Post on Wednesday, November 29th, 2017 in Accounting
First, it’s important to understand what inventory turnover is in plain terms.
It is a figure that defines how many times your inventory is sold or replaced within a specific time period, such as a quarter or a year. Basically, the inventory turnover ratio depends on the amount of purchases and sales. For better inventory turnover, the company should sell more than it purchases to avoid overhead costs for storage.
Actually, it means quite a lot. It is one of the most important aspects of inventory management that shows how efficiently you manage your inventory. By evaluating inventory turnover closely, you can point out possible areas of improvement for your overall business model.
A good inventory turnover ratio ensures that you do not have redundant inventory, meaning inventory that is not sold and just occupies your valuable storage space. At the same time, good inventory turnover ratio means that you are not overselling your projections, which could lead to inventory shortages.
So, first let’s take a look at this magic inventory turnover formula that will help you streamline your business and achieve best results.
A large part of calculating your inventory turnover ratio formula depends on your business model. Some businesses just divide the overall sales by inventory, whereas other businesses divide the cost of goods sold by average inventory.
The second method is more accurate, because it uses the actual cost of goods and also considers possible seasonal fluctuations in sales.
The focus here will be on the second method, the more efficient inventory turnover equation:
Cost of Goods Sold
Before you can do this, you need to know how to calculate average inventory. This process is actually really simple. You just need to add up beginning inventory and ending inventory, then divide the result by two. The formula looks like this:
Beginning Inventory + Ending Inventory
Check out the balance sheets at the start and end of the year or quarter, or whatever time period you use as a base. In this example, let’s use the start and end of the year as your timeframe. In the beginning of the year, your T-shirt company’s inventory was $700,000, and at the end of the year your inventory is $200,000. It would look like this:
$700,000 + $200,000
—————————————— = $450,000
Next you would calculate your inventory turnover. Your reported cost of goods sold is $400,000 through a year. Using the formula above you would find that your Inventory Turnover Ratio would be:
—————————————— = .89
($700,000 + $200,000) / 2
This means that your company replenished its inventory .89 times over the course of a year. That is not good, considering the average turnover ratio in retail clothing sits at around 4 times per year.
This really depends on industry. For example, companies that sell food have a higher inventory turnover rate than those who sell computers and computer peripherals. A sushi restaurant will sell more shrimp tempura rolls than your local electronics shop moves Macbooks.
Therefore, the ratio should be based on specifics of your business.
To start, you should be constantly monitoring your inventory turnover. Here are some other management methods that can help you improve your turnover right away:
Group your items by various criteria, such as manufacturers or raw materials used. This will help you more accurately define prices, sales behavior, availability, and other characteristics. You can also take into account such factors as seasons, currency fluctuations, special events, and more as they apply to your industry.
Identify products that sell slowly or don’t sell at all. Conduct research to find out why they are not selling and maybe adjust the prices or just remove those products from your stock. This will optimize your inventory turnover rate.
It’s also important to define the high-selling items. This will allow you to accurately calculate your reorder point and safety stock values to make sure that the high-selling items are always on hand and that your inventory turnover is stable.
Another way of how to make your inventory turnover more efficient is to set up the respective reorder point and safety stock values in your system. As a result, you will be always aware of when you should replenish your inventory to avoid shortages or costs for storing excessive inventory.
Define the periods or special events when you can reduce or increase the price of your items. For example, you can offer seasonal discounts as well as discounts for holidays. You can also sell the remaining items or low-selling items at a lower price. Finally, you can offer bulk prices or develop special offers for your most valuable clients. On the other hand, you can raise prices depending on the season and demand. All of this is good for your inventory turnover.
A well-designed, effective marketing campaign can significantly improve your inventory turnover and increase inventory demand. There are a lot of outside factors that determine the success or failure of a marketing campaign, but perhaps with some outside help, you can tackle an effective strategy to grow your inventory turnover.
We hope that this article has shed some light on the ins and outs of inventory turnover.
Now that you know how to calculate inventory turnover ratio and how to improve it, the next step is to get powerful software that will help you track and expand your best inventory turnover rate.
Dynamic Inventory offers a range of services to simplify your inventory management routine and make your customers happy. Feel free to browse our website or contact us today to learn more.
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