Inventory is an essential part of many businesses, but managing inventory correctly is a challenge. A key metric to help understand your inventory performance is the Inventory Turnover Ratio. It’s aka “Inventory Turns” or “Stockturns”. This ratio helps you measure how quickly you are selling stock and either buying new inventory or liquidating existing stocks. But how is the inventory turnover ratio computed?
Well, in this blog post, we’ll explain what it means, discuss the formula to calculate it, and provide some helpful tips on how to improve your own inventory turnover ratio! Read on for more insight!
What Is Inventory?
Inventory represents the raw materials, processing goods, and finished goods that are a portion of a business’s assets. These items are ready or will be ready for sale.
When it comes to inventory, it is important to keep accurate records of the quantity and quality of goods in stock. This is done through inventory control systems which track items in and out of an organization’s warehouse or retail store.
Accurate inventory records help companies avoid lost sales due to stockouts. It also maximizes profits by taking advantage of bulk purchases and minimizes storage costs by keeping a handle on excessive inventory.
Inventory is an important part of supply chain management, as it helps ensure companies are able to meet customer demand. It also plays a role in providing good customer service, as customers expect goods to be available when they need them. By keeping accurate records of inventory levels, companies can plan and adjust their production schedules accordingly.
How Is the Inventory Turnover Ratio Computed?
The inventory turnover ratio is a measure of how efficiently inventory is being managed by a company. It is calculated by dividing the cost of goods sold (COGS) by the average inventory over a certain period of time. The result is expressed as a number of times, showing how many times a company’s inventory has been sold and replaced during the specified period.
The higher the number, the better, as it indicates that the company is efficiently and effectively managing its inventory. The inventory turnover ratio can provide valuable information for businesses looking to optimize their supply chain operations. It is also a crucial metric for investors and lenders, as it shows how well a business is managing its inventory and whether it is performing at industry standards.
Inventory turnover ratio is just one of many key performance indicators (KPIs) that can be used to assess the efficiency of a company’s inventory management. Other important KPIs include days sales outstanding (DSO), inventory accuracy, and order fulfillment rate.
By tracking these metrics, companies can make informed decisions when it comes to inventory management. It also ensures that they are operating at peak efficiency.
Do you want to learn how to document your turnover ratio? If so, check out this inventory Excel spreadsheet example.
What’s Considered Good Inventory Turnover Ratio?
Good inventory turnover ratio varies by industry, but generally speaking, a ratio of 5-10 is considered healthy. Companies in the retail sector have higher ratios, while companies in the manufacturing industry have lower ratios.
Companies that have low inventory turnover ratios may be carrying too much stock, which can lead to increased storage costs. On the other hand, companies with high inventory turnover ratios may be running out of stock and missing out on sales opportunities. It is important to strike the right balance between inventory levels and sales.
Businesses should also monitor their inventory turnover ratio over time, as it can be an indicator of changes in the market or shifts in customer demand. By tracking this key metric, companies can ensure they are keeping their inventory levels at an optimal level.
What Your Inventory Turnover Ratio Should Tell You
When you calculate your inventory turnover ratio, there are a few improvements that your numbers will let you know. about Here are the key indicators:
Only Order What’s Needed
If your ratio is low, then you may be ordering too much inventory. To improve your ratio, you need to be smart about what and when you order. Consider optimizing your ordering process by automating it and using an inventory management system.
Improve Forecasting Accuracy
If you’re running out of products, then your ratio will suffer. To prevent this, you need to have a better handle on what customers want and when they want it. Consider investing in forecasting tools and predictive analytics to improve your forecasting accuracy.
Maintain Accurate Records
If your ratio is higher than expected, then you may be losing track of inventory and not accounting for it accurately. To prevent this, ensure that you’re keeping accurate records of your stock levels with an inventory management system.
Move Products Around
Take a look at the products that you can sell as “impulse buys” and put them in places where customers are likely to see them. This can help boost your sales and improve your inventory turnover rate.
Understand When to Discount Items
Sometimes you have to discount items to move them out of your inventory. Consider running promotions and discounts to increase the likelihood of customers buying more products from you.
In doing so, you can increase your sales and improve the performance of your inventory.
Invest in Advertising and Marketing
One of the best things you can do to boost sales is to invest in advertising and marketing. Consider running campaigns on social media, email, or other channels to increase awareness of your products and drive sales.
When you understand your inventory turnover ratio and take the necessary steps to improve it, you can optimize your inventory management process and help your business succeed.
Is a High Turnover Ratio A Good or Bad Thing?
The answer to this depends on the industry that a company is in and its goals. A high inventory turnover ratio can be good if it is an indication of strong sales and customers wanting to buy the company’s products.
On the other hand, a high turnover ratio can also be bad if it indicates that the company is ordering too much stock and having difficulty selling it. Companies should consider their industry and goals when determining what an ideal inventory turnover ratio should be.
Ultimately, the key is to find a balance between having enough stock to meet customer demand and not carrying too much inventory. It is important for businesses to keep track of their inventory turnover ratio and make sure it is at a healthy level.
Ways to Prevent a Bad Inventory Turnover Ratio
To ensure that your inventory turnover ratio is healthy, there are a few steps you can take. Check them out below:
1. Track Your Stock Levels Closely
Businesses should be regularly monitoring their stock levels to avoid over-ordering or running out of products. Use an inventory management system to track your stock levels in real-time and get notified when items need to be reordered. This will help ensure that your inventory is at the right levels at all times.
2. Analyze Your Sales Data
Analyzing sales data can be a great way to identify slow-moving products and optimize ordering based on customer demand. By understanding what customers want, you can order accordingly and reduce wastage due to excess stock.
3. Automate Your Reordering Process
Manually ordering and tracking inventory can be time-consuming and lead to errors. Consider automating your reordering process to streamline the process and prevent over-ordering or under-ordering of products.
4. Review Your Suppliers
It’s important to regularly review your suppliers and determine if they are providing quality products at competitive prices. Look for suppliers that can provide better value and help reduce costs associated with carrying inventory.
5. Invest in Forecasting Tools
Accurately forecasting customer demand is essential for a healthy inventory turnover ratio. Do your research to understand who your customers are and create forecasts to optimize stocking and ordering levels. Invest in forecasting tools to help you make better decisions about your inventory management.
A Helpful Inventory Turnover Ratio Guide
Hopefully this article of inventory tips answers the question, “How is the inventory turnover ratio computed?” As you can see, calculating your inventory turnover is essential. Without it, you could lose out on a lot of money.
Not only will you lose out on revenue from mishandling your products, but you will also miss an opportunity to target certain products to a particular customer demographic. But thankfully, there are ways to avoid that.
If this inventory guide was helpful, be sure to browse more of the content on our website. Happy reading!
