Any retail business needs to manage its inventory most efficiently. One crucial part of inventory to concentrate on is inventory turnover, which will help retailers determine the best pricing strategies and the right time to promote products according to their shelf life.

Understanding this side of inventory management will ensure that businesses have a steady cash flow and continue to make a profit with minimal losses. A business turnover ratio tells how well product performance and forecasting procedures are conducted, with high inventory turnover ratios showcasing solid sales and low inventory turnover ratios showcasing weak sales.

This article will cover all areas of inventory turnover ratio, giving you the formula to calculate your business ratio and all the information you need to analyse it effectively, so you understand what it means.

What is Inventory Turnover Ratio?

Inventory turnover refers to the time between a company purchasing a product until it is sold to a customer. The goal for any retail business is to have a complete turnover of inventory, which occurs when a whole stock order is sold without inventory shrinkage and minimal damages.

Of course, it is essential to point out that all industries will have different turnover rates and ratios. For example, a successful inventory turnover ratio for a luxury goods company will be entirely different from the inventory turnover ratio of a supermarket. On the other hand, items frequently needed and bought by consumers, such as consumer packaged goods, have the best inventory turnover ratio due to their demand.

Accurate demand forecasting is essential to having a good inventory turnover ratio. The business needs to keep its inventory stock at the right level to keep up with demand without overstocking and creating losses.

When we use the term inventory turnover ratio, we refer to the times a company sells and restocks its inventory in a certain period. A deep understanding of a company’s inventory turnover ratio is fundamental to anticipating consumer demand and when a company will need to order more stock.

How To Calculate Inventory Turnover Ratio

You must pursue a specific calculation to understand your business’s turnover ratio. Calculating inventory turnover is simple and can be done with the following sum;

You will take the cost of goods sold divided by the average inventory of the same time frame. You can determine if the answer to your calculation indicates a good inventory turnover ratio if the number is high or low.

From your findings, you can determine if the company generates sales at a reasonable level that supports the business cash flow. In addition, you will be able to note your number of KPIs on how to market your stock in a better way that can positively affect your company’s sales and increase the inventory turnover ratio.

How Average Inventory Turnover Ratios Work

Average inventory is the average amount of inventory over multiple accounting periods. Understanding this average can help businesses manage different retail curves and make changes accordingly. In other words, you can think of your average inventory as the mean value of your inventory at a specific time.

If you find this concept tricky to wrap your head around, the best anecdote for it would be to think of retail companies during the festive season. The average inventory would be sky-high during December but would likely plummet in the following January. But, again, this reflects customer demand and how important it is for businesses to take note of these needs.

One of the most beneficial parts of this practice is that you can manually work out the amount of time it may take to sell your current inventory. Doing this helps businesses anticipate when stock is due to be ordered, ensuring there is always a steady amount of inventory on hand to be sold.

The inventory turnover formula is as follows; (Average inventory /cost of goods sold) x 365

Inventory Turnover Formulas

Of course, to use the formula regarding how much time your inventory is expected to last, you will need to know figures regarding average inventory. Knowing your average inventory figures won’t only help calculate the time for sale but also the exact inventory turnover ratio. Below, we will take you through both of these calculations;

To calculate average inventory, you can use the following formula; (beginning inventory + ending inventory) / 2

Suppose your company isn’t greatly affected by seasons, for example. In that case, you don’t see a rise in profits during festive seasons, and you can divide your monthly inventory rate by 12 to find your annual average inventory helping you further project yearly sales.

Finally, to understand your inventory turnover ratio, you can use this inventory turnover ratio formula; Cost of Goods Sold / Avg. Inventory.

Keeping all of your calculations and figures in a balance sheet will be the best way to keep track of these figures and ensures that you can utilise them to the best of your ability.

Why Do We Analyse Inventory Turnover?

Whilst conducting the above calculations may seem like hard work, there is no doubt that these calculations and figures can impact a business in a positive light. Of course, this will ensure that inventory management is at its best, with managers able to gain better incentives for top sale periods for their company.

Having information surrounding sales helps massively with devising a pricing strategy that will generate the business sufficient profit margins. Slow turnovers indicate that product demand has decreased in a certain period and can therefore shed light on ways the business can overcome trialling periods and see their turnovers increase.

