Inventory Turnover Explained: Definition, Formula & More

Retail businesses live and die by their sales funnel. Even industries that operate in high-value and low-ratio products still need a consistent turnover of stock to ensure smooth operation. If you haven’t got the products your customers want, they’ll simply go elsewhere, costing you a sale and, ultimately, revenue. 

The process of selling stock and replenishing it is called INVENTORY TURNOVER . It is a delicate balance of anticipation and forecasting to ensure you have a stock of in-demand products and maintain a healthy flow of products. 

The challenge lies in properly understanding why it is critical and how to interpret the information to run your product chain effectively. Let’s break it down. 

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Why optimizing inventory turnover is key to business success

Efficient inventory management stabilizes your business. By understanding your product flow and knowing what is a sales methodology, you can cater to customer needs more effectively and maintain a reliable REVENUE stream. There are several benefits to optimizing your turnover. Here are the most important advantages: 

It optimizes cash flow by quickly freeing up capital

If you’re confident in how your products sell, you can confidently free up capital for use elsewhere and still receive consistent revenue.

It REDUCES holding costs by minimizing storage expenses

The fewer products you need to store for lengthy periods, the less you’ll have to invest in large storage solutions. Effective turnover data helps keep the required inventory to a minimum.

It keeps your inventory fresh and CUSTOMERS SATISFIED

Nothing deters a potential purchase like an out-of-stock notification or outdated products. A faster turnover allows you to quickly replenish stock and keep your inventory fresh, especially when new items are launched.

It boosts competitive advantage by enhancing MARKET RESPONSIVENESS .

The added flexibility from knowing your inventory’s movement helps keep your brand agile and ready to adapt to changes in the market. 

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What is a good inventory turnover ratio?

While conventional wisdom suggests a turnover ratio between two and six will be an acceptable ratio for most businesses to work with, it isn’t really that simple. 

A turnover ratio that works for your business will depend entirely on the type of products you sell, as well as your inventory storage overheads. Cars simply don’t sell at the scale of video games, and the margins on each are vastly different. 

The best approach is to understand your turnover ratio and measure it against your wider company’s profitability. If you’re in the green, great. If you NEED MORE REVENUE , you need to boost your turnover. 

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Calculating and interpreting inventory turnover

The core of understanding inventory turnover lies in the calculation itself. While it is a simple formula, we still recommend automating these calculations wherever possible. 

Even with automation in place, it’s important to understand exactly what is happening to give you the inventory turnover ratio figures, as both the input data and output data tell different stories. These figures should feed into your financial reporting activities to ensure an accurate picture.

Cost of Goods Sold (COGS)

The COGS represents the business VALUE OF ALL INVENTORY SOLD in any given period. This number accounts for losses and operational spending. The formula is as follows:

COGS = total inventory revenue during a period + gross loss

Average Inventory (AI) 

Average inventory is the estimated value of inventory held during a period. This is calculated as follows:

Average inventory = (inventory value at start of period + inventory value and end of period) / 2

Formula

The formula for calculating your INVENTORY TURNOVER RATIO is as follows: 

Inventory turnover = Cost of Goods Sold in a period / Average inventory value for that period

This will give you your output figure for inventory turnover in any given period. 

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Factors influencing turnover rates in different sectors

Countless factors will affect inventory turnover rates. It’s not unlike a digital call center and its inbound call capacity – calls need to be handled and resolved to keep the QUEUE MOVING AND SUPPORT ALL CUSTOMERS. Here are some of the key factors to account for when analyzing your data:

Product type plays a crucial role in turnover rates. PERISHABLE OR CONSUMABLE GOODS, which drive frequent repeat purchases, typically see the highest turnover. Conversely, high-value items designed for long-term use, like cars, televisions, or computers, experience much lower turnover volumes.

Most products fall somewhere in between, so it’s important to identify your industry and understand the typical turnover rates to inform your analysis.

Seasonal changes have a marked impact on BUYER PURCHASING BEHAVIOR. Ice cream is a summer purchase, while blankets are winter-driven. 

