Inventory Management in South Korea: Four Steps to Free Cash
Learn how inventory management in South Korea can reveal cash tied up in stock through turnover ratios, ABC analysis, safety stock, and a four-step review.
How can you tell whether inventory is tying up cash?
For a business in South Korea, start with how quickly inventory turns over, rather than its value alone. A warehouse may hold the same amount of stock as last year, but if sales have fallen, that stock will sit longer. Inventory turnover measures the pace: divide the cost of goods sold by average inventory. Then divide 365 by the turnover ratio to find the average number of days it takes to sell the stock, known as days inventory outstanding. As that number rises, cash stays tied up even though no new invoice arrives. For a company with many items, the overall average is only a starting point. ABC analysis separates items into groups and shows where cash is getting stuck.
Table of contents
- Three-year-old packaging materials in the warehouse
- What does inventory turnover measure?
- Why use ABC analysis to group items?
- Why safety stock should not be set by guesswork
- Side effects of using inventory metrics as KPIs
- Where to start when the records do not match the stock
- A four-step inventory management review
- FAQ
- Further reading
Three-year-old packaging materials in the warehouse
While researching management practices in manufacturing, I sometimes visit business owners' warehouses. One owner ran a food packaging processor with annual sales of around KRW 8 billion. Inventory assets on its financial statements were little changed from the previous year, and the owner felt inventory management was going reasonably well.
In a corner of the warehouse, though, sat four pallets of packaging film for a product discontinued three years earlier. The film was still recorded at cost. When I recalculated inventory turnover without it, the result differed considerably from the figure that included it. The total inventory value had held steady because unsellable inventory was still taking up space, not because stock was moving well.
The company began by finding the last dispatch date for every item. It set aside items with no dispatches for more than a year, then sorted them into reusable and unusable stock. Disposal and discounted sales removed an amount from the books equal to a few percent of that year's operating profit. Recognizing the loss was painful, but warehouse rent and staffing costs had continued to accrue while the decision was delayed.
What does inventory turnover measure?
The formula is simple. Comparisons can be confusing, however, because the result depends on what you put in the numerator and denominator.
| Metric | Formula | Interpretation |
|---|---|---|
| Inventory turnover | Cost of goods sold ÷ average inventory | How many times inventory turns over in a year |
| Days inventory outstanding | 365 ÷ inventory turnover | Average number of days it takes to sell inventory |
| Inventory asset turnover (financial ratio) | Revenue ÷ average inventory assets | Used for external comparisons; also reflects the gross profit margin |
| Cash conversion cycle | Days inventory outstanding + days sales outstanding − days payable outstanding | The full period during which cash is tied up |
For day-to-day management, cost of goods sold is the more accurate numerator. Using revenue can make a company with a high profit margin appear to turn inventory quickly. When comparing your figures with external statistics, such as the Bank of Korea's Financial Statement Analysis, use the same definition those statistics use. Check the definitions before comparing your results with an industry average.
How you calculate average inventory matters, too. A simple average of opening and closing balances can be highly misleading for a seasonal business. If a company builds stock just before its peak season, the average of 12 month-end balances is closer to reality. And a higher turnover ratio is not necessarily better: an excessively high ratio may point to frequent stockouts and lost orders. Look at turnover alongside the stockout rate before drawing a conclusion.
Why use ABC analysis to group items?
An overall turnover ratio can hide problems by combining fast-moving items with stock that does not move at all. ABC analysis groups items according to their share of inventory value.
- A items: Around 20% of all items, accounting for 70–80% of the value
- B items: Around 30% of the items, accounting for 15–20% of the value
- C items: More than half of the items, accounting for 5–10% of the value
The categories only help if you manage them differently. Check A-item stock weekly, require purchase-order approval, and forecast demand for those items separately. Review C items monthly or quarterly and order them in batches. Trying to give every item the same level of attention usually fails. Staff can spend their time tracking hundreds of C items while a stockout of an A item goes unnoticed.
Value is not the only useful criterion. Some low-value parts will stop production if they run out; some high-value items are easy to source elsewhere. Plot value against procurement difficulty in a four-cell matrix to make priorities clearer. The low-value, hard-to-source cell is where problems arise most often.