On the other hand, it is essential to note that a fast turnover rate doesn’t always mean everything is swell. Sometimes, inventory control can become a massive issue if an inventory turnover rate becomes exceptionally high. For example, businesses may not keep up with their inventory purchases, and items may become out of stock more frequently.

One way to overcome excess customer demands is by raising prices, which can make the inventory turnover rate progress more steadily. A steady inventory rate will see the supply chain work much more controlled, eliminating the chances of having too much inventory or insufficient inventory.

Is There A Top Inventory Turnover Rate?

Suppose we were to speak in black and white terms. In that case, it can be easy to say that a low inventory turnover ratio is worse than having a high inventory turnover ratio, as a higher turnover indicates better sales.

But, this isn’t always the case, and it highly depends on the type of business. For example, if we think of a company such as Tom Ford, their clothes will likely sell slower than those stored in a more accessible high street brand such as H&M, but this doesn’t always indicate that one is better than the other.

In this case, each business will have different goals due to each brand’s marginally different price ranges. As a result, high-end goods will usually have a lower inventory turnover. Still, again, this doesn’t mean that these businesses are doing anything wrong if they are meeting sales targets and inventory is stocked at a sufficient level. Furthermore, more luxurious items will often have a longer manufacturing process.

So, we can say that an inventory turnover rate depends on the business. Still, a steady number that keeps up with supply and demand will indicate that a company has a reasonable inventory turnover rate.

How To Analyse Your Inventory Findings

If your calculations show a low inventory turnover, you will need to undergo some business analysis to ensure you know the direct cause of this. Therefore, analysing your inventory is a considerable element of inventory management and should be done regularly.

If you are at a loss and unsure what your inventory calculations mean for your business, you can compare them to other companies to give you a better idea. In addition, comparisons can help you gauge your industry average and give you an incentive for how your business performs against others.

If your turnover rate is much lower, this could point out that your sales are moving at a slow pace. But, to determine whether these figures result from weak sales, you should also consider the amount of stock you have in storage. Large quantities of stock can lower your average inventory levels in terms of selling, as the balance between supply and sales will likely lean in one direction.

Therefore, it is important to stock your inventory in a precise way that specifically reflects your sales. Although it may be nice to feel you are always overstocked, buying too much inventory makes inventory management much harder and can increase losses if products go out of date or are damaged.

So, take your inventory turnover calculation and apply it to your own inventory. Are you overstocked? Are you not meeting supply, demand and understocking? Are your prices too high and hindering your sales? There are many ways you can go about changing your inventory management process when analysing your findings and helping your inventory ratio become more settled.

Final Thoughts

There is no doubt that inventory turnover is a valuable means that businesses should take note of when making sale projectors and ordering inventory. Keeping ahead of customer demand is essential to make ends meet whilst keeping inventory orders at a steady level that won’t equate to excess stock.

Multiple calculations are needed when conducting inventory management processes, which can be made much easier using inventory management software. The best software will help businesses track and monitor the inventory process, from placing an order with a supplier to the point of sale. In addition, using software ensures figures are more precise, helping you more when it comes to calculations and going through data backlogs to eliminate certain factors from inventory turnover causes.

In conclusion, any business with inventory should focus some time on the inventory turnover ratio. A grasp on factors such as average inventory will help a business to understand their inventory value and gain a better concept of navigating peak seasons and preparing for downfalls.

Frequently Asked Questions

What is a good inventory turnover ratio?

A good turnover ratio could be between 5 and ten, indicating that you restock your inventory every couple of months, with purchasing and sales departments keeping up with the inventory amount. The trick is always having just enough inventory to sell without any emergency restocks or overstocks.

What is the best way to calculate inventory turnover?

Several calculations are involved in inventory management, but to calculate inventory turnover, you need to divide your average inventory by the cost of goods sold and multiply it by 365 (the number of days in the year).

Is higher or lower inventory turnover better?

Rather than aiming for a high inventory turnover, it is better to aim for a middle ground. For example, high inventory can indicate good sales but can be detrimental to inventory ordering, whereas low inventory turnover rates can show weak sales and overstock inventory.