From startups to established enterprises, efficient inventory turnover is a critical aspect of thriving in today’s dynamic business landscape. Understanding how inventory turnover affects operational efficiency and profitability can give your business a competitive advantage, and propel you to success.
This guide covers concepts, strategies, and best practices for businesses to optimize inventory turnover ratios.
What is Inventory Turnover?
Inventory turnover is a metric in inventory management, that quantifies the rate at which inventory or stock is sold within a given period. Understanding a company’s inventory turnover provides valuable insights into top-selling products and the effectiveness of overall cost management. A high inventory turnover signifies rapid inventory movement, whereas a low turnover indicates the opposite.
What is Inventory Turnover Ratio?
The inventory turnover ratio measures how effectively a company manages its inventory by comparing the cost of goods sold to the average inventory over a set period.
This ratio indicates how many times a company sells its average inventory during a specific timeframe, or, how many times it replenishes its stock in a year.
If you’re familiar with real-estate terms, there is a similar concept in the housing market called “month’s supply.” It refers to how quickly it would take for all the real-estate inventory to sell out, given that no new inventory became available. This is measured in months, hence the term month’s supply.
But how does this calculation work in commerce? Let’s delve into this with the following example.
How to Calculate Inventory Turnover Ratio
The calculation of the inventory turnover ratio involves dividing the total cost of goods sold during a specified period by the average inventory held during that same timeframe.
Cost of Goods Sold (COGS) / Average Inventory = Inventory Turnover Ratio
For instance, if a business has $20,000 worth of average inventory and records $100,000 in annual sales, it suggests that its inventory turned over five times during the year.
Inventory Turnover Ratio = $100,000 / $20,000
Inventory Turnover Ratio = 5 times per year
In this example, the inventory turnover ratio of five times per year highlights the company’s efficient inventory management practices, indicating a healthy turnover rate conducive to operational success rate conducive to operational success. This leads to the natural question: What is a good inventory turnover rate? Let´s find out, in the following topic.
READ MORE: Inventory Management: The Key to Successful E-commerce
What Defines a Strong Inventory Turnover Rate?
Typically, a strong inventory turnover ratio falls between 4 and 6, indicating effective management of inventory turnover.
A high inventory turnover suggests brisk sales, while a low turnover indicates slower sales.
For instance, if your company sold 200 items and kept 50 in stock during a specific period, the turnover ratio would be 4. Conversely, if you sold 600 items while retaining 100 in stock, the ratio would be 6. The calculation period for the inventory turnover ratio usually spans one fiscal year, but this can vary depending on the industry and business practices.
Why Tracking the Inventory Turnover Ratio is Important
There are several reasons why monitoring your inventory turnover ratio is very important. In the following topics, we present some of them.
1. Enhance 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. However, too high of an inventory rate may indicate that you are not ordering enough stock to keep up with consumer demands. Conversely, a lower turnover ratio suggests that you may be carrying excess inventory, leading to increased storage costs and the risk of obsolescence.
READ MORE: How to Improve Inventory Lot Control – Best Practices
2. Increase Supply Chain Performance
Inventory turnover is intricately linked to the efficiency of the supply chain. A favorable inventory turnover ratio indicates a well-optimized supply chain, thereby minimizing inventory holding expenses and enhancing responsiveness to changes in market demand.
3. Improve Cash Flow Management
Proficient management of inventory has a constructive influence on cash flow.
An elevated inventory turnover ratio signifies reduced capital allocation to inventory, thereby enhancing liquidity for investment in alternative business domains or fulfilling financial commitments.
4. Recognize Seasonal Patterns
Examining inventory turnover across various time frames can aid in pinpointing seasonal fluctuations in demand, allowing for strategic adjustment of inventory levels. This allows businesses to prevent inventory shortages during high-demand seasons, such as Black Friday, and reduce surplus inventory during slower periods.
READ MORE: Handling High-Volume eCommerce Periods: A Guide
5. Identify Turnover Ratio for Apparel and Other Businesses
Analyzing your inventory turnover ratio against industry benchmarks and competitors helps assess your market position and pinpoint opportunities to enhance inventory management strategies.
