Table of Contents
More Inventory Content
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Table of Contents
More Inventory Content
Get the PDF version via Email
Inventory turnover is also known as stock turnover, inventory turn, or simply ‘stock turn.’ Regardless of the name, the idea is the same – inventory turnover is a crucial metric for omnichannel sellers regarding inventory administration.
What is Inventory Turnover?
Inventory turnover is your estimated annual inventory. It measures how often your company’s inventory has been depleted over a specific period. This number is significant since it allows firms to plan their strategic options.
What is the Importance of Understanding the Inventory Turnover Ratio?
Now that we have a basic understanding of inventory turnover, let us take a look at the importance of understanding inventory turnover with the points listed below:
- Inventory often holds a large amount of cash for businesses. If the things in stock do not sell, the company will be left with very little money to pay its workers, creditors, bills, distributors, borrowers, and other creditors. As a result, instead of stockpiling blindly, you may use the Inventory Turnover Ratio to precisely determine the quantity of stock to replenish.
- Furthermore, if your stocks grow less in demand over time or are even obsolete, they may finally collapse. You will lose a chunk of the equity stock due to this. As a result, keeping track of the inventory turnover is critical since it allows you to maintain the way of product movement over time.
- Another reason why the Inventory Turnover Ratio is essential for any business’s success is that when you have large quantities of inventory and little demand, it takes up a lot of valuable space in a distribution center.
- Because the Inventory Turnover Ratio reveals whether commodities are in high or low demand, it helps you plan for replenishing and avoiding excess inventory.
- Inventory Turnover Ratio also reveals ineffective inventory management and the necessity for opportunities to improve inventories and your economy in general. It assists you in determining how quickly your company sells its merchandise and compares your company’s efficiency to industry norms.
The Inventory Turnover Ratio is also used to assess your company’s financial position. For instance, if your company has a significant inventory turnover, it shows that you have sold significant amounts of products and earned payments from customers more frequently.
Inventory Turnover and Dead Stock
Inventory turnover is crucial for maximizing efficiency when selling consumables and other time-sensitive commodities. Dairy, poultry, produce, automobiles, and publications are examples.
Unsold stock and lost income may result from excess winter clothing, particularly as seasons change and stores refill with a fresh, seasonal inventory. Obsolete inventory, often known as deadstock, is unsold inventory.
Inventory Turnover and Open-to-Buy Systems
Open-to-buy (OTB) is a stock control approach that assists businesses in determining how many goods they need. OTB systems comprise on-hand and in-hand physical inventory and any pending sales.
An OTB can be computed in either units or dollars. However, it’s commonly done in dollar bills because costs vary between items. OTB strategies are also quite adaptable; you can use one for a single product or service, a division, or your complete retail operation.
OTB systems should include store inventory, distribution hub stock, and anything else in the inventory counts. However, there are exceptions: items that have been sold but not yet dispatched are not recorded as Start of Month Stock.
Even though the open-to-buy method can be based on units, it’s most commonly done in dollars as retail value or cost. OTB can be calculated on a monthly or weekly basis. Promotional periods and other sales times are also beneficial.
As for the open to buy process, it is divided into three steps which are as follows:
Keep track of your inventory turnover
OTB is affected by turnover rates. For your OTB strategy to work, you’ll need a comprehensive understanding of your current stock inventories and an accurate demand forecast.
Adjusting and Tracking
Dozens of variables influencing demand and inventory must be accounted for in your OTB procedure as they occur. It must be flexible enough to make quick adjustments when necessary.
Organize your finances
Using the OTB formula, make your budget. The most precise budgets are generated by using a detailed OTB planning strategy — by store, by week, and at the lowest item sub-category or SKU.
What is an Example of How to Use Inventory Turnover?
Inventory turnover equals the cost of goods sold divided by the average inventory value.
Suppose your inventory turnover ratio would be four if your COGS (Cost of goods sold) was $640,000 in items last year and your average inventory value was 160,000.
Understanding inventory turnover may give you a lot of information on how your e-commerce firm handles expenses, how marketing efforts are doing, and how you can improve incoming and outgoing logistic processes.
Once you’ve figured out how to compute the inventory turnover ratio, the next phase is to assess what a high turnover against a low turnover rate implies and the ideal inventory ratio, so you can devise a strategy for improving the higher turnover.
What is the Difference Between Inventory Turnover and Days Sales of Inventory?
Inventory turnover indicates how rapidly a business may sell a company’s inventory (turned over). Days of stock (DSI) is a system that measures how fast a company can convert its list into sales.
The opposite of inventory turnover is computed as (stock / COGS) * 365 for a particular period. DSI is the number of days it requires to convert inventory into cash, whereas inventory turnover is the total number of times goods or services are sold or used in a year.
How Do You Calculate Inventory Turnover?
To get the inventory turnover ratio, divide the cost of goods sold by the average inventory for one period.
