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What is Inventory Turnover?

Inventory turnover is a measure of how quickly a business sells, replaces or uses its stock. A high turnover indicates rapid sales while a low turnover may indicate overstocking and performance issues.

What is the inventory turnover ratio?

Inventory turnover ratio (ITR), measures how often a company sells and replenishes its inventory over a period of accounting. Divide the cost of the merchandise by the average stock to get the ratio. This ratio gives you a good idea of how long your stock will last before it is sold out.

Let’s get things into perspective. Consider your inventory the unsung hero that is often overlooked by more expensive assets such as buildings and machinery. In the retail industry? Your MVP. If you see an ITR 12 it means that your inventory goes through a complete cycle every month, selling out and replenishing.

You may also hear “stock turn” or “turn”. Businesses typically crunch these figures annually. Why? Seasons. Inventory numbers can be affected by different shopping seasons, such as back-to-school or holidays.

How to interpret the inventory turnover ratio

High turnover is good for your business. When turnover is high, it means:

How to buy the right amount of products
Maintain a consistent stock
Reduce storage costs
Update your displays frequently.

A high turnover rate indicates that you are selling what you purchase efficiently. A low turnover rate is also possible. This suggests that items are sitting in storage for too long, increasing costs. Inventory turnover is low.

Excess Inventory
Weak sales
Gaps and marketing
Loss in product appeal

There are exceptions to every situation. Ineffective inventory management or ineffective purchasing can lead to a high turnover, which will result in increased backorders and less sales.

How to calculate the inventory turnover ratio

In order to calculate your inventory turnover rate, you must first determine:

Cost of goods (COGS) – COGS includes labor costs, and any other direct expenses that are associated with the sale of a product. This figure is usually listed on your income statement for ease of reference.

The average inventory is the quantity of stock held on average over a certain period. Add your initial inventory and your final inventory over a certain period. Then divide the total by 2.

Use the formula below to find your ratio:

Formula for calculating inventory turnover ratio:

Inventory Turnover Ratio = COGS / (Initial Stock + Final Inventory / 2)

Want to know which products are selling well or if they are unused? Shopify admin allows you to access the report Percentage Inventory Sold. This report shows the product’s starting quantity, end quantity, percentage of sold, and more.

Your ratio will reveal:

Marketing Gapsspan size=”font weight: 400 ;”>: Does your product promotion miss the mark? Holding costs are eating up your advertising returns, which is affecting the value of your inventory.

Sales insightsspan size=”font weight: 400 ;”>: Do items sell well? You may want to introduce special offers or concentrate on certain products in order to determine if they have an impact on your costs. You may want to replace or phase out products that are not performing well in order to improve your inventory balance. You can use your ratio to guide you in making important inventory management decisions.

Pricing evaluationspan size=”font weight: 400 ;”>: An inventory turnover ratio that is high could indicate that you are selling your products too cheaply. Your financial data may indicate that you can increase the price of certain products or prioritise specific product stocks to boost sales.

Example inventory turnover ratio

Imagine that you are a hat seller and sell hundreds of hats each month. What would be the inventory turnover rate if you had a $6,000 beginning inventory, a $2,800 ending inventory, and 4% cost of goods sold?

This is how you would set up the equation.

COGS = (Starting inventory + Finishing inventory / 2) = Inventory turnover ratio

$4,000 / ($6,000 + $2,800/2) = 2.5

What does a ratio of 2.5 indicate? This number indicates that the hat seller cycles through their inventory about 2.5 times over a period of a year. This rate may be commendable depending on the inventory goals of your shop.

If the goal is to sell hats more, then steps need to be taken to improve this low inventory turnover rate. Increase the pace of restocking and the 2.5-year turnover, but be careful not to overbuy, which could lead to an excess in inventory.

What’s a good ratio of inventory turnover?

Industry-specific inventory turnover ratios vary. Inventory turnover ratios are ideal for some businesses between 5 and 10 percent. This means that the company sells and replenishes its inventory every one to two weeks.

CSIMarket’s Q1 2023 insights reveal a fascinating pattern: retailers reached a turnover rate of 11.92. This indicates a complete stock refresh more than eleven times per year.

Consumer discretionary brands are the ones that stand out when you dig into the details. Consider luxury clothing. Think luxury clothing.

Inventory turnover rates are higher in businesses that deal with perishable goods, such as grocery stores. Why? The reason?

Does high inventory turnover make a good or a bad business?

High inventory turnover ratios are usually a sign of efficiency and profitability. Why? This shows that a company is able to sell its stock quickly. When you see a high ratio it usually means that the company is doing something right with its inventory or sales strategies.

What is a ratio of 1.5 in inventory turnover?

