Managing your inventory is only as complicated as you make it to be.
While your inventory control and levels quite literally dictate whether you have the right amount of product to meet the customer demand, they also reflect on your sales and business performance.
That said, inventory management is an important aspect to consider so you can level up your supply chain performance. Inventory turnover especially is an important measure to consider in the process.
Let us start with the meaning of inventory turnover and understand the concept in detail.
What is Inventory Turnover?
The inventory turnover refers to the period between the time of the item’s purchase and the item’s sale. The term inventory turnover means the purchased stock that is sold, minus all the stock that is lost as a result of shrinkage or damages.
Whether your inventory turnover is high or low largely depends on the nature of the goods in your inventory, and successful companies usually experience multiple turnovers every year.
It should also be considered that factors such as inventory management challenges, order cycle times, and fluctuating customer demand can impact inventory turnover.
What is the Inventory Turnover Ratio?
With this understanding of inventory turnover, let us learn what the inventory turnover ratio means. The inventory turnover ratio refers to the ratio that indicates the number of times an inventory is sold and replaced within a specific duration.
The average inventory turnover is an important measure that indicates the robustness of business performance, sales, and cost management. It is also inversely proportional to days in sales inventory and should be benchmarked against other companies in the industry to boost competitiveness.
4 Benefits for Calculating the Inventory Turnover Ratio
Now that we are on the same page about the definition of inventory turnover and inventory turnover ratio, let us delve deeper into the importance of calculating this metric.
It is one of the most versatile metrics to track in terms of your supply chain performance and you could miss out on valuable insights by not calculating it.
By keeping a close watch on your inventory turnover ratio, you can understand the improvement areas in your operational areas and ensure that your performance keeps improving.
That said, here are some of the most important merits that make the case for calculating inventory turnover::
#1 Identifying Trends and Customer Demand
By calculating the inventory turnover ratio for specific products, you can identify the fastest-selling products and ones that sit on your shelves for longer durations.
Once you have identified the popular products in your finished goods inventory, you can regularly stock up on them and maximise your sales.
You can also identify seasonal trends and predict customer demand in advance, to equip your decisions going forward.
By monitoring the inventory levels and turnover ratio over time, you can gain knowledge of your customers’ spending habits that can inform your supply chain decisions.
#2 Measuring Business Performance
The most obvious benefit of calculating the inventory turnover ratio is to understand your inventory performance, which can say a lot about your overall business performance.
More than anything else, your inventory turnover ratio is a reflection of your sales performance.
You see a higher turnover ratio may not always mean that your business is successful but it indicates that you have been generating consistent sales.
#3 Reducing Dead and Obsolete Stock
Without a proper inventory tracking mechanism, you are more likely to keep reordering stock in the same quantities without any underlying logic.
This can quickly get counterproductive as you may end up with large product quantities that don’t sell which can result in obsolete or dead stock.
You can also make proactive decisions by calculating inventory turnover for specific products, regularly identifying products that should be discontinued and consider reordering fewer units of SKUs with lower turnover.
#4 Decrease Backorders
While running out of products in your inventory can seem like a scary situation to handle, having too many products in stock is equally daunting.
By calculating the inventory turnover ratio regularly, you can ensure that you don’t end up reordering less than necessary.
Your inventory turnover ratio will let you ensure that you reorder popular items well in advance, and are stocked enough to fulfill customer demands. As a result, you can prevent stockouts and avoid dealing with too many backorders.
Calculating Inventory Turnover Ratio & Examples
Now that we have gotten the basics of inventory turnover and inventory turnover ratio out of the way, let us look at how we can calculate it accurately. You can calculate inventory turnover using costs or units.
We will look at both the formulas and understand them better with examples.
The first formula is one of the most common ways to calculate inventory turnover. For this approach, you must first identify the cost of goods sold, and calculate the average inventory value (beginning inventory+ending inventory/2).
