The inventory turnover ratio is a valuable metric for assessing inventory management. It indicates how many times inventory is sold within a given timeframe. This ratio is calculated by dividing the cost of goods sold by the total or average inventory. By identifying situations where inventory levels exceed sales, this ratio can help to pinpoint excessive inventory.
Turnover Ratio Formula and Examples
The formula to calculate the inventory turnover ratio is:
Cost of goods sold represents the production cost of goods sold within a specific time frame, which you can find on the company’s income statement.
Average inventory is the average value of inventory during that same time period, and it can be calculated by taking the mean value of inventory over time. Note that some analysts may use end-of-period inventory values instead.
Why Is It Important
The inventory turnover ratio is essential for assessing inventory management efficiency and cash flow generation. A high ratio indicates swift turnover and better cash flow, while a low ratio suggests excessive inventory and higher costs. Monitoring the ratio helps identify trends and optimize resource allocation. It offers insights into competitiveness and financial health for investors and businesses.
5 Inventory Optimization Techniques
1. Streamline the supply chain
To improve your supply chain, consider more than just low prices from suppliers. If a product is crucial for sales or in high demand, prioritize faster delivery. In any case, streamlining the supply chain to remove inefficiencies will boost sales, profits, and overall margins.
2. Adjust your pricing strategy
Increase prices on high-demand items to achieve better margins and release capital by selling off old, obsolete inventory. If certain items are difficult to sell, consider donating them to charity for a tax deduction or selling them through an alternative channel.
3. Check or change your ranking in your industry
Assess if your inventory turnovers match the industry standards. Take advantage of emerging trends in inventory ratios to gain a better strategic position on competitive items. By managing your inventory strategically, you can increase your market share and improve your ranking within the industry.
4. Improve forecasting
Enhance your forecasting by using sales numbers and inventory reports to gather valuable data. This information can lead to more accurate predictions about inventory needs. Additionally, you can utilize the data to plan future sales strategies, like changing product mixes or bundling items creatively to sell slower inventory at higher margins.
5. Automate purchase orders
Automating the process adds efficiency and potential cost savings. When combined with an order management system that ensures well-selling inventory remains in stock, the benefits increase. Consider using an inventory system that automatically generates purchase orders for review, leading to better control and reduced errors.
Improve Turnover With an Inventory Management Software
Using inventory management software can help improve turnover by accurately tracking inventory levels, automating reordering, forecasting demand, identifying slow-moving items, optimizing inventory mix, minimizing excess stock, enhancing order fulfillment, reducing manual errors, and making data-driven decisions.