Understanding Inventory Turnover Ratio and How to Calculate It
Inventory turnover is an important inventory management metric you need to keep an eye on at all times. It gives you insight into how fast – albeit slow – your inventories are moving along your sales channels and supply chain.
While a high inventory turnover value is indicative of a fast-moving inventory, a low value says the exact opposite.
Inventory turnover is calculated by dividing the cost of goods sold (COGS) by the average inventory value for a given period. The period here could be a year, six months, three months – on and on, but rarely a week. You will want to stretch it minimum over a month, or else you might get inaccurate figures.
Calculating your company’s inventory turnover, as well as the turnover rates, has many benefits. If nothing else, it enables you to figure out your retail prices accurately to ensure optimum profits. More detail on this in a bit.
In this piece, we will be diving a bit deeper to understand what inventory turnover is about. We will also discuss the benefits and how to calculate it.
Let’s dive in!
What is Inventory Turnover?
Inventory turnover, or just inventory turns, goes by many names: inventory turnover ratio, stock turnover, stock turn, inventory turn – and sometimes inventory holding period.
Inventory turnover ratios measure how fast or slow you sell and replace your inventory over a specific period. It reflects the pace at which you convert your inventory into revenue.
A high inventory turnover can mean one of two things:
- You are experiencing strong sales
- Your inventory levels are low
A low inventory turnover ratio, on the other hand, is indicative of excess inventory or weak sales.
You will want to aim somewhere between these two extremes.
Streamline your processes with a tailor-made inventory management solution.
How Does Inventory Ratio Work?
The inventory turnover ratio is an essential metric that helps businesses understand how efficiently they are managing their stock. This ratio measures how often a company sells and replaces its inventory over a specific period, usually a year. A higher inventory turnover indicates a more efficient operation, where goods are sold quickly and cash flow is better managed. Conversely, a lower turnover may signal overstocking or challenges in selling products.
Is Inventory Turnover Ratio the Same as Stock Turnover Ratio?
Inventory turnover ratio and stock turnover ratio both mean the same thing: they are a yardstick for measuring how fast or slow a business converts products into sales.
How to Calculate Inventory Turnover
How do I calculate inventory turnover? Thankfully, inventory turns calculation is pretty straightforward. Here’s how to do it:
To calculate inventory turnover ratio, divide the total cost of goods sold (COGS) for a given period by the average inventory value.
The equation for inventory turnover is as follows:
Inventory Turnover Ratio Formula = Cost of Goods Sold (COGS) / Average Inventory
The cost of goods sold (COGS) represents the direct costs incurred in producing or purchasing the goods that you sell during a given period. The average inventory is the average value of inventory held over the same period.
Typically, the average inventory calculation is done by adding the beginning and ending inventory values for the chosen period and dividing by two.
That is:
Average inventory = (Beginning inventory + Ending inventory)/2
Another way to go about calculating average inventory is to divide your total sales over a given sales window by your average inventory value.
Let’s illustrate some examples to help you get a better grasp of the topic.
Example 1: Corel Fashion, an apparel retailer that deals in women’s wear has an average annual cost of goods sold worth $360,000. And on average, each inventory intake per cycle amounts to $10,000
Their inventory ratio is as follows:
Inventory turnover = $360000/$10000
This equals 36.
Example 2: Sly Collections, a high streetwear retailer, is unable to calculate its COGS, but knows its quarterly sales value, which is about $45,000 on average. And in the 3-month period, they process inventory worth $6000 on average.
Inventory turnover = $45000/$6000
This equals 7.5, which you can round off to 8.
The two examples above are hypothetical, but they at least show you how to calculate your inventory turnover ratio without needing an inventory turnover calculator software.
You will want to aim for a higher inventory turnover ratios by stocking fast-moving products and eliminating hiccups along your supply chain.
Inventory Turnover Ratio Meaning
Inventory turnover ratio doesn’t always give you sufficient insights into your inventory management processes. It only gives you clues about how fast inventory is moving along your sales channel but scarcely tells you how many days it takes to replenish your stock on hand.
Inventory turnover rate does.
Inventory turnover rate is calculated by dividing the number of days in a given sales period by the inventory turnover ratio.
