Inventory turnover has a direct correlation to the health of a business or organization. In eCommerce, it is generally a driving force within the company, telling them how efficiently they’re running while calling out areas in need of improvement. Inventory turnover ratio is a number that represents how many times a business has sold through, then replenished their inventory. A number that is too high or too low can help companies to adjust how they are both buying and selling their products, which can improve efficiency overall.
How to Calculate Inventory Turnover Ratio
Calculating inventory turnover ratio is simple, once you’ve got the data. Inventory turnover ratio is generally tracked per quarter for best results, so the data needed would be the total number of sales for the quarter, and the average inventory. Those would then be divided by each other. The average inventory is determined by simply adding the inventory at the beginning of the quarter to the inventory at the end of the quarter, then divided by 2. The turnover ratio formula in the form of an equation is as follows:
Total Number of Sales / Average Amount of Inventory = Inventory Turnover Ratio
According to Investopedia, there is another method of determining inventory turnover, that some market analysts consider even more accurate. This method may be more valuable for high volume retailers, as it gives a more definite sense of how much the on-hand inventory costs them. To determine if this way, you need the COGS (cost of goods sold) and the average value of inventory. Since COGS include costs of materials, labor, overhead, and other direct expenses related to the inventory, it can give a much more accurate glimpse at efficiency when it comes to shipping and selling the inventory. Then, the average value of inventory is found by adding the value (purchase cost) of the inventory at the beginning of the period, to the inventory value at the end of the period, and divide by 2. This turnover ratio formula in the form of an equation is as follows:
Cost of Goods Sold / Average Value of Inventory = Inventory Turnover Ratio
What Can Inventory Turnover Ratios Tell Us?
Aside from telling us how many times inventory has turned over, there are a few other things that this number can help explain within an organization. Since inventory turnover mostly shows us the speed at which a company purchases and sells through its inventory, it can display how efficient or inefficient a company’s purchasing practices are. It can also tell us how well a business is managed, how well products are priced, and if a company is effective in their marketing efforts.
The inventory turnover ratio helps organizations evaluate their business practices and make continuous improvements to better their overall performance and inventory turnover. This number helps businesses in the following ways:
- Assists in pricing strategy and helps to price more competitively.
- Can be a good indicator of what marketing strategies are or are not working
- Closes gaps within the supply chain between businesses and their manufacturers
- Improves purchasing power and strategy — makes sure they get the best price on products.
- Calls out slow-moving inventory so it can be strategized to sell or better to write-off
- Can determine how they stand up against competitors in their industry and shows the state of the market
As you can see, a company would be remiss if it failed to regularly and accurately track and evaluate their inventory turnover each quarter.
What is a Good Inventory Turnover Ratio?
A “good’ inventory turnover ratio is not a one-size-fits-all number. It depends on the industry and business operations. We have previously analyzed how companies stand up against Amazon’s 2019 turnover ratio of 10.92, which is an excellent ratio to have in eCommerce. Anything between a 2 and 4 is baseline good. It means you’re going through your inventory at least twice throughout your specific period. Lower inventory turnover of say 0.5 is probably not a good sign. If you have only gone halfway through your inventory in the quarter, you may be looking at slow growth and perhaps a drop in sales.
But, this number can mean different things for different industries. For example, that 2-4 range is excellent for a mid-level eCommerce company. A higher net worth company may look more towards 4-6 as the sweet spot. Amazon is a high volume, low margin business, which is why 11 seems easily attainable to them. But, that was also their ratio for the entire year, which is still good to measure. Still, quarterly tracking inventory turnover may be more accurate in making swift changes to purchasing and marketing strategies for smaller companies.
A low inventory turnover ratio in eCommerce or manufacturing is not a good sign. If your inventory turnover is under 1, that means you likely are spending more time and energy on storage than selling and shipping. That business probably has more of its capital wrapped up in inventory and is just watching products sit on shelves as they go obsolete. Although a love inventory turnover is not a good sign, by regularly tracking these numbers gives companies a leg-up to fix the problem and ensure they don’t lose any more money. Check out ways to improve inventory ratio here. Some examples include:
- Automate Inventory Management Tracking
- Boost Demand With New Marketing Strategies
- Have a Warehouse Clearance Sale or Introduce Promotions
- Re-visit Forecasting Practices
- Adjust Purchasing Amounts and Frequency
- Bundle Slow-moving Products with Top Sellers
How Can Scout Help Improve My Inventory Turnover?
Utilizing tools within your organization and especially your warehouse solutions can ultimately bring your business from getting by, to thriving. Using tools like topShelf integrated within your inventory management processes can automate how you handle picking, packing, shipping, inventory counts — you name it. Automation can be the key to improving not only inventory turnover ratios but overall performance and efficiency. Contact us here for your FREE topShelf Demo today.