The Basics of Inventory Turnover Ratio and Its Importance

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Inventory turnover ratio is an essential measurement for businesses to manage the inventory. For small ones, it is crucial to optimise the stock to make the best use of limited budget and space. Inventory management has a substantial impact on short- and long-term goals.

Therefore, you need to keep track of the stock alongside working on the vital operations for the business.

What is Inventory Turnover Ratio?

Inventory turnover ratio measures the amount of time inventory is used or sold within the set period. You get a better insight into the time taken to sell products and when to refill it. We divide the cost of good sold with the average inventory to get the turnover ratio.

Inventory Turnover = Cost of Sold Goods / Average Inventory

You need to keep track of the cost of goods sold and average inventory overtime to get the Inventory turnover ratio. We have explained these two terms below for better understanding.

  • Cost of Sold Goods: This is the direct cost incurred while purchasing or producing the items your business sells to the customer. You should only consider the expenses that involve producing the good, commonly the material and labour.
  • Average Inventory: Here, we calculate the cost of the total items in the inventory over a period. Add both the sold and unsold items to get the average inventory while using the producing and purchasing expenses.

What Ratio is Good for the Business?

The result from the above formula has a different meaning for different businesses. For perishable goods, it needs to be higher. However, the too high ratio also means you need to upgrade the inventory or increase the purchase. You can check different articles to get an idea on what number works best for your venture.

How to Apply Inventory Turnover Ratio

The whole exercise makes no sense if we don’t know the application of it. You can use the calculated ratio to get inventory turnover by different aspects. The turnover than can be used to create and update strategies for product placement or marketing. Here are the 5 ways you can use the Inventory Turnover Ratio for your business.

  • Category or Product

The best way to optimise the inventory is to fill the stock based on how much time they take to sell. Compare the ratio for different products and category for a better understanding of their popularity.

  • Season or Different Periods

Business like wedding accessories makes the majority of their sales in a specific season. They need to make sure the stocks are not excessive in the seasons with a low volume of sales. Reduce the time frame of data from a year to month to get more detailed information on the required stocks.

  • Product and Season

You can also use the ratio for finding how much of stock to store for a specific product in a season. For example, a store with sporting goods will sell minimal swimming accessories in winter when compared to summer. Therefore, you can use storage space more efficiently.

  • Total Inventory

The total inventory turnover helps you get a bigger picture of how well you are managing the inventory. While more detailed insight is recommended, the total turnover helps you make a decision based on long-term goals.

You can use the total inventory turnover to make batch-purchase of items for the whole season. If you are out of budget, take loans for bad credit with no guarantor, no fees, and instant decision to not miss out on special discounts. But make sure the investment is work the interest rate you’ll be paying the lender.

  • Analysing Product Placement and Marketing

You can use the inventory turnover ratio to analyse how well the marketing strategies are performing. Put some extra effort to promote products that are not performing with more targeted marketing.

In some cases, you can change their position inside the store to make them more visible to the customers. You can further use the before and after ratio to decide on whether a product is worth procuring in future.

Tips to Improve Inventory Turnover Ratio

These are the measures you can take to improve the inventory turnover ratio if the numbers aren’t bright.

  1. Focus on Seasons

Stocking items based on the seasons is essential to keep the storage optimised. There is no point in buying items that will await buyers for months. Calculate the inventory turnover byproducts and seasons to reduce the seasonal items purchase in off-seasons.

  1. Smart Ordering

Do not fall for a discount from the vendor. You may end up overstocking the item in the shelf. Not even the best product in the market should be purchased in large batches that may take a long time to get sold. Always purchase or produce stocks conservatively and be ready to lose some special discount in the process.

  1. Combine Complementary Products

Look for the items in your store that go together naturally. Take a walk around the store, and you are sure to find products that make a great combo. Place them together or put a special discount on the combined purchase.

  1. Offer Discounts

The items sitting in the inventory for a long time can be sold with a discount. The space is limited, making its use for performing items essential. You can put a discount on items during the off-season to let the customer hoard them for the season. There is a perfect chance they might go out of trend by the time season come.

In the Nutshell

To sum up, Inventory Turnover Ratio is a measurement you should use to improve inventory management. You get to make decisions based on numbers rather than intuition or some promotional pitch from the vendor. And the overall sales can be increased to make more profit alongside smooth refilling of stocks.