) -- Inventory management is a sleepy topic typically given little credit for its effect on a business. But with
a few days away and a potentially grim shopping season ahead, retailers are trying to offer enough must-have products without creating an overstock that wastes space and earns nothing.
Now that the holidays are here and Black Friday looms, inventory will be a key topic in the coming weeks. While most stores may struggle to keep hot deals on the shelf during the shopping rush from Black Friday and beyond,
superior supply-chain management will allow it to better satisfy customers' shopping needs.
As the biggest sellers for the shopping season sell out, most likely HDTVs and video-game systems like the Wii and Xbox, a store with active management will have a steady stream of new products arriving daily to replenish shelves, while stores that have weaker inventory management will most like have a large hoard waiting on Black Friday and miss out on a sales bonanza.
For companies like Wal-Mart or
, which have $39.6 billion and $9.2 billion in inventory, respectively, at any given time, inventory management is crucial to maximizing profitability since it can free up cash for investment and reduce exposure to adverse events related to inventory, such as obsolescence.
Comparing inventory turnover and so-called days inventory on hand can help discern which companies are managing inventory levels responsibly and which are losing out by failing to wring out the most money they can.
The theory behind inventory turnover is simple. The cost of goods sold for the year should be the aggregate inventory cost for sales made. If that number is divided by the average inventory over the period, we can determine how many times inventory cycled through in the period. More cycles mean the company is holding less in inventory at any one time in relation to sales. The less a company can hold in inventory while still not missing out on sales, the more cash it frees up to invest in growth or to return to its investors.
Taking that a step further, by dividing the number of days in the period by the number of inventory cycles, we can see the average length of time a product sits on the shelf before it's purchased. The less time on the shelf, the better.
The advent of so-called "just in time" inventory, in which companies coordinate inventory purchases with projected demand, has greatly improved inventory management. However, even with this focus, several companies are still lagging behind their competition.
Wal-Mart has long been thought of as a supply-chain master, and its inventory turnover statistics seem to back that up. With inventory turning over about 7.6 times a year, Wal-Mart appears to be far more efficient than Target and
, which turn over inventory 4.8 and 2.8 times a year, respectively.
Converting those numbers into days inventory on hand shows that the average product sits on a Wal-Mart store shelf for only 47.9 days versus 76.6 days at Target and 130.9 days at Kohl's. Since Wal-Mart is able to turn over its products nearly twice as fast as its main competitor, Target, Wal-Mart essentially frees up billions of dollars in financing that carries no interest rate. This will allow Wal-Mart to plow more money into expansion and advertising than Target, eventually leading to an even wider gap between the two.
While improved inventory management shouldn't have an effect on profit margins -- proper inventory management doesn't infringe on or improve sales -- the benefits appear in the capital structure of the company. Better inventory management leads to lower debt. Wal-Mart has only 19% of its capital structure in debt, while Target has more than 35%.
The benefit of Wal-Mart's dominance in inventory management is reflected in its stock price. Over the past two years, Wal-Mart has risen 25%, while Kohl's has increased 11% and Target has fallen 14%.
Comparing this metric between similar companies allows investors to peer into the efficiency of operations while also judging the effectiveness of executives.
-- Reported by David MacDougall in Boston.
Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.