Why safety stock should not be set by guesswork
Safety stock is the extra quantity held in case demand exceeds expectations or a delivery arrives late. Many small and medium-sized businesses set it at something like “about a month's supply.” That leaves too much stock for items with stable demand and too little for highly variable items.
Base the level on three factors: how much demand varies, procurement lead time, and how many stockouts you are willing to tolerate. Greater demand variation and longer lead times call for more safety stock. A higher service level, aimed at avoiding almost all stockouts, raises the amount required sharply. Raising the service level from 95% to 99% requires far more additional inventory than raising it from 90% to 95%.
Different item groups therefore need different service levels: higher for essential A-item parts and lower for C-item consumables. Shorter procurement lead times also reduce the safety stock needed, and this often works best in practice. Ordering from suppliers more frequently or arranging split deliveries can cut inventory while maintaining the same service level. The warehouse alone cannot solve every inventory problem.
Businesses with pronounced seasonality adjust safety stock each quarter instead of keeping it fixed. Demand varies differently in the two months before peak season than it does in the off-season. Use a figure set at the start of the year all year, and you can end up with excess stock in the off-season and shortages at the peak. Simply putting review dates on the calendar can eliminate much of this problem.
Side effects of using inventory metrics as KPIs
Make inventory turnover a departmental performance measure, and the number almost always improves. How it improves matters.
First, staff may delay orders at the end of a reporting period. To lower inventory on the evaluation date, they run down stock during the two weeks before closing and place a cluster of orders at the start of the next period. The smaller denominator raises the turnover ratio, but the metric misses orders lost to stockouts in the meantime.
Second, staff may put off disposing of obsolete inventory because disposal creates a loss in that period. Stock left on the books appears as an asset; disposed stock becomes an expense. For the person responsible, delay is the easier choice.
Third, the metric can conflict with evaluations based on purchase price. Large orders help lower the unit price, while smaller orders help raise turnover. If different departments are judged by those two measures, they will keep reaching different conclusions in meetings.
View the metrics together to discourage these behaviors. Put days inventory outstanding, the stockout rate, the share of obsolete inventory, and the cash conversion cycle on the same report. That makes it harder to improve one number at the expense of the others. Month-end averages are also better for evaluation than a single reading at the end of the reporting period.
Where should you start when the records do not match the stock?
Even well-designed metrics are useless if recorded quantities differ from physical stock. In small and medium-sized manufacturing, discrepancies tend to have a few common causes.
The most common is an unrecorded issue of materials. When staff urgently send materials to the production line and post the transaction later, the records are wrong until they do. Mixed units cause trouble, too: quantities cannot match if the same item is recorded in rolls on one transaction and meters on another. Defects and returns may also go unrecorded. Materials discarded as defective but left on the books become phantom inventory.
Cycle counting is more efficient than counting everything at once. Count A items once a month, B items once a quarter, and C items once a year. Counting everything together requires a production shutdown, so it gets postponed year after year. Smaller counts fit into normal work. When a count reveals a discrepancy, correct the quantity and record what caused it. Repeated discrepancies for the same item point to a gap in the process for handling it.
A four-step inventory management review
Step 1 is to find the last dispatch date for each item. Do this before preparing a list of inventory values. In Excel, you need just four columns: item code, current quantity, value, and last dispatch date. First, calculate the total value of items with no dispatches for at least a year. If it exceeds one month's operating profit, the situation needs immediate attention.
Step 2 is ABC classification. Sort items by annual dispatch value. Assign items accounting for the first 80% of cumulative value to A, those up to 95% to B, and the remainder to C. The initial classification need not be finely tuned. Start by establishing different levels of oversight.
In step 3, set ordering rules for A items. Give each a reorder point and an order quantity. The reorder point is the quantity expected to be used during procurement lead time plus safety stock. Write down the rules so someone new to the role will make the same decisions. Rules passed on verbally can disappear after a single staff change.
The final step is a monthly review sheet. On the same day each month, fill in four lines: days inventory outstanding, number of stockouts, value of items with no dispatches for at least a year, and the cash conversion cycle. Sharing four figures in a management meeting takes five minutes. Compare them with industry averages each quarter to check the trend.