With that in mind, the simple formula for calculating the inventory turnover is as follows:
Inventory Turnover = Cost of Goods Sold / Average Inventory Value
Example:
Let’s assume that the Cost of Goods Sold associated with your business last year was $500,000. Your average inventory value for that period was $75,000. Now, let us replace these values in the aforementioned formula to calculate inventory turnover:
Inventory Turnover = 500,000/75,000 = 6.67
So, the inventory turnover ratio for this business within that period can be calculated as 6.67.
Let’s also look at the alternative inventory turnover formula.
Inventory Turnover = Number of Units Sold / Average Number of Units On-Hand
Example:
Let’s assume that you sold at least 10,000 units of a specific product within a fixed duration, in which you always had at least 3,000 units on hand. If you apply these values to the aforementioned formula, your inventory turnover can be calculated as follows:
Inventory Turnover = 10,000/3000 = 3.33
Hence, the inventory turnover in this example can be calculated as 3.33.
How to Analyse it?
You should get a better understanding of your inventory turnover ratio to ensure that you always have deeper insights into your sales performance that will help you optimise your logistics workflows.
You should also seek out the reasons that lead to high or low turnover ratios so that you can make necessary improvements and repeat what works.
You can calculate the inventory turnover rate for any time period and equip you to make important business and supply chain decisions.
5 Challenges of Using Inventory Turnover
While all the aspects we have discussed till now position inventory turnover as an essential metric in your supply chain process, it is so much more.
However, before you consider your inventory turnover ratio a definitive measure, you should also learn about the challenges associated with it.
Here are a few that you should begin with:
1. Seasonality Issues
While calculating your inventory turnover, it is important to know that seasonal trends and issues impact the metric. Beyond the ratio calculation, you must consider that seasonality tends to impact the process of inventory turnover itself.
Depending on the products you sell, you will inevitably have a few products that may sell more during a specific period. For instance, your umbrellas are likely to sell more during monsoons and hot summer periods than at other times of the year.
2. Bulk Over-Ordering
One of the biggest challenges of managing inventory properly is dealing with excess inventory at times. You might end up ordering too many specific items in bulk which can lead to a lower inventory turnover.
Depending on your brand, a large amount of capital may be tied to the items in your inventory, which means wasting the items is essentially a loss of revenue. If you are running a small online store, this revenue loss can even bleed into your overall business performance.
3. Slow Moving, High-Cost Goods
Selling high-cost items should prepare you to store them for longer durations. The customer base with the buying power to purchase high-cost goods is limited which slows down its movement and increases the inventory turnover time.
In the case of high-value items, you have even more working capital invested in your inventory. As a result, your inventory turnover ratio might be lower, and this inefficiency in your inventory management can cost you a lot of money.
4. Dead Stock
Deadstock refers to the goods that have been lying in your inventory for a long duration and have become obsolete. Multiple reasons may lead to you having a lot of dead stock in your inventory.
An item may be experiencing low demand, out of style, or may have even become irrelevant leading to piling up of dead stock in the process. The general definition of dead stock is any item that has been on the shelves for a minimum duration of 12 months or more.
Evidently, dead stock can negatively impact your inventory turnover and business performance.
5. Inaccurate or Missing Inventory Data
Calculating inventory turnover accurately entails having access to the most recent and correct inventory data. If your inventory data or numbers are inaccurate or missing, you may end up miscalculating your entire inventory situation.
To avoid this situation, many brands prefer investing in inventory management software that will give them access to real-time and accurate inventory data.
12 Ways You Can Optimise Your Inventory Turnover Rate
Now that you know most of the things you need to know to understand and calculate inventory turnover, here are a few actionable ways you must consider applying to optimise your inventory turnover.
#1 Streamline Your Supply Chain
As a brand, if you are overly dependent on your suppliers to get order fulfilment right, it may be tempting to find the ones offering the lowest rates.
However, that should not always be at the top of the priority list. Instead, looking for other important features such as faster delivery times, or a better quality product might be more crucial to your success.
Streamlining your supply chain is not always about having the best possible players as a part of the process, but also about eliminating any inefficiencies from the supply chain process. By doing so, you can boost your sales, profits and overall margins.
