Inventory that doesn’t sell not only takes up space in your warehouse but also blocks your cash flow. This can prevent your business from growing efficiently and limit investment in other areas. At the same time, running out of popular items means missed sales and possible loss of customers.
This is where a key performance indicator, the inventory turnover ratio, helps. It shows how often products sell and are restocked. With this insight, you understand customer demand, avoid overstocking, and free up cash for the right products.
In this blog, we’ll explain what the inventory turnover ratio is, how to calculate it, and why it matters.
Inventory Turnover Rate Definition
The inventory turnover rate shows how often the stock of the business is sold and replaced during a set period.
A high rate shows that your inventory is sold quickly, which frees up cash to be allocated elsewhere. Whereas a lower rate indicates poor inventory health. This means you might have obsolete products and tied-up cash in inventory.
How To Calculate Inventory Turnover Ratio
To calculate the inventory turnover ratio, use this simple formula:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) ÷ Average Inventory
The key elements in this formula are:
- Cost of Goods Sold: The total cost of the inventory sold over a period.
- Average Inventory: Average of the opening and the closing inventory. You can calculate this by adding them both and then dividing the total figure by 2.
Businesses can calculate the inventory turnover ratio using this formula easily. It can be done weekly, monthly, or yearly, depending on the goals.
What does the Inventory Turnover Ratio Tell You?
The inventory turnover ratio tells you how efficiently you are able to manage the inventory for your business. For example, a grocery store may have a higher turnover rate than a furniture store due to faster product movement.
Here are a few benchmark ratios for common industries:
- FMCG: This industry has quicker restock levels due the the nature of products, so 8-12 times is a good ratio for businesses.
- Food and beverage: This industry deals with spoilage and waste issues, so the ideal rate would be between 15 and 30 times annually.
- Manufacturing:This industry has inventory with long product cycles, which is why the ideal replenishment rate is 3 to 6 times per year.
Now that you know what the inventory turnover ratio tells you, let’s explore what qualifies as a healthy rate and when it becomes a concern.
What is a Good Inventory Turnover Ratio
A good ratio doesn’t always have to be high. It should align with the type of product, the capacity of your supply chain. If the ratio is too high, it might indicate you’re not keeping enough stock to meet demand. This can lead to frequent shortages and loss of sales volume for a business.
These signs indicate a healthy inventory turnover ratio:
- Your business maintains a fresh stock with reduced chances of obsolete products.
- People buy your product at the set prices.
- You have a strong relationship with your suppliers.
What is a Poor Inventory Turnover Ratio
Poor turnover doesn’t always represent a low sales volume. It might also reflect a poor pricing strategy or weak marketing efforts. You need to monitor this ratio carefully. A long-term low turnover can lead to the exit of products from the market and reduced profitability.
The following signs indicate a poor inventory turnover ratio:
- Increased warehousing costs for the business due to unsold inventory.
- Frequent discount offerings to sell off inventory with close expiration dates.
- Poor coordination between the purchasing and sales teams.
Ways to Improve Your Inventory Turnover Ratio
If your business is struggling with a poor inventory turnover ratio, here are a few ways to improve:
- Forecast demand using past sales data to avoid overstocking or shortages.
- Use POS or inventory software to track stock levels and sales in real time.
- Reduce low-performing products to make space for items with quicker movements.
- Order smaller quantities more often to save storage space and reduce excess stock.
- Set accurate reorder points to restock only when needed.
- Train staff to follow correct inventory practices and reduce handling errors.
- Do regular cycle counts to catch mistakes and keep inventory records reliable.
Conclusion
Inventory turnover ratio isn’t just a number; it’s a strong indicator of your sales performance. If monitored well, it could significantly improve your cash flows.
Looking to track your inventory turnover with ease?
Choose a POS system from CISePOS that complements your business and starts giving you the insights that matter.