That is to say:
Inventory turnover rate = Number of days in a sales cycle/Inventory turnover ratio
In the case of Corel Fashion, their inventory turnover rate for the one-year cycle will be:
Inventory turnover rate = 365/36 = 10.1
This means it takes Corel Fashion approximately 10 days to replenish its inventory.
Five Reasons Why Tracking Your Inventory Turnover Ratio Is Important
Here are five reasons why monitoring your inventory turnover ratio consistently is important
1. Improves Inventory Management
A higher inventory turnover ratio indicates that you are efficiently managing your inventory by quickly selling products and restocking at a rapid pace. Conversely, a lower turnover ratio suggests that you may be carrying excess inventory, leading to increased storage costs and the risk of obsolescence.
2. Enhances Supply Chain Performance
Inventory turnover is closely related to supply chain efficiency. An optimal inventory turnover ratio signifies a streamlined supply chain, reducing holding costs and enabling you to respond more effectively to fluctuations in demand.
3. Improves Cash Flow Management
Effective inventory management positively impacts your cash flow. A higher inventory turnover ratio means that less capital is tied up in inventory, providing you with more liquidity to invest in other areas of the business or to address financial obligations.
4. Identifying Seasonal Trends
Analyzing inventory turnover over different periods can help identify seasonal demand patterns and plan inventory levels accordingly. This enables businesses to avoid stockouts during peak demand and minimize excess inventory during slower periods.
5. Performance Benchmarking
Comparing your inventory turnover ratio with industry averages and competitors helps you gauge your market competitiveness and identify areas for improvement in inventory management practices.
6. Enables You To Calculate Retail Prices Accurately
The key to staying profitable in business is calculating your product prices accurately. This is another area where tracking your inventory turnover ratio is beneficial.
What Is a Good Inventory Turnover Ratio for Apparel Businesses?
What ideal inventory turnover ratio should you aim for as an apparel retailer? While there is no silver bullet for determining the right figure for your business, you will want to aim for something in the range of 5 to 10.
A very high inventory turnover ratio is desirable, but might not be good for your business, as it’s often indicative of perennial insufficient inventory problems. Aim for a moderate figure.
Tips to Improve Your Inventory Turnover Ratio
A low inventory turnover ratio breeds a lot of problems. One is that it causes dead stocks to fill up your inventory, leading to too many unsold inventories tying down your cash flow.
If you’ve been experiencing this, here are strategies you can try to turn your fortunes around for the better.
1. Regularly Monitor Stock Levels
Frequent monitoring of stock levels and efficient inventory control are both crucial for identifying slow-moving or obsolete items. Regularly assess inventory reports to determine which products are not contributing significantly to revenue and decide whether to reduce prices, run promotions, or discontinue them altogether. By promptly addressing slow-moving inventory, you can prevent it from dragging down your overall inventory turnover ratio.
2. Negotiate with Suppliers
Establish strong relationships with suppliers and negotiate favorable terms to reduce lead times and inventory costs. Seek discounts for bulk orders or early payments to improve cash flow and ensure a steady supply of goods. Efficient supplier management can lead to faster restocking and improved inventory turnover.
3. Optimize Order Quantities
Balancing order quantities is crucial to prevent excessive stock accumulation. Employ economic order quantity (EOQ) principles to determine the ideal order quantity that minimizes holding costs while meeting demand. Striking the right balance will help you maintain optimal inventory levels and enhance inventory turnover.
4. Leverage Inventory Management Software
Invest in reliable inventory management software to streamline your inventory processes and gain real-time insights into stock levels, sales patterns, and demand fluctuations. Modern inventory management systems can help automate tasks, reduce human errors, and provide data-driven suggestions for inventory optimization, ultimately leading to improved inventory turnover.
What Is a Good Inventory Turnover in Days?
Ideally, you should aim for an inventory turnover of 4 to 12 days for a healthy cash flow.
Move Your Business Forward With Uphance
Using the right inventory management software is crucial for achieving the optimum inventory turnover ratio. Doing so lets you track your inventory levels at all times, monitor stock as they move along your sales channels, and see stocks selling the fastest and slowest.
What better software to use than Uphance? Uphance comes with a load of features that make managing your inventory a breeze.
Schedule a demo right away to see things for yourself.