#2 Adjust Your Pricing Strategy
Your pricing strategy may seem to be a different thing compared to your inventory, but you must remember that both aspects are quite connected and crucial to your supply chain performance.
When you are dealing with goods that are in high demand, you may want to adjust their pricing and try to earn larger margins. You could also work on freeing up some capital by getting rid of your dead or obsolete stock.
Consider hosting discount offers and sales to get rid of the hard-to-move stock, and feel free to donate that stock to a charity where you can earn a tax deduction. All these steps will help you optimise and manage your inventory turnover better.
#3 Improve Forecasting
Without an accurate forecast for your inventory, you will end up experiencing a lot of stockouts or deadstock. That said, an accurate inventory forecast is one of the most crucial parts of regulating supply chain performance.
Your sales and inventory reports can provide deep-rooted insights and data that make the entire process of inventory forecasting more accurate.
Properly executed demand forecast methods can help you in sales planning so you never stock out of high-demand products. They can even suggest creative ways to mix or bundle products so that you can get rid of the dead stock.
#4 Automate Your Purchase Orders
As discussed earlier, inaccuracies and missing inventory data can negatively impact your inventory turnover calculation.
With that in mind, it is a good idea to invest in inventory management software that helps you have access to real-time and accurate inventory data at all times.
When done right, automation can not only help you eliminate inefficiencies from the process but also help you cut down on costs.
Having a robust order management system or inventory management system ensures that your inventory data is always updated, and the process of reordering products is simpler.
You can also use this software to automate purchase orders so that buyers can easily review them, resulting in minimal to no errors.
#5 Take An Objective Look At Your Website
When managing an online store and your sales entirely depend on the products you sell through it, your website should always be updated and conducive to providing an exceptional shopping experience.
The user experience you provide on your online store impacts the sales you generate through it, which is why it is important to take an objective look at it regularly.
Before you start working on changing your inventory management strategy, analyse your marketing to know you are doing enough to capture the product demand.
When you conduct an objective audit of your website, you can get more insights into why certain products are popular or unpopular. Some of the questions you are seeking answers to include:
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Are all the high-demand and high-value products visible to customers?
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Do all the products have enough social proof presented to showcase their quality and effectiveness?
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Is the website layout easy for customers to navigate and are all the essential features accessible?
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Is there a logical structure to the organisation of your product and product categories on the website?
#6 Store Excess Inventory Separately
Lower inventory turnover rates can be especially daunting when you are paying a lot for warehouse management and storage. A great way around it is to identify the low-velocity items or dead stock that you are unable to sell.
Thus, you must consider storing these low-velocity items in a cheaper warehouse for longer durations, and keep the fast-moving items on the more expensive shelves.
This option is especially applicable if you store your items for sale in fulfilment centres designed to deal with high inventory turnover.
Storage costs can also vary based on the geographical location of the warehouse. It is important to consider that slow-moving or bulk goods be stored in a rural, less-expensive facility compared to the more high-end facilities in commercial areas.
#7 Improve Your Replenishment Timing
Managing your inventory can be much more complex than necessary if you don’t get the basics right.
One of those basics is getting your reordering strategy right and ensuring you restock your products well in advance, but not too early.
Similarly, you can ensure that you restock products in the right quantities to avoid stocking out or accumulating deadstock.
You can also calculate and implement reorder points and safety stock carefully to time your inventory replenishment properly. You can also enable reordering notifications to ensure that you never go out of stock and automate the inventory reordering process.
#8 Optimise the Warehouse Space
For better management and record-keeping of inventory, you need to store each SKU properly and separately in the warehouse.
You should use the space and storage in your warehouse as efficiently as possible. In fact, before choosing a warehouse, you need to align its specifications with your growth goals.
You can reorganise the space in your warehouse to accommodate more SKUs and even re-arrange the shelves to increase storage space.
You can also plan and store SKUs that are frequently ordered together, closer to each other to make it easier for order pickers to pick those products.
