To generate cash and pay the bills, you need to sell what you buy.
Inventory turnover rate helps you understand how fast inventory moves through your warehouses. A high inventory turnover rate suggests optimal performance, while lower turnover means inefficiency.
Knowing your inventory turnover ratio can help you make smarter decisions on pricing, manufacturing, and inventory management. It will help you balance stocking the right amount of products with maintaining a healthy bottom line.
Want in on the action? Learn everything you need to know about inventory turnover ratio in this article.
What is inventory turnover?
Inventory turnover is a financial metric that measures your efficiency in managing and selling stock. High turnover signifies rapid sales, while low turnover may indicate weak performance or overstocking.
What is inventory turnover ratio?
Inventory turnover ratio (ITR), also known as stock turnover ratio, is the number of times inventory is sold and replaced during a given accounting period. It’s calculated by dividing the cost of goods sold (COGS) by average inventory. ITR shows the number of days it takes to sell inventory on hand.
Understanding inventory turnover ratio
Even though buildings and equipment have a higher dollar value, inventory is your most important asset. One way to measure the performance of your retail business is inventory turnover.
A company’s inventory turnover measures the number of times stock is sold and replaced throughout the year. Turnover of 12 means that the average inventory moves through the store once a month.
Also known as “stock turn” or “inventory turn,” inventory turnover is often calculated annually to account for different shopping seasons throughout the year, like back to school or the winter holidays, which can affect total inventory numbers.
High inventory turnover equals high business performance. It suggests that you:
- Buy the right amount of inventory
- Keep enough inventory on hand
- Maintain low storage costs
- Replenish display case
High inventory turnover rates suggest you effectively sell the inventory you buy. Low inventory turnover means the opposite, because products get stuck in a warehouse and acquire holding costs. Low turnover also indicates you:
- Overstock products
- Have inefficient marketing efforts
- Experience weak sales
- Are experiencing a decline in product popularity
There are also exceptions to the rule. An extremely high turnover can also indicate ineffective buying and low inventory, which results in stock shortages and lower sales.
Inventory turnover calculation
Knowing how to calculate inventory turnover ratio starts with knowing your COGS, or cost of goods sold, as well as your average inventory.
Inventory turnover ratio
Inventory turnover ratio measures how many times inventory is sold and replaced over a given period of time.
To calculate the inventory turnover ratio you divide the (COGS) or cost of goods sold by your average inventory (starting inventory plus ending inventory in a given time period, divided by two).
Inventory turnover formula:
💡 PRO TIP: Want to see which items are flying off shelves or collecting dust? View the Percent of inventory sold report in Shopify admin to see your entire product catalog’s starting quantity, ending quantity, percent of sold, and more.
Cost of goods sold (COGS)
Your cost of goods sold, or COGS, is usually reported on your income statement. It’s the cost of labor and all other direct costs involved with selling the product.
Average inventory (AI)
To figure your average inventory value, or AI, add your starting inventory during a given period of time with your ending inventory during that same period of time, then divide that by two.
Once you’ve plugged in your numbers and worked the formula, here are some additional areas into which your ratio gives you more insight:
Sales performance: Are products moving off the shelf at a decent rate? Do you need to run special sales or pay attention to specific items and figure out how much holding them for longer is costing you? Are there any poorly performing products you should replace or remove altogether to improve your inventory balances? Your inventory turnover ratio can help lead you through important inventory control questions like these.
Holes in your marketing strategy: Is your product marketing strategy not doing the best job at product positioning? Is the ROI on your advertising efforts not panning out due to holding costs eating into your margins and diminishing your inventory value?
Improper pricing: A high inventory turnover ratio might mean you’re undercharging for your products—which will be reflected in your financial statements. This could mean you can charge more per unit or that you can prioritize a specific product’s inventory to sell more.
What is a good inventory turnover ratio for retail?
A good inventory turnover ratio in retail depends on what you sell, how you sell it, and who you sell to. Research shows that the inventory turnover ratio benchmark for retailers is 10.86.
This means retailers restock their entire inventory over 10 times per year.
Consumer discretionary brands, which refer to nonessential but desirable goods like luxury clothing, replenish their inventory nearly seven times per year.
Grocery stores and other businesses that sell perishable goods often have a higher inventory turnover ratio because their products expire.
As of Q1 2023, CSIMarket reports the average inventory turnover ratios per economic sector are:
Your goal is to rotate inventory as much as possible to maximize profits. If you have older products that are low sellers, run a sale on them and discontinue the line after it's sold out.
Example of inventory turnover ratio
Say you’re a sock retailer and your company sells thousands of packs each month. What would an ideal inventory turnover ratio be if your starting inventory for the year was $5,800 and your ending inventory for that same year was $2,600, with a cost of goods sold total of $3,700?
Your formula would look like this:
COGS / (beginning inventory + ending inventory / 2) = Your inventory turnover ratio
$3,700 / ($5,800 - $2,600/2) = 2.3125
What can you infer from a 2.3 inventory turnover ratio? This number means that, within a year, the sock retailer turns over its inventory around 2.3 times. Depending on what your store’s inventory management goals are, this might be a satisfactory rate to maintain.
However, if you’re wanting to sell more socks, you'd need to look for ways to fix your low inventory turnover ratio, restock your shelves more quickly, and increase that 2.3 yearly turnover ratio while being careful not to go overboard with purchases that simply turn into excess inventory.
