Raw Material Turnover- What You Need to Know
Businesses that either manufacture or deal with manufactured goods, dealing with inventory is a big part of your business. In particular, transforming Raw Materials into Work-in-Progress (WIPs), and then Finished Goods can sometimes be tricky. In this article we’ll cover everything you need to know to effectively manage raw materials.
What are Raw Materials?
To put it simply, raw materials are the base of any manufactured product, for example one of the main raw materials to make cars is steel. Raw materials include everything from lumber to plastic to minerals, and everything in between.
Direct Raw Materials
Within raw materials there are two distinctions made, direct and indirect. Direct refers to all the materials that directly go into the final product, for example, steel for a car, leather for a leather jacket, etc.
While indirect materials refer to things that don’t go into the final product, but are still involved in the production process. Therefore, indirect materials can include things like personal safety equipment, lightbulbs, cleaning supplies, etc.
What’s Raw Material Inventory?
Like many other factors of production, raw materials are stocked and stored by business, sometimes even in excess. This is to have the necessary supplies ready on hand when you start to manufacture the final product, to protect against shortages, and other reasons. Like WIPs and Finished Goods, if raw materials sit around the company’s warehouse or factory for a long enough period of time, they start to become a cost to the business. That’s why companies look at how they balance having enough raw materials for production while also having a profitable turnover.
How to Calculate Raw Material Turnover?
Raw material turnover is the amount of times a business sells and replaces its stock of raw materials in a given period of time. Therefore, it shows how well a company is at managing a part of the costs associated with the production process. Businesses tend to want a high turnover rate, because this means that there’s demand for products and so more raw materials are being used to produce more products that will be sold relatively quickly. Low turnover, however, means that there’s less demand for the company’s products so raw materials aren’t needed as much.
Raw material turnover is calculated by:
- Total cost of goods sold / ((Inventory Value of Raw Materials at Start of Period + Inventory Value of Raw Materials at the End of Period) / 2)
Total cost of goods can typically be found on the quarterly and annual filings.
Turnover may also be influenced by other factors, such as overall economic performance. If the economy is doing poorly and overall consumer demand is down, that may affect the turnover ratio.
Tips on Raw Material Inventory Management
As stated before, businesses look to have a higher turnover rate, this means they move raw materials out of inventory due to faster sales. There are some ways a business can increase their turnover, those include:
- Better forecasting - forecast which products will sell better so you know which raw materials you need
- Selling old raw material stock - if a certain stock of raw material sits around, it might affect your turnover ratio, so selling a part of your raw material inventory to a third party could be helpful.
- Restocking more efficiently
- Faster shipping
- Negotiate with suppliers for a better price on raw materials
- Analyze sales data to stock raw materials that go to build products that sell
Benefits of Raw Material Inventory Management
Implementing simple raw material inventory management techniques, like the ones we highlighted above, can have several big advantages for your company. For example, forecasting better can cut back on costs and increase profitability, the same with analyzing data to only stock raw materials that go to produce products that sell the most. Doing things like selling old raw material stock can also increase the efficiency of your business.
Raw Materials- The Base of Your Business
As we’ve discussed throughout this article, raw materials are the starting point for your product and your production process. Businesses also want to be able to stock raw materials so they can jumpstart manufacturing and protect against certain external factors. However, businesses also have to be conscious about the amount of inventory they have, keeping too much can be a drag on profitability, and having too little can hinder production capabilities. That’s where raw material turnover comes in, turnover is a ratio, given above, which describes the amount of times raw materials are sold and replaced, therefore the higher the ratio the better.
In sum, the more you know about raw materials, and the ways and techniques to improve their turnover, the better. What we outlined in this article can go a long way in helping your company.