Which metrics best show that inventory management is improving?

Question

AcadiFi · Accepted Answer

Credible inventory improvement leaves a fingerprint across four metrics: DIO, gross margin, obsolescence reserves, and cash conversion cycle.

Start with DIO trend. For Northbridge Hardware, DIO fell from 78 to 62 over four quarters. That 16-day reduction is meaningful only if gross margin held or expanded. A DIO drop paired with margin compression indicates discounting, not productivity.

Next, inspect the obsolescence or lower-of-cost-and-net-realizable-value reserves. Genuine improvement shows the reserve declining as a percentage of inventory while the absolute inventory shrinks. If the reserve grows, the firm quietly admitted stock is stale.

Third, check cash conversion cycle. CCC = DIO + DSO - DPO. Improvement should flow through to working capital release visible in operating cash flow versus net income. For Northbridge, operating cash flow exceeded net income by $34 million versus a $6 million deficit the prior year.

Fourth, reconcile to the purchases-to-sales ratio. When purchases grow slower than COGS, inventory genuinely right-sizes.

Finally, look for capex on warehouse automation or systems upgrades in the MD&A. Sustained improvements typically follow an investment, not merely rhetoric. Three quarters of consistent gains is the minimum for believability.

Which metrics best show that inventory management is improving?

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