Running a store means buying and selling. But how fast are you selling? Inventory turnover ratio can tell you. A high rate? You’re on fire. A low rate? Time to switch things up.
But this metric isn’t just about counting goods. It’s about making smart choices. It helps with setting prices, deciding what to stock, and more.
Interested? This article breaks down everything you need to know about inventory turnover ratio.
What is inventory turnover?
Inventory turnover is the rate at which a company sells, uses, or replaces stock. High turnover signals rapid sales, while low turnover hints at possible overstocking or performance issues.
What is inventory turnover ratio?
Inventory turnover ratio (ITR) measures the frequency at which a business sells and restocks inventory during an accounting period. You get this ratio by dividing the cost of merchandise sold by the average inventory. The result offers a clear insight into the number of days your current stock lasts before selling out.
Now, let’s put things in perspective. Think of your inventory as the unsung hero, often overshadowed by pricier assets like buildings or machinery. But in the retail world? It’s your MVP. When you spot an ITR of 12, it’s hinting that your inventory completes a full cycle—sells out and restocks—every month.
Here’s another term you might hear: “stock turn,” or sometimes just “turn.” Businesses usually crunch these numbers annually. Why? Seasons. Different shopping seasons like back to school or winter holidays can skew inventory numbers.
How to interpret inventory turnover ratio
When turnover is high, it’s good for business. High turnover indicates that you:
- Purchase the right quantity of items
- Consistently maintain adequate stock
- Efficiently reduce storage costs
- Frequently update your displays.
A high turnover rate means you sell what you buy efficiently. But a low rate? That suggests items sit too long in storage, adding costs. A low inventory turnover ratio might indicate:
- Excess inventory
- Weak sales
- Gaps in marketing
- Loss of product appeal
But exceptions exist in every scenario. A significantly high turnover can also indicate ineffective purchasing or low inventory, which leads to increased back orders and less sales.
How to calculate inventory turnover ratio
To calculate your inventory turnover ratio, you first have to determine your:
Cost of goods sold (COGS): COGS encompasses the labor costs and other direct expenses associated with selling a product. Your income statement typically lists this figure for easy reference.
Average inventory: This represents the median stock quantity held over a particular time frame. You can find your average inventory value by adding your initial inventory to your final inventory for a specific period, then dividing the total by two.
Then use the formula below to discover your ratio:
Inventory turnover ratio formula:
COGS / (Initial Inventory + Final Inventory / 2) = Inventory Turnover Ratio
Quick tip: Curious about which items are hot sellers or sitting idle? Access the Percentage of Inventory Sold report in your Shopify admin. It showcases product starting quantity, ending quantity, percentage sold, and other insights.
After you’ve processed the formula, your ratio can shed light on:
Marketing gaps: Is your product promotion missing the mark? Are your advertising returns getting swallowed by holding costs, affecting your inventory worth?
Sales insights: Are items selling well? Should you introduce sales promotions or focus on specific products to see if holding them longer impacts costs? Should you swap out or phase out low-performing products to enhance your inventory balance? Your ratio will guide you through crucial inventory management decisions.
Pricing evaluation: A high inventory turnover ratio might indicate you’re selling products at too low a price. Your financial data could hint that there’s room to bump up the price or prioritize certain product stocks for enhanced sales.
Example of inventory turnover ratio
Imagine you’re a hat vendor, and your business sells hundreds of hats every month. How would the inventory turnover ratio appear if your beginning inventory for the year stood at $6,000, while the ending inventory for the same year was $2,800, with a cost of goods sold of $4,000?
Here’s how you’d 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 2.5 inventory turnover ratio signify? This figure implies that, over a year, the hat vendor cycles through its inventory roughly 2.5 times. Depending on your shop’s inventory aspirations, this might be a commendable rate to sustain.
Yet, if the aim is to sell more hats, steps should be taken to address this mediocre inventory turnover rate. Enhance the speed of restocking, push the 2.5 yearly turnover up, but stay alert not to over-purchase, leading to a surplus in inventory.
What is a good inventory turnover ratio?
Inventory turnover ratios tend to vary across industries. For some businesses, the ideal inventory turnover ratio is between 5 and 10. This implies the companies sell and replenish their inventory approximately every one to two months.
CSIMarket’s Q1 2023 insights reveal an intriguing pattern: retailers hit a turnover ratio of 11.92, indicating a complete inventory refresh more than 11 times annually.
When you dive into specifics, consumer discretionary brands stand out. Think luxury attire. Such brands cycle through their inventory close to seven times each year.
However, businesses dealing in perishable items, like grocery stores, tend to have an even higher inventory turnover ratio. The reason? Their products have a limited shelf life, so frequent restocking is essential to prevent losses from spoilage.
Is high inventory turnover good or bad?
A high inventory turnover ratio typically signals efficiency and profitability. Why? It shows a company can swiftly sell its inventory. So, when you spot a high ratio, it often means the company’s doing something right in its sales or inventory management strategies.
