Part 7/8: Understanding Your Economic Engine: Inventory
In part 7 of the Understanding Your Economic Engine series, ActionCOACH Rick Phelps introduces inventory into the throughput accounting model and reviews the following important definitions:
- Throughput (T) – The rate at which the system generated money through sales.
- Inventory (I) – All the money the system invests in purchasing things the system intends to sell. It includes materials and raw materials.
- Operating Expenses (OE) – All the money the system spends in turning inventory into throughput.
Using these terms and the following formulas, you can accurately calculate your net profit, return on investment, and inventory turns.
- Net Profits (NP) = Throughput – Operating Expenses
- Productivity = Throughput / Operating Expenses
- ROI = Net Profit / Inventory
- Inventory Turns = Throughput / Inventory
As a business owner, your number one focus should be to increase throughput dollars through sales. The second focus is to drive inventory down – that is the cost of producing your product in terms of materials. Your third focus should be to drive operating expenses down but never to the detriment of throughput dollars or inventory.
Watch the vlog to learn more!