There is all types of turnover in business. You might be aware of human resource turnover, margin turnover or turnover costs in general. Typically, these types of turnover have to do with measuring a rate of change. However, today we will be discussing inventory turnover specifically. This ratio can be a helpful tool for anyone managing a business, offering you the opportunity to make the most of your production or buying decisions and avoid the dreaded Christmas downturn. Keep reading to learn about the inventory turnover ratio calculation and what it can do for your business.
What Is Inventory Turnover?
Inventory turnover is a ratio that measures how many times a business acquires and sells inventory within a given time period. In simple terms, the ratio calculated how many times inventory is turned over per month, quarter or year. These calculations will give you a rate of turnover that can be used to evaluate your inventory supply and demand.
Inventory Turnover Ratio Benefits
An inventory benefits analysis has a ton of advantages. The most notable, however, is the fact that an inventory turnover ratio provides a glimpse into overall business performance. If your inventory turnover ratio is low, you have weak sales. Identifying business weaknesses will allow you to devise strategies to improve sales volume. Inversely, a high turnover ratio indicates strong sales or large discounts. If you have not been discounting your products deeply, you can rest easy knowing your sales volume is high. This means your business is performing well. The knowledge an inventory turnover formula provides regarding overall sales performance is indispensable.
How To Calculate Inventory Turnover Ratio?
To calculate the efficiency of the inventory sales, there are four ways to calculate the inventory turnover ratio. This can be done using Cost of Goods Sold (COGS), Gross Sales, Net Sales or Beginning Inventories and Ending Inventories. Using any of these measurements of the sales process, as per your business analysis needs, then divide it by the average inventory during a specific time period. Of course, you can use any time period you choose, preferably one that matches your balance sheet or cash flows statements.
To summarize, the formulas would be:
- Cost of Goods Sold / Average Inventory = Turnover Rate
- Gross Sales / Average Inventory = Turnover Rate
- Net Sales / Average Inventory = Turnover Rate
- (Beginning Inventories – Ending Inventories) / Average Inventory = Turnover Rate
Which Inventory Turnover Rate Is Right?
Depending on your business, you might find it most accurate to use any one of the inventory turnover formulas listed above. For a COGS based approach, you might not have a quick payment turnaround so basing calculations off of costs would make sense. Meanwhile, you might be focused on the upcoming tax season, using net sales as measurement against the previous year’s inventory. Finally, you can use either gross sales or inventories to get a more broad idea of the rate of selling inventory.
Inventory Turnover Analysis
Once you have calculated the inventory ratio and rate of turnover, then you probably want to analyze these metrics properly. At a basic level, a low inventory ratio means that the company is moving inventory slowly. Meanwhile, a high inventory turnover indicates strong sales. In both cases, managers have to be aware of any old, unused or obsolete inventory that could be hurting the overall turnover ratio. A truly efficient company will use these rates as a baseline to continue improving the inventory turnover by shortening lead times to complete sales.
Why Increase Inventory Turnover?
If your business can turnover inventory quickly, that means it is generate sales quickly. This is great for any business. As long as payments are coming in promptly, which is definitely the case if you have a credit card processor, additional sales leads to funding to either grow the business or report increased profits. In either case, the business owner, stockholders and stakeholders would be pleased.
These are great ways to calculate inventory turnover ratios. They can be used by almost any business that wants to improve lead times and increase sales. Most commonly, businesses will use the COGS divided by Average Inventory approach to calculate the turnover rate. Of course, the time period is up to you and your analysis requirements. Finally, let the business data give you insights to increase sales and grow your business.
Image from https://www.thebalance.com/calculate-inventory-turnover-357280