What is the inventory turnover ratio? In summary, an inventory turnover ratio is a figure that calculates how quickly you’ll sell through your inventory during a specific timeframe. This calculation is essential for all businesses because it measures how efficiently a company is using its assets.
In other words, it shows how often a company sells or uses its products or inventory.
So what is a good inventory turnover ratio and how do you calculate inventory turnover ratio?
Keep reading to learn more!
What is an inventory turnover ratio?
Inventory turnover ratio is a figure that calculates how quickly you’ll sell through your inventory during a specific timeframe.
If you have a high inventory turnover rate, that indicates that you are selling your products quickly and efficiently. If it’s low, that means you’re overstocked or that sales are down.
You might hear other terms used for inventory turnover ratio, including stock turnover, stock turn, and inventory turns.
How an inventory turnover ratio is calculated
There is a simple formula you can use to calculate inventory ratio. It includes timeframe (such as a year), average inventory (the dollar value of the beginning inventory plus the ending inventory, divided by two), and the cost of goods sold (which is the final number on your annual income statement).
Why knowing your inventory turnover ratio is important
There are a few reasons why you should prioritize your inventory turnover ratio. Let’s take a closer look at two reasons.
Having an idea of your inventory turnover ratio can increase your profitability. You’re increasing your product turn-around by reducing your storage costs, which increases your net income and boosts your overall profitability. Plus, when inventory turns quickly, that increases your responsiveness to customer demands.
Measure business performance and efficiency
An accurate inventory turnover measurement can help you measure how efficient and high-performing your business is. The higher the inventory turnover, the better performance. You’re not buying too much and you’re getting rid of the inventory you do buy.
Formula to calculate inventory turnover
Want to know how to calculate inventory turnover ratio? As mentioned earlier, you’ll need to know the period of time, usually a year, the average inventory, and the cost of goods sold.
Once you have those variables, you can use the formula to calculate your inventory turnover rate.
The formula is:
Cost of goods sold/average inventory = inventory turnover rate
Inventory turnover ratio example
Say you own a sporting goods store and you’re trying to figure out the turnover rate for one of your best selling products. If your cost of goods is $10,000 and your starting inventory is $3,000 with an ending inventory is $1,000, your average inventory is $1,000 (since it’s $3,000-$1,000 divided by two).
When you plug those numbers into the formula, you get a turnover rate of 10. You turned your inventory for that product ten times throughout the year. With that number in hand, you can average out how many days it will take you to sell through your inventory once. To do this, take 365 days (the number in a year) and divide it by 10, or your inventory turnover rate.
That should result in 36.5 days, meaning it takes an average of 36.5 days to sell through your inventory. This number will give you an idea of how much stock you need in the future.
What causes inventory turnover ratios to vary significantly?
There are some limitations of inventory turnover ratios. For instance, it won’t give you the best insights as to how your business is performing if you’re not accounting for things like discounts, special campaigns, and markup.
There are other factors that cause variation in inventory turnover ratios, too. For example, turnover rates tend to increase during the introduction and growth phase of a product, then peak as a product matures. As the market becomes more saturated, there are improvements to existing technologies, or customer preferences change over time, these can all cause inventory turnover to fluctuate or vary.
What is considered a good inventory turnover ratio?
While what’s considered a good inventory turnover ratio will differ between industries, since the ideal ratio depends on what you sell and your specific industry, the higher your turnover rate is, the better. Shoot for an ideal turnover ratio between 5 and 10.
A high inventory turnover rate indicates that sales are strong but it can also indicate that your inventory is too low. It’s a tricky balance to follow. If your inventory turnover rate is too low, though, it is either because you’re overstocked or sales are weak (both of which are things you should be trying to avoid).
Tips to improve your inventory turnover ratio
Once you know your inventory turnover ratio, there are simple steps you can take to improve it for your business.
Review purchase prices on regular basis
If you’ve had the same prices for many years and you’re concerned about your inventory turnover ratio, one of the easiest things you can do is adjust your prices. Compare them with similar products and businesses in your industry. If other companies are asking for prices that are much higher or lower than yours, it’s time to revamp your pricing.
Increase inventory demand
One easy way to increase your inventory demand? Change up your marketing strategy. Make sure your campaign is targeted toward your ideal customers. It should be clear that you have a product to solve their problems – get people excited about what you’re selling so there’s a higher demand for the inventory you have!
Choose best selling products
Don’t keep products on the shelves that just aren’t selling. If the items you have in your store have a high turnover rate, that’s great – but if they don’t, get rid of them.
Another simple strategy for increasing your inventory turnover is to group similar items together. You can then compare how well they do on the shelves so that you can recognize trends and be able to project how much you need to order in the future.
How Kickfurther can help
Applying some of these inventory management basics should help you keep your stock under control, ensuring that you always have what your customers need on hand.
Kickfurther is the world’s first online inventory financing platform that enables companies to access funds that they are unable to acquire through traditional sources. In just an hour, you can get the fund you need to purchase inventory. Drilling down on just how much inventory you need to stock is an important step to take before connecting to our community of backers. Our backers will want to know a little bit about your company and see revenue between $150k to $15mm over the last 12 months. To get started, simply create a profile at Kickfurther to connect with backers. Kickfurther is up to 30% lower cost than other options and allows you the freedom to repay only when you start making sales. You’ll get to outline your expected sales periods for customized payment terms.