Is Your Company Making Money?
By Jon and Matt Schreibfeder
Last month we discussed a profitability metric known as the “adjusted margin”. It is calculated with the formula:
[Annual Gross Profit $ – (Average Inventory Investment * Annual Inventory “K Cost”)]
Annual Sales $
The adjusted margin is better than the gross margin for measuring profitability, because it considers the cost of maintaining the inventory you must carry to generate the annual profit dollars. EIM will help you calculate your organization’s inventory carrying cost, if you fill out the questionnaire in the Resources section of our website, www.EffectiveInventory.com. Today, (August 2022) in North America inventory annual carrying costs typically range from 17% to 27%. This means that it costs anywhere from 17 cents to 27 cents to maintain a dollar’s worth of inventory in your warehouse for an entire year. If you have a 20% annual carrying cost and turn your inventory over four times a year, each dollar of each inventory turn must absorb five cents of the annual carrying cost. But again, it is important for you to calculate your actual carrying cost for each facility that stocks inventory.
But, we still have to answer the question, “is your company making money?”. The answer is simple if we employ another metric, the NIREP. NIREP stands for “Non-Inventory Related Expense Percentage”. The NIREP is calculated with the formula:
Annual Non-Inventory Related Expenses
Total Annual Sales
Annual non-inventory related expenses are comprised of all of the expenses you incur, other than those included in the carrying cost of inventory. This includes all selling, marketing, and administrative costs. Every expense from your profit and loss statement (also known as an income statement) is included in either the carrying cost or NIREP. To correctly perform this analysis, every expense must be classified into one of these two categories.
Compare your adjusted margin to your NIREP:
- If your adjusted margin is higher than your NIREP, you’re making money.
- If your NIREP is higher than your adjusted margin, you’re losing money.
Today a typical NIREP ranges from 7% to 9%. As with the carrying cost, it is important for you to calculate your organization’s NIREP. If your NIREP is 8%, this represents your “break even” point. An adjusted margin greater than 8% represents a profitable transaction. Adjusted margins less than 8% represent money losing situations.
Next month we will explore reasons why you would want to continue to stock unprofitable items in inventory.
In the meantime, if you have any inventory-related questions, please email Jon ([email protected]) or Matt ([email protected]). Our goal is to help your organization achieve effective inventory management.