The inventory turnover formula is Cost of Goods Sold / ((Beginning Inventory + Ending Inventory) / 2) = Inventory Turnover.
The turnover ratio can also be calculated by dividing total revenues by stock. This comparison, however, can provide deceptively exaggerated findings because sales are typically reported at market price while inventory is documented at cost.
Because COGS indicates the total cost of the products for sale and eliminates retail pricing, most organizations use it as the numerator rather than net revenue.
What is a Good Inventory Turnover Ratio?
Most businesses’ optimal inventory turnover ratio is between 5 and 10, which means that stock should be sold and restocked every two months. The appropriate percentage for perishable products companies, such as florists and supermarkets, will be higher to avoid inventory losses due to spoiling.
What is a Bad Inventory Turnover Ratio?
Any inventory turnover ratio below two could suggest sluggish sales and diminishing product performance. A bad inventory turnover ratio could lead to a surplus of merchandise in warehouses and waste resources and space.
An inventory turnover ratio of more than six, on the other hand, indicates that demand outweighs supply. Your stock buy levels may be too low, resulting in missed market opportunities or poor customer interactions due to delivery delays.
Things to Keep in Mind When Navigating Inventory Turnovers
When you start using inventory turnover rates in your retail inventory system, you must bear a few factors. Let us take a look at these factors:
- Inventory turnover and open-to-buy systems – Evaluate if your company’s inventory management procedures include an “open-to-buy” approach. Computerized budgeting methods for purchasing merchandise are known as open-to-buy systems. These technologies aid merchants in monitoring goods, stock control, and finance, making inventory control and restocking more effective.
- Inventory turnover and deadstock – Any retailer’s fear is deadstock—or outmoded merchandise. Money is wasted when there is an overflow of reduced (or no-demand) commodities. Whether consumable, seasonal or highly susceptible to the latest scenarios, excess stock can quickly become a cash flow drain if not correctly managed. Calculating your inventory turnover ratio is critical to preventing a situation like this. Your company should be able to stay in the black with a well-balanced demand and supply chain.
What are the Challenges Faced When Using Inventory Turnover?
Businesses that sell items seek to maintain a healthy inventory turnover rate. Turnover refers to how fast goods move through a company from acquisition to the point businesses that sell items strive to maintain a healthy inventory turnover rate. Some of these challenges are:
Inventory turnover that is too fast might negatively impact sales. Retailers may sell the merchandise rapidly but may not provide a diverse assortment to suit client expectations. To avoid a bottleneck of stock and keep products flowing through the operation, merchants may limit the number of products. Consumers who can’t find what they’re searching for or aren’t satisfied with the overall mix will go elsewhere.
Small-quantity buyers incur higher expenditures to maintain a high inventory turnover rate. Sellers might not qualify them for lower pricing or other special offers accessible to bulk buyers. Manufacturers and retailers frequently charge huge shipping charges for modest purchases, so transportation costs may also be higher. To avoid out-of-stock problems, retailers may have to use costly express shipping options in some scenarios. Merchants may be required to make purchases more often, which will result in higher processing costs.
Costs Of Carrying
In businesses with poor inventory turnover, enterprises risk being trapped with unsaleable products due to depreciation. The company may be forced to sell the goods at drastically discounted rates, lowering its earnings. Holding unsold merchandise could be a severe issue in sectors where customer tastes are continually changing or rapidly evolving technologies. Maintaining outmoded goods may result in a lack of storage capacity for currently in-demand items, resulting in lost revenue.
Overstocking (over inventory) is the adversary of profitability and productivity. The inventory turnover ratio will suffer if you acquire too many things in bulk. With so much money invested in extensive inventories, recovering that money could take time. In general, sellers should avoid the desire to buy in bulk, even if there are economies of scale or discounted rates. The manufacturer’s projected savings may be useless if those products don’t sell.
Costs Of Carrying
When inventory turnover is low, it can increase financing costs. Inventory must be maintained, handled, and protected, which incurs expenses for the company. Shrinkage occurs when stock is housed due to events such as theft or damage—supporting a significant amount of slow-moving things results in missed chances due to a lack of storage room for faster-moving items.
What Is an Inventory Tracking System?
The average inventory value is the average worth of a company’s inventory over a given period. It’s computed by summing two possible values and dividing by two, just like any other average. In this scenario, the starting stock is added to the ending inventory of a time frame. To get the average stock on hand, divide the total by two.
Both stock control and e-commerce finance benefit from average inventory. It’s frequently used in marketing to compute inventory turnover ratios and inventory days. Over a certain length of time, this is the number of times a sale is made and restocked. When analyzing total inventory control efficiency, inventory turnover is a critical indicator. To compute it, you’ll need an average inventory on hand.
However, the average value of average inventory might refer to either cost of merchandise or stock levels. Keep the FIFO (First In, First Out) approach in mind when determining inventory levels.
What is the Importance of Inventory Turnover for a Business?
