The Magic of Inventory Turnover

Why it matters to inventors

Businesses that make and sell tangible products carry inventory. Inventory is all of the stuff that's sold with a finished product including materials, subassemblies, packaging and printed instructions. When inventory is sold it's turned into cash. That cash pays for salaries, rent, operations and restocking more inventory. The inventory cycle is the process of turning inventory into cash, back into inventory and then into cash again. Each time you convert inventory into cash is a "turn". Along with profit margin, the rate of turn is a key factor that determines how fast a business can grow.

Profit margin multiplied by inventory turn is like compound interest, except that each turn is like a year. The examples shown below are simplistic and do not exist in the real world, but they do demonstrate the significance of this concept. If inventory is turned 5X in one year with 10% profit margin, an initial investment of $100 turns into $161. This is more than the profit derived from inventory that's turned just once at a 30% profit margin!

Profit margin isn't everything. But it matters a lot...

If the profit margin is 30% and the turn is 5X in one year, the initial investment of $100 grows to $371. In two years it grows to $1379. At this point you're probably thinking, "I want to do that". Me too! But it's extremely rare and focusing on profit margin and inventory turn is not conducive to creativity. The point here is to have these concepts in the back of your mind when thinking about what types of inventions to work on and, more importantly, when negotiating licensing deals or seeking to launch businesses.

Inventors seeking licensing deals should keep in mind that every dollar paid out in royalties reduces profit margin. At the same time nventors should note that products that offer more inventory turns can be more profitable than higher margin products that turn less frequently.

Inventory 100
Profit 10%
Start turn 1 turn 2 turn 3 turn 4 turn 5
100 110 121 133 146 161
turn 6 turn 7 turn 8 turn 9 turn 10
177 195 214 236 259
Inventory 100
Profit 15%
Start turn 1 turn 2 turn 3 turn 4 turn 5
100 115 132 152 175 201
turn 6 turn 7 turn 8 turn 9 turn 10
231 266 306 352 405
Inventory 100
Profit 30%
Start turn 1 turn 2 turn 3 turn 4 turn 5
100 130 169 220 286 371
turn 6 turn 7 turn 8 turn 9 turn 10
483 627 816 1060 1379

- Mike Marks

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