable for the vendor to monitor the sales patterns and know which product have a higher turnover rate that can give full credit on them, for the others with a moderately fair or no turnover rate, he should apportion his credit accordingly. For example, by pegging is as a percentage of the turnover rate. For example, a credit of $2,000 of the product's turnover rate is 100% while on the other hand a credit of $1,400 of the product's turnover rate is 70%.
Ignoring of critical stock (Repair Parts)
To avoid stock-outs, and make Vendor managed inventory succeed, the vendor must in his premises maintain a buffer/safety stock. Running out of stock is costly and a considerable safety stock need be maintained. But important also is the fact that this buffer stock shouldn't be too high as this would consequently catapult the stockholding costs to higher levels.
Vendor managed inventory is a situation whereby a customer enters into a contract/agreement with a vendor for the latter to procure and store goods for him in his premises so that the customer can continue buying from him frequently and a lower