By George J. (Jack) Bailey and Marilyn M. Helms, CFPIM, CIRM, CSCP

A standard measure of inventory performance is the inventory turns, or turnover, ratio. There are various ways to express this ratio; but, in general, it is the ratio of sales from inventory to the average inventory level, which can be figured from the following equation: Inventory turns equals dollar sales (issues) from inventory divided by average inventory dollars.

Typically, a high turn ratio shows that inventory is being used effectively. Also, it demonstrates that a firm has desirable products customers want and that business is manufacturing and holding appropriate levels of finished goods inventory to meet this demand. Excess inventory on the warehouse shelf is a nonproductive asset, so that higher turn leads to lower carrying costs and higher profits.

However, before we jump on the high inventory turnover bandwagon, we need to consider maintenance, repair, and operating supplies (MRO) management, which employees use to track spare parts, maintenance supplies, and consumables that support and maintain operations and the operational infrastructure. While this inventory keeps operations running smoothly, it often is overshadowed by the “real” inventory of products manufactured for sale to customers. MRO goods usually are consumed as a result of the production process; but these goods, unlike raw materials, are not part of the finished product. Common examples are repair or replacement machine parts, cleaning and janitorial supplies, and office supplies.

In some industries, MRO inventory is on the front line. For many electric utilities, MRO inventories represent a significant investment and affect a company’s efficiency and profitability. A major North American electric utility provider reported an MRO inventory of $335 million in 2007. The total annual inventory turnover ratio was 50 percent. Three years prior, in 2004, the inventory turn ratio was 39 percent on an inventory of $340 million. At first look, the increase seems to be an improvement in inventory use. However, while more of the inventory investment has been used and therefore is not sitting on the shelf as a nonproductive asset, the higher turn ratio is not necessarily a reason to celebrate. Issues from manufacturing inventories represent increased sales that have a positive impact on revenue; but issues from MRO inventories represent expenses that adversely influence or lower revenue.

Equipment maintenance could be adding cost, equipment may be aging, or parts may be failing, resulting in a loss of production. Such a decrease may not mean lost sales, but it does represent additional expenses because the company must purchase power from competitors to keep customers supplied with electricity.

Lower MRO turns also may result from technological advances and new and improved equipment with parts and components requiring less maintenance and fewer issues from inventory. The lower turn does not represent an undesirable situation, but it may indicate an opportunity to reduce MRO inventories to lower levels given the updated quality and reliability of new equipment.

Alternatively, low MRO turnover may highlight excess maintenance and repair inventories, signaling the need to set new stockkeeping levels, standardize cleaning and safety items, and make other improvements in MRO investment and stockkeeping. Inventory management and maintenance personnel may need to establish goals for optimal MRO management. Criticality rankings also can be implemented to determine the impact of MRO inventory levels on plant productivity, safety, efficiency, or other key criteria. Stocking up on unneeded items can be expensive, limiting strategic opportunities due to the capital investment. Risk of shrinkage, damage, and obsolescence are other issues to consider.

While inventory turnover is a useful measure of finished goods inventory performance, one’s thought process must be different in the MRO environment. It is important to analyze the ratio with care and conduct root cause analysis before mistakenly thinking higher MRO inventory turns are always a good thing.

Of course, they’re not all bad, either. It would be desirable to support given issues from inventory via higher turns as a result of a lower inventory investment. The same needs are being supported with a lower investment, and inventory carrying costs are down. Tracking MRO turnover and MRO inventory is a way to better understand the demand for and drivers of MRO usage.

George J. (Jack) Bailey is a retired manager from the Tennessee Valley Authority. He may be contacted at (423) 875-2274 or gjbailey@bellsouth.net.

Marilyn M. Helms, CFPIM, CIRM, CSCP, is sesquicentennial chair and professor of management at Dalton State College. She may be contacted at (706) 272-2600.