A company's annual cost of goods sold is $350 million, and inventory carrying cost is 18%. The company averages four inventory turns. The cost savings resulting from increasing inventory turns from four to six would be:
To calculate the cost savings from increasing inventory turns, we first need to determine the current inventory level and the inventory carrying cost.
Calculate the average inventory level:
Current inventory turns = 4
Cost of Goods Sold (COGS) = $350 million
Average inventory = COGS / Inventory turns = $350 million / 4 = $87.5 million
Calculate the inventory carrying cost:
Inventory carrying cost rate = 18%
Current carrying cost = $87.5 million * 18% = $15.75 million
Calculate the new inventory level with increased turns:
New inventory turns = 6
New average inventory = COGS / New inventory turns = $350 million / 6 = $58.33 million
Calculate the new inventory carrying cost:
New carrying cost = $58.33 million * 18% = $10.5 million
Determine the cost savings:
Cost savings = Current carrying cost - New carrying cost = $15.75 million - $10.5 million = $5.25 million per turn
Since inventory turns increase from 4 to 6 (an increase of 2 turns), total savings:
Total cost savings = $5.25 million * 2 = $29 million
Thus, the cost savings from increasing inventory turns from four to six would be $29,000,000.
References
Coyle, J. J., Langley, C. J., Novack, R. A., & Gibson, B. J. (2016). Supply Chain Management: A Logistics Perspective. Cengage Learning.
Stevenson, W. J. (2018). Operations Management. McGraw-Hill Education.
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