READ MORE: Top 10 Tips to Fulfill E-commerce Orders: Apparel Companies
Exploring ways to elevate your inventory turnover rate is crucial for optimizing operational efficiency and financial performance. By implementing strategies to improve turnover, businesses can streamline inventory management processes, enhance supply chain performance, and bolster cash flow management. In the next topic, will review a technique to improve your inventory turnover ratio.
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How to Improve the Efficiency of Your Inventory Turnover Ratio
Merely understanding the calculation of inventory turnover isn’t sufficient. Enhancing your inventory turnover can significantly enhance inventory management efficiency, reduce warehousing expenses, and stimulate sales.
A low inventory turnover ratio can lead to various challenges, including the accumulation of obsolete stock that hampers cash flow due to excessive unsold inventory.
If you’re encountering this issue, here are some strategies you can implement to improve your situation:
1. Monitor Stock Levels Frequently
Regularly checking stock levels is vital to spot slow-selling or outdated items.
Review inventory reports often to pinpoint products that aren’t generating much revenue.
Decide whether to lower prices, promote them, or remove them entirely (which is often done through liquidation). Addressing slow-moving inventory promptly helps maintain a healthy inventory turnover ratio.
2. Negotiate with Suppliers
Build strong relationships with suppliers and negotiate favorable terms to decrease lead times and inventory expenses.
Pursue discounts for bulk purchases or prompt payments to enhance cash flow and guarantee a steady stream of goods.
Effective supplier management can lead to quicker restocking and improved inventory turnover.
3. Optimize Ordering 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. Cut Down on Costs
Identifying areas of excessive spending can lower the Cost of Good Sold (COGS) average inventory.
For instance, each square foot of inventory storage incurs a portion of the rent expenses. Inefficient manufacturing and shipping practices raise COGS, diminishing profits.
5. Improving your Supply Chain Efficiency
Do you identify any vulnerabilities in your supply chain? Are you experiencing lengthy delays in receiving supply orders on your shop floor?
These prolonged lead times result in reduced manufacturing output.
While it’s acceptable to purchase low-storage items like maintenance, repair, and operations (MRO) goods in small quantities, accumulating raw materials and finished products merely elevates your average inventory without contributing to sales growth.
6. Make-to-Order
The most straightforward method to boost inventory turnover is by implementing a make-to-order system.
This approach minimizes on-hand stock, preventing material and effort waste, as items are shipped promptly.
Adopting a make-to-order workflow is the most effective strategy to elevate your inventory turnover ratio, though not always feasible for every industry.
Closing Thoughts
In conclusion, mastering the intricacies of efficient inventory turnover is paramount for businesses striving to excel in today’s competitive landscape.
By understanding the significance of inventory turnover and implementing strategic measures to optimize it, companies can enhance operational efficiency, improve cash flow management, and drive profitability.
Whether you’re monitoring stock levels, negotiating with suppliers, or streamlining ordering quantities, the journey to efficient inventory turnover is multifaceted but rewarding. With a focus on continuous improvement and adopting best practices, businesses can unlock their full potential and achieve sustainable success in managing their inventory turnover with Shipedge WMS.
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What is a good inventory turnover rate for eCommerce?
A good inventory turnover rate for eCommerce businesses is typically around 4-6 per year. This means a company will entirely deplete and replace its stock between four and six times each year.
Can my inventory turnover rate be too high?
Typically, a good yearly inventory turnover rate for eCommerce brands is around 4-6. An inventory turnover rate that is too high means you’re not ordering enough stock to keep up with demand and can experience issues fulfilling customer demands. Remember, each industry is unique, and inventory turnover rates may vary.
What to do if my inventory turnover rate is too low?
Although a low inventory turnover rate is not always indicative of success in eCommerce, it can be used as a tool to measure efficiency. If you’re experiencing a low inventory turnover rate of 1, or less than 1 per year, you may want to reevaluate your inventory to see what is actually selling. It’s expensive to hold inventory for long periods of time, so aim for an inventory turnover rate of 4-6 per year. Remember, each industry is different and a good inventory turnover rate may vary.