A ratio of inventory turnover of 1.5 reveals some important information. A company’s entire inventory was sold 1.5 times in a given time period. This is a sign that the company’s inventory control and sales are on track.

What happens if your inventory turnover ratio falls below 1?

A turnover of inventory less than one is concerning. It takes over a full year to get rid of all the inventory. There could be several issues at play. There could be old stock that is unsellable. Perhaps inventory management is a mess, or the pricing is driving customers away. It’s important to pay attention, regardless of the reason.

How to calculate inventory turnover ratio

Have you received your ITR yet? Good. You can use it in your online or retail store.

Forecast demand

Demand forecasting involves using previous sales to predict future sales. It’s that simple. Consider it as a way to prevent any unpleasant surprises in the future. If winter jackets sold well last year, you may want to buy more. What if the swimwear was left on the shelf? Order less swimwear this summer.

Forecasting demand can help you make better decisions. Are you considering opening a new shop? Forecasting can help you make the right decision by using data from previous sales. How to prepare for holiday sales? Forecasting can help you to make better decisions by identifying the best time to place your order and the right amount.

By using forecasting to your advantage, you can get closer at finding the sweet spot of supply and demand.

Detect issues in the supply chain

Supply chain challenges are a part of every business. No one anticipated the recent global supply chains hiccups.

What about your inventory turnover rate? This tool can help you identify problems before they become serious. It will show you the amount of safety stock that you’ll need for most popular items. It can highlight:

Ordering and stocking issues: You may be ordering too much or not enough of something.
Changes in delivery time: It’s important to be aware if products are taking longer to reach you.
Misaligned marketing: When you are stocked with one product but the marketing is pushing for another, it’s a misalignment.

You can also find out what items are taking up too much room by identifying slow-moving items. It may be time to adjust orders or clear out old stock. You can use your turnover ratio to see where you might need to make some changes in your supply chain.

How to increase inventory turnover

Now that you know your inventory turnover rate, it’s time to improve it. Now you know how to improve your inventory turnover rate.

1. Marketing efforts to be increased

Is your inventory piling up? Increase customer demand to move products more quickly. Paid ads are a good option for the short-term. Why not use your social media channels to reach out? Promote flash sales or discounts. If this does not work, you may need to reconsider your pricing.

Your audience may value your product differently from what you thought. Adjust your marketing campaign with targeted campaigns. If it suits your brand, use influencers and brand ambassadors.

2. Optimise your supply chain

To avoid the annoying delays, strengthen your supply chain. Review your supply chain regularly and collect data at every phase. This allows you to gauge your efficiency and keep a close watch on your retail stock.

Inventory turnover rates reveal your carrying costs. You can lower these costs by adopting a “just-in-time” (JIT). Remember, however, that there is a cost: the risk of out-of-stock increases.

A clear understanding of your inventory turnover rate will also help you build better relationships with suppliers. This ensures that needs and delivery are aligned.

3. Forecasting is improved

You can also look at the ratio of inventory for each product. You can see which products aren’t selling well. You can adjust your forecasting.

Next time, you might order less. Stocking smaller quantities more often will result in faster inventory turnover. Forecasting is improved by:

Maintain clean records. Use a reliable inventory management software.
Dive deep into individual product numbers. Do not merge all the numbers together.
Include seasonal variations in your analyses.

Platforms such as Shopify Point of Sale make forecasting easier.

4. Bundle products

Bundling is a way to combine complementary products in order to attract more buyers. Say that some products don’t sell. Assort them with items that sell faster. This could help to clear the stock faster without compromising profit.

What is another approach? Quantity discounts are available. Offer discounts on multiple purchases of the same item.

What is the secret to bundling success? Data. Identify items that are slow to move and plan accordingly. Inventory turnover ratios provide valuable insights that can help you make smarter, more effective bundle decisions.

5. Review and update your product line-up

Stock clutter can slow down your turnover rate. Assess which products are flying off the shelves, and which ones linger. If a certain style of shoe isn’t selling well, you may want to discontinue it.

Introduce new, trendy items that resonate well with your audience. Have you noticed a rise in eco friendly products? Stocking up on eco-friendly products could attract a whole new crowd.

It is important to act on feedback from customers. Consider introducing a product that several customers have raved about. This proactive approach will revitalize your stock and meet customer needs.

Optimizing Inventory Turnover

Inventory, sales and profit are the three things that retailers care most about. What is the key? The key?

Dive into your numbers. Divide your cost of sales by the average amount in your inventory. You now have a road map to streamline. You could refine your supply chain. Maybe you can trim those high warehouse costs.

Don’t just stop with the numbers. Increase your Cash Flow. You may need to adjust your pricing. Consider changing your product mix. When you have solid ratios, new opportunities will open.

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Author: Adeel Qayum

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