What is inventory turnover ratio, what is its appropriate rate, how to calculate it and how to maximize it? Find out the answers here!
The inventory turnover ratio is a business indicator that indicates how well your product business is doing.
It takes into account not just how much inventory your company sells, but also how efficient your supply chain is, how much cash you have on hand, how profitable you are, and how effective your inventory control and management efforts are.
Calculating your inventory turnover ratio is similar to taking a patient’s temperature in the doctor’s office. A high temperature, like an unhealthy ratio, is a solid symptom of a problem.
However, recognizing that a problem exists is only half the battle. You don’t just need to know how to calculate inventory turnover rate to put it to good use; you also need to know how to enhance it.
Inventory Turnover Ratio Definition
Inventory turnover ratio calculates the rate at which an item is sold and replenished over time. The cost of products sold is divided by the average inventory for the same time period to compute inventory turnover.
The inventory turnover ratio, in basic terms, represents how quickly a company sells an item and is used to analyze sales and inventory efficiency.
Inventory turnover, also known as inventory turns, stock turnover, or stock turn, is a term used to describe the movement of inventory.
What Is an Appropriate Inventory Turnover Rate?
A healthy inventory turnover ratio does not have a single magic figure. The definition of a “good” inventory turnover ratio varies by industry and business; high inventory turnover might be beneficial in some circumstances but destructive in others.
As a result, you should compare your inventory turnover to that of other companies in your industry and optimize your inventory from there.
For example, an annual inventory turnover ratio of 4 to 6 is considered healthy for online businesses/retailers.
Jewelleries, on the other hand, who offer little things with significant profit margins, have a low inventory turnover rate of 1 to 2.
This is why benchmarking your ratio is critical. Don’t subject yourself to an inappropriate standard because inventory turnover ratios vary by industry. Keep track of your own past data.
Calculate your turnover ratio on a regular basis and compare it to previous results to see how far you’ve come. Improve your graph.
How Can You Calculate The Inventory Turnover Ratio?
You can calculate inventory turnover ratio using two factors. COGS and average inventory are the two terms used here.
We’ll presume you have your COGS already. Here’s how to figure out COGS if you don’t.
Inventory averaging
The value ($) or number (units) of various categories of inventory at any given time throughout a given time period is calculated using average inventory.
Here’s how to figure out how much inventory you have on hand at any one time:
(Beginning Inventory + Ending Inventory) / 2
Formula for Inventory Turnover
The inventory turnover ratio formula is straightforward if you have your COGS and average inventory:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
Why is Lower Inventory Turnover Ratio Are Bad?
A lower inventory turnover ratio can indicate inefficiency in managing inventory, which can have several negative implications for a business
This include higher holding costs, risk of obsolescence, decreased profit margins, and less responsive to market changes.
Also, lower ITR reflect to inefficient operations in supply chain management, purchasing, production, or sales processes. Find theses solution can lead to cost savings and improved profitability.
Overall, a low inventory turnover ratio can signal poor financial health and operational inefficiencies, which can ultimately harm a company’s competitiveness and long-term viability.
How to Improve Your Inventory Turnover Ratio?
It’s time to arm yourself with techniques to enhance your inventory turnover ratio now that you know what it is and how to measure it.
Here are some few things you can do to improve your ratio.
1. Increase sales by improving the customer experience
In today’s market, customer experience is the most important brand differentiation (over both price and product).
According to study, brands that provide an excellent customer experience generate 5.7 times more income than competitors who provide a poor customer experience.
Refining your customer experience is a fantastic place to start if you want to boost annual sales (and sell more inventory).
2. Increase inventory turnover by using just-in-time inventory management
Just in time (JIT) is a form of inventory management in which items are ordered, stored, assembled, and/or created at the last feasible moment to fulfill orders.
The JIT approach aims to get orders to customers as rapidly as possible while reducing product holding costs.
You don’t employ safety stock when you use the JIT approach, which minimizes the overall inventory in your warehouse at any one time and hence leads in higher stock turnover.
3. Consider the seasons when making your plans
During particular holidays, many businesses see a spike in demand. For example, flower businesses may notice a 5x spike in order volume in the weeks running up to Valentine’s Day.
To maintain a healthy turnover ratio throughout the year, inventory levels can and should fluctuate in accordance with demand.
Capacity planning can help you figure out when you’ll need more inventory (and more people to make or assemble things) and when you can cut back on your supply (and workforce).
4. Use A Good Inventory Management System
Maintain business performance by keeping track of inventory availability using inventory system that provides product reports and storage in a quick, easy, and real-time manner.
Mekari Jurnal is one of them which allows you to keep the stocks up to date and track warehouse activities with its warehouse software.
Try the 7-days free trial now!
Reference:
Investopedia, “Inventory Turnover Ratio: What It Is, How It Works, and Formula”.
Accounting Course, “What is the Inventory Turnover Ratio?”.