You should also perform periodic warehouse audits and identify inefficiencies and issues in the supply chain for better inventory management.
#9 Remove Poor-Performing SKUs
Low-velocity SKUs can be quite detrimental to your inventory management and performance. While creating a large list of SKUs does provide a lot of variety to your customers, it may not always equate to better customer retention and higher lifetime value.
After all, when your products do not sell out quickly or drive the different kinds of revenue you expected, having a large catalogue or stocking up too many products will quickly become unprofitable. Moreover, every additional SKU than is necessary can add more complexity to your inventory forecasting process.
To avoid any issues resulting from overstocking, you must utilise SKU rationalisation which can help you identify products and SKUs that should be discontinued if their sales and profitability are declining.
#10 Dispose Excess Inventory
You have to consider getting rid of the excess inventory by identifying SKUs that have lower inventory turnover rates. Once you identify the products you want to get rid of, here are a few ways to go ahead with that:
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Run a flash sale and offer huge discounts on your products
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Consider bundling slow-moving SKUs with best-selling items, or offering them as mystery items, freebies or gifts.
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Consider disposing of or donating the excess products in your inventory at the end of the year or accounting periods.
Even though running flash sales or traditional discount offers can be quite successful, it is a good idea to take a creative approach towards them. This can be especially crucial in retargeting customers and helping you focus on the most valuable SKUs.
#11 Consider Product Drops
Some brands are too attached to their product catalogue, and end up forgetting that customers need to be enticed to buy products.
However, the drop model refers to announcing a product with a limited number of units to create urgency in the customers’ minds and help mask supply chain issues because of the surprising nature of timing.
This is admittedly one of the most effective ways to launch a product and allows you to test its popularity right from the get-go. While many brands use this to sell out their existing inventory, a lot of them use this model to test out their products.
#12 Implement an Inventory Management Software
Choosing a robust inventory management software and implementing it to complement your processes can not only help you automate certain parts of it but also give you detailed insights into your performance.
Implementing inventory management software will also mean that you have access to the most recent and accurate data at all times.
You’ll also have visibility into the various parts and levels of your inventory management strategy with the help of data tracking features that will help you find dead stock, forecast demand and control inventory turnover over time.
Wrapping Up
Inventory turnover is a critical measure in determining the performance of your inventory and overall supply chain. Calculating it regularly will help you ensure that your inventory levels and control measures do not negatively impact your business performance and bottom line.
You must focus on implementing strategies like a more organised warehouse space, flexible pricing strategies and inventory management software to optimise inventory turnover. Get a quote from the PACK & SEND website to boost your order fulfilment and supply chain operations.
Frequently Asked Questions (FAQs)
What does inventory turnover measure?
The inventory turnover measures the efficiency of your inventory by calculating the duration it takes between stocking up your inventory and selling it. Your inventory turnover will also help you understand your business management, performance and sales.
What is a good inventory turnover ratio?
An inventory turnover ratio between 2 to 4 is considered to be ideal for most retailers, however, this measure can vary depending on the industry. If your inventory turnover ratio is between 2 to 4, it means that your sales cycle is aligned with your inventory restocking.
While there is no right or wrong or best inventory turnover ratio, taking the right steps to optimise and improve it can positively impact your bottom line.
Is a higher or lower inventory turnover ratio better?
A high inventory turnover ratio is better than having a lower inventory turnover ratio. An alarmingly low inventory turnover ratio means that you have excess inventory and you have way more products than are required to meet the demand.
On the other hand, a high inventory turnover ratio indicates that you are selling products promptly and helps you save on inventory-related costs. Having said that, you should keep in mind that having too high of an inventory turnover ratio can leave you to keep replenishing inventory unless you can keep up with the demand.
What happens if inventory turnover is high?
A higher inventory turnover is generally a good thing but quickly becomes a problem if you are unable to keep up with the increase in demand and constantly experience stockouts. Additionally, if your stock replenishment process for a specific SKU is lengthy, you can have weeks of lost sales.