If all four steps are difficult to tackle at once, step 1 alone can help. Adding a last-dispatch-date column takes a day. Often, one management review of that list is enough to prompt a decision. If managers say “reduce inventory” without knowing the figures, staff may cut essential A-item materials first because those are easiest to reduce. The list shows where reductions should be made.
FAQ
What is an appropriate inventory turnover ratio? The range varies greatly by industry, so there is no universal benchmark. Fresh food distributors may turn inventory dozens of times a year, while heavy manufacturers may do so only a few times. Compare your figures with the industry average and your company's past trend. Publications such as the Bank of Korea's Financial Statement Analysis, which reports financial ratios by industry and company size, can provide a reference point. The direction of change matters more than the absolute figure.
Disposing of obsolete inventory increases losses. Can we put it off? Costs keep accruing while you wait: warehouse space, staff time, and the opportunity cost of working capital tied up in that inventory. More troubling is the effect on decisions. If the inventory stays on the books as an asset, inventory turnover and return on assets appear better than they really are, making management decisions harder to ground in accurate figures. Consult your tax and accounting staff about when to dispose of it, but do not delay recognizing the problem itself.
Will an inventory management system solve the problem? A system automates rules; it does not create them. Introduce one before setting ABC categories, reorder points, and safety stock levels, and you will only add data-entry work. Running the process in Excel for about six months to refine the rules before moving to a system is less likely to fail.
What should we do with items whose demand is hard to forecast? Focus on shortening procurement lead times instead of trying to improve forecast accuracy. Negotiate split deliveries with suppliers or secure multiple suppliers. Shorter lead times reduce the safety stock needed even when demand remains just as variable. For items that are hard to forecast, investing in flexibility costs less than piling up inventory.
Is having a lot of inventory always bad? It depends on the circumstances. If raw material prices are about to surge or supply chains are unstable, deliberately increasing inventory can be sensible. Ask whether the stock was accumulated by decision or simply left unattended. For strategically held inventory, the items, holding period, and plan for reducing it are documented. Neglected inventory has no such record, and the person responsible cannot explain why it is there.
Further reading
- Profitable but short of cash: Where should an SME start improving cash flow? A guide to working capital and the cash conversion cycle (CCC)
- How should you set KPIs without encouraging the wrong behavior?
- How should you compare your company's financial ratios with industry averages?
Sources
- Bank of Korea 2023 Financial Statement Analysis Results (Commentary and Statistical Tables) https://www.bok.or.kr/portal/bbs/P0000599/view.do?menuNo=200455&nttId=10087575
- 2025 Financial Statement Analysis Results (Preliminary) https://eiec.kdi.re.kr/policy/materialView.do?num=282437
- Differences in Firm Characteristics Affecting Improvements in Inventory Turnover by Industry https://kci.go.kr/kciportal/ci/sereArticleSearch/ciSereArtiView.kci?sereArticleSearchBean.artiId=ART002199482
- ABC Analysis for Inventory Management: Key Items and Ordering Criteria https://blog.stackcube.io/ko/abc-analysis-guide-for-inventory-management
- What Is Inventory Management? (SAP) https://www.sap.com/korea/resources/inventory-management
References
- Bank of Korea 2023 Financial Statement Analysis Results (Commentary and Statistical Tables) https://www.bok.or.kr/portal/bbs/P0000599/view.do?menuNo=200455&nttId=10087575
- 2025 Financial Statement Analysis Results (Preliminary) https://eiec.kdi.re.kr/policy/materialView.do?num=282437
- Differences in Firm Characteristics Affecting Improvements in Inventory Turnover by Industry https://kci.go.kr/kciportal/ci/sereArticleSearch/ciSereArtiView.kci?sereArticleSearchBean.artiId=ART002199482
- ABC Analysis for Inventory Management: Key Items and Ordering Criteria https://blog.stackcube.io/ko/abc-analysis-guide-for-inventory-management
- What Is Inventory Management? (SAP) https://www.sap.com/korea/resources/inventory-management