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How To Calculate Inventory Turnover Ratio | 11 Tips To Increase Inventory Turnover For Business
Article written by Kate Williams
Product Marketing Manager at SurveySparrow
12 min read
17 May 2021
Best Of
Article written by Kate Williams
Product Marketing Manager at SurveySparrow
12 min read
17 May 2021
Let’s cut straight to the chase.
The number of times inventory is sold or consumed during a given period is called inventory turnover and is represented in ratios. It is also called the stock turn, stock turnover, inventory turns, inventory turnover formula, and you arrive at it by dividing the cost of goods sold by average inventory.
Inventory turnover helps businesses make smarter business decisions on manufacturing, pricing, marketing, manufacturing and replenishing their inventory.
Inventory turnover formula= (Cost of Goods Sold/Average value of inventory)
It is the expense that the business incurs when it creates a product, starting from the money spent on the raw materials and the labor. For a merchandising business, the cost consideration is the actual amount of the product paid by the merchandiser through a supplier or a manufacturer. Cost of Goods Sold is accurately arrived at by maintaining an inventory account or the list of raw materials or goods purchased.
It is considered as the average cost of goods during two or more periods. Usually, it considers the beginning inventory and the ending inventory during the period. When you are trying to see how to calculate the inventory turnover ratio for the whole year, you consider inventory at the beginning of the year and inventory at the end of the year.
You can find the average value of the inventory by adding the beginning inventory and ending inventory, and dividing it by 2.
One more method will answer the question ‘how to calculate inventory turnover’ effectively. In the first method, it was calculated using the cost of goods sold. Here, you can calculate instead the number of sales made.
The reason why using COGS is a much accurate option is because the value of the sales might not be the right one. After all, the value has a markup sometimes.
Let’s say you are trying to figure out the inventory turnover of a specific item in your retail store. We will assign certain arbitrary numbers to the terms that will tell us how to calculate inventory turnover.
COGS= $15,000
Your beginning inventory is $6,000, and your ending inventory is $3,000. So your average inventory is $1,500.
When you calculate using the inventory turnover ratio formula, you will get the following:
$15,000/$1,500= 10.
10 is your turnover rate.
To put it in words, it means that the specific product has turned in your inventory more than ten times throughout the year.
Do you want to calculate how many days it takes to turn the inventory once? All you need to do is divide the number by 365.
By using the days in inventory formula→ 365/10= 36.5.
It means that the product was sold once every 36.5 days at the store. This is how to calculate days in inventory.
Using the inventory turnover formula, you can easily understand how much stock you should keep in the future and how you can anticipate.
In simple words, it tells you how fast a company sells its goods. If the turnover is low, it means that the sales lag, or there could be a case of excess inventory. There can be a lot of implications to this. The marketing team might have done a shoddy job because of which sales are not up to expectations. The goods offered on sale might not be of great quality, which is why people are not intent on purchasing from here.
If the inventory turnover is high, it might be because the products are going off the shelves rapidly or the inventory is insufficient.
The business should have an idea about the pace with which it can sell its goods. Businesses that can sell many of their products faster will also be in a good position because they would also be getting cash in their registers.
When there is inventory which just does not sell, the business also loses confidence. It ends up drafting strategies that might not make sense. You would have even noticed that most retailers make it a point to sell many of their goods at a huge discount after a season is over. Just holding the inventory is a waste of space when new inventory comes in.
The ideal inventory turnover ratio depends on the products that you are selling and on the specific industry. Certain goods sell immediately. E.g., any products in the FMCG sector will sell fast, while a hobby product like a stamp will take a lot of time to sell. Businesses that have higher profit margins have lower inventory turnover. For example, an art gallery, a place that has low inventory turnover, will have a turnover rate of five. In contrast, a retail store like Walmart will have a higher turnover rate for most of its products.
In other words, to find out if your inventory turnover ratio is good or bad, you need to check with competitors in your field. The general understanding is that if you have a higher inventory turnover rate, your business is good.
