Inventory Turnover Ratio: Calculation + How to Improve 2024

Inventory turnover rate (ITR) is a ratio measuring how quickly a company sells and replaces inventory during a given period. Maintaining an optimal ITR helps in reducing storage costs, decreasing the risk of product obsolescence, and boosting cash flow. Average Inventory is the mean value of the inventory during a specific period, typically calculated by adding the beginning and ending inventory for a period and dividing by two. Inventory turnover is only useful for comparing similar companies, because the ratio varies widely by industry. For example, listed U.S. auto dealers turned over their inventory every 55 days on average in 2021, compared with every 23 days for publicly traded food store chains.

If, for example, inventory turnover was 9.5 in the previous year, Green Thumb Gardening Supplies would want to investigate why inventory turnover had dropped from the previous year. This works out to 6.67 which means that Green Thumb Gardening Supplies turned over its inventory approximately 6.67 times during the year. To get a better idea of how inventory turnover works, let’s look at a real-life example.

Efficient Inventory Management

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 what turbo tax is used for an llc partnership of clearing your shelves faster while still turning a profit. 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.

Improve market forecasting

To determine the average inventory for the period, take the starting inventory, add the ending inventory, then divide by two. Inventory turnover ratio is a key metric used to evaluate how well a company is managing its inventory. Efficient inventory management is a priority when it comes to inventory-based businesses. Suppose a retail company has the following income statement and balance sheet data.

There is the cost of the products themselves, whether that is manufacturing costs or wholesale costs. There is the cost of warehousing the products as well as the labor you spend on having people manage the inventory and work on sales. The more efficient the system is, the healthier the company is with its cash flow. By regularly monitoring your inventory turnover ratio and implementing strategies to optimize it, you can improve cash flow, reduce costs, and enhance customer satisfaction. A high inventory turnover ratio can indicate products are selling quickly, and the business has effective inventory management strategies in place.

How to Calculate Inventory Turnover Ratio

ITR is calculated by dividing a company’s Cost of Goods Sold by its Average Inventory. Companies need to make sure their high turnover is due to strong customer demand, rather than simply keeping too little stock on hand. A high ITR means that inventory is selling and being replenished quickly, which often points to robust sales. For example, a company with $20,000 in average inventory with a COGS of $200,000 will have an ITR of 10. It helps you to boost productivity by removing manual dependencies, such as phone calls for every update, delays in deliveries, and lack of estimated time of arrival. With such an automated process, you don’t have to monitor drivers or continuously look after your clients.

This formula gives a clear picture of how effectively a company’s inventory is being utilized in relation to its sales. Secondly, average value of inventory is used to offset seasonality effects. It is calculated by adding the value of inventory at the end of a period to the value of inventory at the end of the prior period and dividing the sum by 2.

1. Keeping an eye on this ratio is essential because if your company’s inventory takes a long period of time to proceed, you are tying up too much money and inventory stock in unsold products.
2. As you can see, you can make specific business decisions to move the products more efficiently.
3. However, if a company exhibits an abnormally high inventory turnover ratio, it could also be a sign that management is ordering inadequate inventory, rather than managing inventory effectively.
4. It is calculated by adding the value of inventory at the end of a period to the value of inventory at the end of the prior period and dividing the sum by 2.

Inventory Turnover Ratio: Calculation + How to Improve (

Generally, a higher inventory turnover ratio indicates efficient management of inventory because more sales are being made. For the retail industry, a good inventory turnover ratio might range from 5 to 10. However, it’s important to benchmark this ratio against industry standards or peers for more accurate insights. It estimates the amount of additional inventory a company has over an extended period. Say you sell car parts and your historical inventory turnover ratio points to sales picking up the second quarter of the year.

Consumer discretionary brands, which refer to nonessential but desirable goods like luxury clothing, replenish their inventory nearly seven times per year. Market competitiveness also allows businesses to adapt quickly to market demands and changes. A lower inventory turnover should alert management to investigate further.

You can launch marketing campaigns to help shape that perception—including influencer marketing or ambassadorship efforts. Access and download collection of free Templates to help power your productivity and performance. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise. Our mission is to empower readers with the most factual and reliable financial information possible to help them make informed decisions for their individual needs. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.

Inventory turnover measures how often a company replaces inventory relative to its cost of sales. Capacity planning will help you in managing inventory levels to have the right supplies. It helps you predict when consumer demand will be high and when you’ll need more employees. Having good inventory management software is vital, so you can keep track of your stock inventory and calculate the stock turnover ratio for each SKU. A warehouse management system (WMS) or an enterprise resource planning (ERP) inventory module can do this for you. The inventory turnover ratio shows how many times you turn over your inventory annually.

The inventory turnover ratio may one way of better understanding dead stock. In theory, if a company is not selling a lot of one product, the COGS of that good will be very low (since COGS is only recognized upon a sale). Therefore, products with a low turnover ratio should be evaluated periodically to see if the stock is obsolete. Competitors including H&M and Zara typically limit runs and replace depleted inventory quickly with new items.

Also, the number represents the days from inventory purchases, unsold inventory, and obsolete inventory. An extremely high turnover can also indicate ineffective buying and low inventory, which results in stock shortages and lower sales. Products with a short shelf life or that are subject to rapid technological advancements may require higher turnover ratios to minimize the risk of obsolescence. If Green Thumb Gardening Supplies has been in business for several years, they can compare inventory turnover across the years they’ve been in business. Comparing their inventory turnover to the industry standard can help Green Thumb Gardening Supplies know if they are on track for their industry. It is vital to compare the ratios between companies operating in the same industry and not for companies operating in different industries.

That gives you foresight into the amount of inventory you need to order months ahead of time to be ready for strong sales. 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. As you can see, you can make specific business decisions to move the products more efficiently.

An inventory turnover of 35 during a 52-week period means your business is selling its entire inventory 35 times during the year. Thus, the inventory turnover rate determines how long it takes for a company to sell its entire inventory, creating the need to place more orders. Simply put, the inventory turnover ratio measures the efficiency at which a company can convert its inventory fair value vs fair market value purchases into revenue. A low ratio can imply weak sales and/or possible excess inventory, also called overstocking. With an automated solution, you can gather essential statistics about your business, find the economic order quantity for each product, and determine your business’s ideal inventory turnover ratio. When you use product bundling, you’re curating a set of complementary items to capture more buyers.