What does a 1.5 inventory turnover ratio indicate?
When you see an inventory turnover ratio of 1.5, it’s revealing some key info. The company sold its entire stock 1.5 times over a specified time frame. It’s a hint: the company’s inventory management is on track, and sales are humming.
What if the inventory turnover ratio is below 1?
An inventory turnover of less than 1 is a bit concerning. It’s taking over a year to offload all inventory. Several issues could be at play. Perhaps there’s old, unsellable stock. Maybe inventory management has gone awry, or pricing is pushing customers away. Whatever the cause, it’s a red flag that deserves attention.
How to use inventory turnover ratio
Got your ITR? Good. Let’s dive into how you can use this in your retail or online store.
Forecast demand
Demand forecasting is about using past sales to predict future ones. Simple as that. Think of it as looking at what sold well before to avoid any surprises later. Say those winter jackets were a hit last year; you’ll want to stock up again. But if swimwear sat on the shelves? Maybe order less this summer.
Demand forecasting can also assist in your decision-making process. Thinking about opening a new store? Forecasting offers data from past sales to inform that move. Prepping for holiday sales? Forecasting provides clarity by pinpointing both the best time and the amount to order.
By leaning on forecasting, you get closer to finding that sweet spot where supply meets demand perfectly.
Detect supply chain issues
Every business faces supply chain challenges now and then. Look at recent global supply chain hiccups; no one saw them coming.
But your inventory turnover ratio? It’s a tool to help you spot problems before they grow. It can show you how much safety stock you need for top-selling items. It can highlight:
- Stocking and ordering issues: Maybe you’re ordering too much of one thing and not enough of another.
- Shifts in delivery times: If products start taking longer to get to you, it’s good to know.
- Marketing misalignments: If marketing pushes one product, but you’re stocked for another, there’s a mismatch.
Knowing which items sell slowly also tells you what might be taking up too much space. Maybe it’s time to clear out old stock or adjust your orders. With your turnover ratio in hand, you can see where your supply chain might need a tune-up.
How to improve inventory turnover
Now you understand your inventory turnover ratio. Here’s how to enhance that rate in your store:
1. Increase marketing efforts
Is your inventory piling up? Boost customer demand to shift products faster. Short-term options include paid ads. But why not tap into your existing social media channels? Promote discounts or flash sales. If this doesn’t work, it’s time to revisit your pricing.
Perhaps your audience values your product differently than you assumed. Adjust with targeted marketing campaigns. Use influencers or brand ambassadors if it fits your brand.
2. Optimize your supply chain
Strengthen your supply chain to avoid those annoying late deliveries. Regularly review your supply chain and gather data at each phase. This helps gauge efficiency and keeps a close eye on your retail inventory.
Your inventory turnover rate reveals your carrying costs. By adopting a just-in-time (JIT) strategy, you can reduce these costs. But remember, there’s a trade-off: the risk of running out of stock increases.
Also, a clear grasp of your inventory turnover ratio fosters better supplier relationships. It ensures clear communication, aligning needs and deliveries.
3. Improve forecasting
Look at the inventory ratio for each product. This tells you which items aren’t flying off the shelves. Now you know where to adjust your forecasting.
Maybe order less from suppliers next time. After all, you’ll see faster inventory turns if you stock smaller quantities more frequently. For improved forecasting:
- Keep clean records. Use trustworthy inventory management software.
- Dive deep into individual product numbers. Avoid merging everything together.
- Integrate seasonal variations in your analysis.
Platforms like Shopify POS can make forecasting less of a headache.
4. Bundle products
Bundling combines complementary items to entice more buyers. Let’s say some products aren’t selling. Group them with faster-selling items. This might help clear stock quicker without compromising profits.
Another approach? Offer quantity discounts. For instance, give deals on buying multiple units of the same product.
The trick to successful bundling? Data. Identify slow-moving items and strategize accordingly. Your inventory turnover ratio offers insights, making bundle decisions smarter and more effective.
5. Evaluate and adjust your product lineup
Inventory clutter can clog your turnover rate. Periodically assess which products fly off the shelves and which linger. For instance, if a particular style of shoes isn’t selling, it might be time to phase them out.
Introduce fresh, trending items that resonate with your target audience. Notice a spike in eco-friendly products? Stocking up on sustainable goods could draw a new crowd.
Acting on customer feedback is also crucial. If several customers rave about a product you don’t carry, consider introducing it. This proactive approach can revitalize your inventory and cater directly to customer needs.
Optimizing inventory turnover
Three things matter most to retailers: inventory, sales, and profit. The key? Achieving the right balance.
Dive into your numbers. Take your cost of goods sold and divide it by your average inventory. Now, you’ve got a roadmap to streamline. Maybe you refine your supply chain. Perhaps you trim those hefty warehouse costs.
Most importantly, don’t stop at the numbers. Boost your cash flow. Adjust your pricing. Even consider changing up your product mix. Remember that when you’ve got solid ratios on your side, opportunities open up.