As we discussed earlier, a high turnover rate is a common phenomenon for businesses that sell daily use products to people. Here is what a high turnover rate indicates:
If you see that your turnover rate for a particular product is much lower when compared with your competitors for the same product, then here’s what you do:
When you know that you need to put more efforts to increase your inventory turnover ratio, here are some of the things that you can do:
Are there products in your store that are usually considered high selling because of their nature or novelty? You might want to push more of these products for your customers. Place it strategically in areas where your customers will notice.
When your current marketing strategy is not yielding the results, it should immediately make changes based on observation and analytics. The best thing about marketing these days is that you can tweak your strategies when you see that it is not doling out the kind of numbers you are expecting.
One of the main mistakes that most marketing campaigns make is that they do not know their ideal customer. Without knowing this, you cannot reach out to those who are more likely to buy from you.
Find your buyer personas. A buyer persona is a fictional representation of your most ideal customers based on various characteristics, including demographic, firmographic, behavioural, etc. Get these ideal customers interested in what you are offering and market your products to them.
There are bound to be products that your customers are not interested in. Products such as these will only be occupying the space without being of use to anyone. When you are trying to stock your inventory with goods that will sell, if you find non-selling goods there, you will waste time clearing the space. You can sell these products at an extremely low price so that you can get rid of the inventory without having to store it again at the warehouse.
Some businesses do not get their pricing right, and this eventually affects their sale immensely. Pricing a product high might not be the only problem; you might even be pricing a product too low and will end up shooing away customers looking to pay for value and are not looking at the price tags.
One of the best ways to get an idea about your pricing is to observe how your competitors have priced your product. But that doesn’t mean that you cannot price your products at a premium, especially if your brand has such a high value. E.g., Apple.
Another clever way to ensure that your products are always stocked is to keep buying fewer products but do it more often so that there is never an issue of not finding the products that your customers want. Do remember that not every business has the money and ability to buy often. If you have that kind of muscle power, this is a strategy that will pay dividends.
Identify similar products and put them into a separate category. By doing so, you should compare how they are performing. Based on their sales, you will be able to recognize trends. It will even be possible for you to make your inventory calculations correctly.
If you are selling on both offline and online channels, using automation technology becomes a must. This technology lets you know when a sale is made, and it will even update when new inventory comes in. Automation processes will even send automated messages to the distributor, saying that certain products need to be replenished. Just by using AI, you can iron out so many issues that happen regularly with most companies.
There is no doubt about the fact that not all products are of similar importance. Some items sell only during a particular season; some are occasional items, holiday items, fashion trends, etc. If you keep a clear view of your products taken off the shelves, you can forecast depending on your information.
Follow local trends to see stock more of a product and also the products that are usually best-sellers.
One way to ensure that your sales are always on the right track is to ensure that you have proper stock of all the products. Just because an item sells a lot doesn’t mean that you should overstock it, but keep stocking small quantities of it, but do that more frequently. Before a fast-selling product is about to go off the shelves, you need to ensure that the order to get more quantity should already have been done.
When you get your customers to pre-order and register for products, then it means that you will have a list of people who are ready to buy from you. You will have an idea of the stock that you need to purchase.
Getting pre-orders from customers is difficult because people are always on the lookout for better offers and are willing to wait until the last minute. You can get more pre-orders with the help of smart marketing tactics and leverage products that are usually in high demand from all quarters.
Some of the above methods that we have outlined will surely help the business. Following the above steps will not only help in terms of sales or making your inventory management efficient, but it will also make sure that your business runs smoothly.
Inventory turnover is a good measure of your business prospects. It tells you how your business is faring and when compared against industry averages, it will also offer a comparison. Some of the above methods will help you increase your inventory turnover and offer more stability for your business. One can do many more things to increase the chances of ensuring that the inventory turnover ratio remains reasonable.
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