Not all products have a seasonal factor as pronounced as our above examples, but many are impacted in some form. Use historical data to see if there is a visible effect on your target product lines. 

Consider how EASY AND DIRECT REPLACING STOCK is for your chosen product within your supply chain. If it is brought from abroad or needs to be manufactured on demand, for example, then you will need to order replacements earlier and HOLD STOCK FOR LONGER.

The size of your sector and the demand for the product will have a significant effect on how many units you can turnover in a given period. Some items will have a small niche they serve, while others will be demanded by the LARGE MAJORITY OF POTENTIAL CUSTOMERS. 

All products will expire at some point. Your product’s intended lifecycle should be factored into your turnover. A product designed to LAST SIX MONTHS will have a higher turnover than one intended to last six years. 

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Common causes of low inventory turnover

With the factors that can affect turnover established, let’s outline the acute causes of poor inventory turnover:

Simply carrying too much of a product will reduce your turnover ratio. Even if your product is selling well, if you aren’t replenishing it DUE TO LARGE VOLUMES OF STOCK your turnover ratio will be low.

A lack of sales is the most damaging reason for poor turnover figures. If it doesn’t sell, you don’t restock. 

Inefficient inventory management

Not having your inventory properly restocked as you sell will result in a lack of stock and likely a LACK OF SALES, even if pre-orders are offered. Customers are likely to go elsewhere and receive it immediately instead. This affects SME growth greatly, as they cannot hold as much stock as larger companies.

Products that have been rendered obsolete from new launches or refreshes will stagnate in your warehouse. This will REQUIRE HEFTY DISCOUNTS TO SHIFT, which can cause a loss of profits.

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Strategies to improve inventory turnover

Here are several strategies you can use to ensure consistent turnover and avoid the pitfalls we’ve explored:

Optimize inventory levels by forecasting demand accurately

With HISTORICAL SALES AND TURNOVER DATA, you can effectively forecast upcoming demand. Keep seasonality and other factors in mind when calculating this and then adjust your inventory levels to meet the expected demand. 

Prioritize high-demand items and reduce slow-moving stock

If something sells, then sell more of it. It’s a basic premise but it sure does work. SLOW-MOVING STOCK will clog up your warehouse and cost you money, all while being difficult to shift. Identify the high and low performers and adjust accordingly. 

Increase marketing for high-turnover items and run promotions

Support product lines that are providing a good turnover ratio with pushes from your marketing department. Be ready to up your replenishment rate to suit any GROWTH IN DEMAND resulting from your marketing activity. 

Negotiate better terms with suppliers and diversify sources

Minimize risks in your inventory replenishment strategy by not relying on a single supplier, especially if they STRUGGLE WITH FLUCTUATING DEMANDS. Instead, diversify your suppliers to ensure consistent supply. If a supplier consistently meets your needs, consider negotiating improved terms that could include some level of exclusivity as a reward for their reliability and performance.

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Conduct regular inventory audits and adjust policies

Always be aware of your stock levels. Any changes that aren’t tracked will lead to issues long term and will AFFECT FUTURE PROJECTIONS. Be sure to take a regular inventory and SOC 2 audit, adjusting your inventory policies as necessary.

Invest in advanced inventory management systems and barcoding

There are numerous POWERFUL AUTOMATED SOLUTIONS to monitor and manage stock levels using AI. Explore the options available and find the one that fits your needs best. This will save time and money while reducing potential errors. 

Conclusion

Inventory management is crucial for any retail business. When it functions properly, it supports consistent sales and expected revenue. However, if mismanaged, it can lead to significant problems for the business.

The impact of poor inventory management is significant; you have to stay vigilant. Automation and careful monitoring will ensure your products move in and out of your warehouse consistently and effectively, leading to the desired turnover metrics. 

With eShipper’s advanced fulfillment and inventory management solutions, businesses can streamline these processes, ensuring seamless product flow and optimal efficiency during peak seasons.