How to use inventory turnover ratio
Now that you’ve figured out your ITR, let’s look at how to use it in your retail or ecommerce store.
Demand forecasting
When demand forecasting, you making predictions about future sales based on past sales data that are both qualitative and quantitative. Knowing how well you did in historical sales through each quarter makes it easier to plan for the next one and not get stuck with unsold goods.
Demand forecasting also helps with figuring out tasks like weighing the pros and cons of opening another store, inventory control, or planning for holiday sales, where you’ll need to order ahead for additional inventory.
Say you sell car parts and your historical inventory turnover ratio points to sales picking up the second quarter of the year. That gives you foresight into the amount of inventory you need to order months ahead of time to be ready for strong sales.
Identify supply chain issues
Supply chain issues are challenging businesses that don’t plan for mishaps—which are bound to happen at some point. Just take a look at the most recent supply chain issues that were felt worldwide.
So, how can you identify supply chain issues with data like your inventory turnover ratio? For starters, it can help you more accurately calculate the amount of safety stock needed for products that sell faster.
It can also help you identify:
- Gaps in stocking and ordering policies
- Forecast variance in marketing
- Changes in lead time
The more a product sells, the more spending on storage costs for safety stock can be worth it. Understanding which SKUs have low turnover also helps you get rid of dead stock or write it off. Without your turnover ratio, it’s hard to spot the weak points in your supply chain.
How to improve inventory turnover
Now that you know how to use your inventory turnover ratio, let’s look at some ways to improve inventory turnover in your store:
- Increase demand
- Improve forecasting
- Optimize your supply chain
- Product bundling
Increase demand
Is inventory not moving fast enough, and storing it for longer eating into your profit margins? Increasing customer demand can help you move inventory faster.
Sure, you can invest in paid ads in the short term for long-term returns, but you can also use your social media channels to market new discount prices or flash sales. If that isn’t quite working, consider adjusting your prices across the board.
It might be that your target audience’s perceived value of your product isn’t what you thought. You can launch marketing campaigns to help shape that perception—including influencer marketing or ambassadorship efforts.
Resources:
- 15 Digital Marketing Ideas for Retail Store Owners: How to Promote Your Business and Get More Customers
- The New Normal: A Guide to Future-Proofing Your Business
Improve forecasting
Calculate the inventory ratio for each product line. This helps you identify which lines are moving slowly and not providing high returns, so you can improve forecasting.
Consider reducing the quantity you normally order from suppliers. Inventory turns improve when you buy less product more often.
Improved forecasting for lower inventory turnover rates can look like:
- Getting granular about specific products and their numbers instead of bundling forecasting into one general data set
- Keeping clear and organized records with a reliable inventory management software
- Considering seasonality as part of your overall forecast
Shopify POS has built-in inventory reports to help forecast for each product line. It’s much easier than crunching numbers in an Excel sheet.
Optimize your supply chain
Trimming unnecessary delays and strengthening your supply chain can help safeguard you from the headaches that come with delayed product deliveries. Besides reviewing your supply chain periodically, one of the best things to do is improve how much data you capture at each step to assess for efficiency and become more aware of how well you’re managing retail inventory.
In this case, our inventory turnover rate gives you a glimpse into how much carrying cost you’re shouldering that you might not have to. Adopting a just-in-time (JIT) inventory strategy can help you trim a substantial amount of your carrying costs, but at the risk of increased stockouts.
Knowing your inventory turnover ratio can also help you strengthen your relationship with your suppliers since you’ll be able to communicate your needs with more precision and fewer inconsistencies.
Product bundling
When you use product bundling, you’re curating a set of complementary items to capture more buyers. For example, a buy-more-save-more strategy can be beneficial if products aren’t moving off the shelf fast enough. You pair complimentary items that are selling the slowest together in hopes of clearing your shelves faster while still turning a profit.
There are also quantity discount bundles to consider if you’re selling bundles of the same product. Think of three-for-two deals in which customers receive more for their money. But product bundling takes data to do successfully.
At the very least, knowing which items move the slowest will help you make better decisions on which bundles you can create to attract higher sales. The inventory turnover ratio formula can increase visibility in those areas.
Optimize your inventory turnover ratio
Inventory, sales, and profit have always had a significant relationship for retailers. Optimizing your inventory turnover ratio starts with using the right formula for the job. Overstocking can be just as hurtful as understocking, as it's bound to reflect on your balance sheet.
Yet once you figure out what your cost of goods sold divided by your average inventory is, you can start optimizing for efficiency, whether you’re planning for inventory control, streamlining your supply chain, or lowering warehouse expenses.
But don’t stop there. There’s plenty you can do once you have accurate financial ratios in your hands—from improving cash flow to adjusting your price points or even rethinking the mix of products you offer for better margins and less stocking expenses.
Read more
- A Complete Guide to the Retail Inventory Method (RIM)
- The Complete Guide to Purchasing Product Samples
- Limited Drops: Everything You Need to Know + 9 Brands Doing it Right
- Procurement: What it Is and How to Create Your Own Process
- Keeping Up With Demand: Tactics to Boost Productivity And Get Orders Out on Time
- The Retailer’s Guide to the Weighted Average Cost Method
- 8 Benefits Of Outsourcing Order Fulfillment for Your Retail Business
- Purchase Orders: How to Create, Manage, and Use POs for Your Retail Store
- 10 Ways On-Demand Manufacturing Can Help Retailers Streamline Their Operations