The concept of an inventory turnover provides a number that symbolizes a measure of units sold compared to teams on hand or how well a company is managing inventory and generating sales from that inventory. It’s an essential component of effective supply chain management.
Inventory turns are incredibly crucial for retailers and businesses that sell tangible goods. Reduced inventory stocks might result in lower overhead expenses and more profits for your company.
What are Some Inventory Turnover Optimization Techniques?
One of the most practical ways to use inventory turnover ratios is to improve inventory management.
Here are some ideas for doing so:
Inventory automation is critical for good inventory management, primarily if you sell online and offline. AI can effectively handle every aspect of your inventory, allowing your company to run like a well-oiled engine. Many systems notify you immediately when a deal is made, and stock levels are updated in real-time. Automated replenishment messages are also issued to your dealers in sound inventory systems.
Using Marketing That Works
Optimizing your inventory turnover requires an effective marketing plan. You can concentrate on products in the market that sell less and reach difficult-to-reach clients. Seeking out emerging businesses and utilizing all available marketing channels will assist you in achieving your aim of growing sales and, as a result, improving your inventory turnover rate. Social networking, SEO, sponsored content, digital marketing, and email campaigns are powerful tools for attracting new customers and keeping existing ones interested.
Increasing The Shipping Speed
Fast and dependable delivery can help an online company increase sales. As a result, efficient inventory movement requires quick and safe shipment. If a consumer shops electronically and waits weeks for a broken item, they are likely never to purchase again or write negative feedback, which could hurt potential sales by discouraging potential purchasers.
Restocking With Efficiency
Keeping a good inventory of your most popular products on hand is a smart strategy to keep your selling process running smoothly. However, efficient replenishment is essential. If an item sells quickly, don’t overstock yourself by purchasing large numbers of it.
Efficient restocking is done to order a new product before the current one sells out, keeping your business on track and reducing overstocking and surplus inventory. It is preferable to store modest amounts of it more often. Furthermore, you may be able to negotiate better pricing with suppliers, which will benefit your turnover.
Regularly Negotiating Purchase Rates
Strategically Ordering Products Can Help You Increase Your Profitability, So Be Careful To Bargain For Reasonable Prices. If You Frequently Purchase, Even In Modest Amounts, You May Likely Get Steep Discounts From Your Providers. Patrons Obtain Better Deals And Lower Prices From Distributors And Retailers.
Encouraging Customers To Place Pre-Orders
You can have immediate and guaranteed sales of your merchandise if you convince your clients to preorder and subscribe for specific items. Preordering will enhance your turnover, but ensure your inventories can handle your requests.
Using A Pricing Strategy That Works
Might Be Challenging, Mainly If You Sell Many Things Internationally. A Single-Price Approach Will Not Always Work For All Of Your Items. Consider Promoting Numerous Pricing Policies Based On Various Circumstances, Such As Seasonality, Free Delivery, Bulk Discounts, Etc.
Encouraging The Sale Of Old Inventory
Your inventory may be burdened with old stock no longer in demand. It is advised to avoid such circumstances at all costs, but if you find yourself in one, provide special deals and coupons to assist sell out the old goods as rapidly as possible. It’s also worth considering conducting a particular advertising campaign to move obsolete inventory.
Stocking Up On In-Demand Items
Stock In Great Demand Is Critical For Inventory Turnover. A Good Forecast Can Help Determine Which Items Will Sell Quickly And Which Items Should Start Stocking Up. Similarly, Order Small Quantities Of Slow-Moving Products.
Improving Inventory Turnover with Inventory Management Software
Many capabilities in inventory management software can help you update and optimize your inventory control and rules. For instance, such software allows your business to migrate to the continuous inventory way of accounting, which keeps track of inventories in real-time. By monitoring sales and business loss or replenishing, automated point-of-sale devices and corporate wealth management technology may rapidly detect differences in merchandise.
Moving average inventory can be used by businesses using the continuous inventory technique rather than a periodic inventory system to evaluate mean stock levels over several periods. Moving average inventory adapts prices to the present market norm, making period comparisons more realistic.
When used in conjunction with an ERP system (Enterprise resource planning), inventory management software can assist in optimizing your distribution network, SKU (Stock keeping unit) allocation and maintenance, computerized sales order, and other tasks and capabilities. Automated software will lower errors, boost efficiency, give you greater oversight, increase client happiness, and make your business more profitable.
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Divide the cost of products by the average inventory for the same period to get the inventory turnover ratio.
An ideal inventory turnover ratio is anything between 5 and 10.
A higher inventory turnover is better as a higher ratio points out your business is doing exceptional business, whereas a lower percentage points out the weak sales figures.
No, an inventory turnover ratio of 1 shows poor performance in the market. A low turnover ratio brings bad news for a business as it is doing poorly.
The higher the sales turnover, the better because it indicates that a business sells things rapidly and has significant demand for its products.