If you're like most business owners, you're probably aware that you're constantly running low on inventory. You have stock, but there is always something more which needs to be ordered. You can track orders manually. But you have a dozen other things that you need to worry about, and there's always something more that needs to be done.
It's one thing to work with small quantities of inventory. When you're bootstrapping, you can easily manage all of it. But once you have a large-scale business, you'll quickly discover that dealing with large amounts of inventory is quite a different story. First, you'll have to decide whether you want to keep your inventory on hand or if you need to order it regularly. The answer will largely depend on your sales volume and the type of products you sell.
I'm sure you know what inventory turnover is. But do you know how to calculate it?
Inventory Turnover
Inventory turnover is a measure of how effectively a company sells its inventory. It can be calculated by dividing of cost of goods sold by the average inventory.
When evaluating a company, inventory turnover is an essential metric for investors. It can give insight into how well a company is managed and how efficiently it operates.
Several factors can affect inventory turnover, including
- The type of business
- The business's seasonality
- The products' pricing
What Is the Average Inventory Turnover
In business, inventory turnover is the measurement of how often a product is sold or used in a period of time, such as a year.
Average Inventory turnover is a critical metric in evaluating a company's operational efficiency. It measures the number of times a company's inventory is sold and replaced over time. Which can be a good indicator of how well a company manages its inventory.
Businesse with a high inventory turnovers typically sell items in high demand or seasonal items. Conversely, businesses with a low inventory turnover may sell items that are not in high demand or have slow sales periods. There are several ways to improve inventory turnover, such as reducing prices or offering discounts.
Why Is It Important
Inventories are an essential part of any company, regardless of whether or not it is food oriented. An inventory represents the company's current state of affairs. If you are wondering about the health of your company or business, you should look into how quickly its inventory is turning over vs how much it is lasting.
For instance, if current inventory is at a three-month high and prior inventory is at a nine-month high. You can be sure that your inventory turnover is rising and indicates that your inventory will likely be sold or changed soon.
This is especially useful for determining whether it is a good idea to order more inventory at this time or if it is better to wait until your current inventory is down to a more normal level before ordering more goods.
Thus, it is vital for companies to monitor their inventory turnover ratios and strive to improve them over time. By doing so, they can ensure that their businesses are running efficiently and effectively.
Average Inventory Turnover Formula
Inventory turnover is a critical metric for any business because it indicates how well a company manages its inventory.
The most common way to find the inventory turnover ratio is by dividing the cost of goods sold (COGS) by the average inventory.
To properly manage inventory levels, businesses must understand and utilize average inventory turnover calculations. Average inventory turnover ratio measures insight into how fast a company sells its products, which can be used to make decisions about production levels and purchasing. Here is a step-by-step guide for using average inventory turnover calculations.
First, we need the inventory turnover ratio to determine the average inventory turnover.
To calculate the inventory turnover ratio, we need the average inventory. To calculate average inventory, add the beginning and ending inventory values and divide by the total time period.
Calculating The Inventory Turnover Ratio
Calculating the inventory turnover ratio is a simple process that can give you valuable insights into your business.
The inventory turnover ratio formula is:
The ratio of Inventory turnover = cost of goods sold / Average inventory
Where,
Average inventory = (Beginning inventory + Ending inventory) / Time period
The resulting answer will tell you how often your inventory is turning over in a given period of time. An inventory turnover ratio is valuable for assessing your business's performance and making necessary adjustments.
Calculating The Average Inventory Period
The inventory turnover average is the number of days it typically takes to sell the average amount of inventory.
To calculate the average inventory period, we need the number of days in a year divided by the ratio of inventory turnover. For example, if the inventory turnover ratio of a company is 10, it takes an average of 36.5 days to sell its inventory (365 /10).
The average inventory period can be used to assess a company's efficiency in managing its inventories. A shorter average inventory period indicates that a company is selling its inventories faster and may be more efficient than a company with an extended average inventory period.
Benefits Of a High Inventory Turnover Rate
Investing in inventory is a necessary evil for most businesses. While having enough inventory on hand to meet customer demand is important, too much inventory can interrupt working capital and lead to cash flow problems.
Generally speaking, a higher rate of inventory turnover is better than a lower one.
There are several benefits to having a good inventory turnover ratio, including the following:
- Increased cash flow - When inventory turns over quickly, businesses have more cash to reinvest in other areas or pay down debt.
- Reduced storage costs - Companies with high inventory turnover rates don't have to worry about storing large quantities of unsold products, which can save on warehousing and other storage costs.
- Improved customer service - Having less inventory on hand can improve customer service levels because there's less chance of products being out of stock when customers need them.
Drawbacks of a Low Inventory Turnover Rate
A low inventory turnover rate can be a drawback for several reasons.
- First, it can tie up much cash in inventory that could be used for other purposes.
- Second, it can lead to obsolescence issues if products need to sell more quickly.
- Finally, it can also create storage and space problems.
You can do a few things to improve your inventory turnover rate, such as reducing the amount of stock you keep on hand, streamlining your ordering process, and enhancing your forecasting. You can keep your business running smoothly and avoid any costly errors by keeping close tabs on your inventory turnover rate and making improvements where necessary.
When Is It Appropriate to Order More Inventory?
You may wonder when it is appropriate to order more inventory. After all, the purpose of having an inventory is to have enough goods in stock to meet customer demands. However, let's take a quick moment to consider the situation from the supplier's point of view. When your inventory turns over frequently, it can be a good indication that your company is likely to be under much pressure to meet demand.
In these situations, it may not be a good idea to order more inventory because there may not be enough to go around once it is all delivered. To prevent yourself from being burnt by overordering, you should consider how much inventory you need vs how much you want. In most cases, if you order more than required, you risk getting some of it back and making do with what you have left. This can lead to many problems, so it is always better to order what you need and nothing more.
Conclusion
Inventory turnover is a critical metric in supply chain and inventory management. By understanding what it is, how to calculate it and what factors affect it, businesses can use it to optimize their inventory and improve their bottom line.
While there's no magic number for inventory turnover, the average is around 4-5 times per year for manufacturers and approximately ten times per year for retailers. The important thing is to track your own company's performance over time and compare it to industry benchmarks to see where improvements can be made.
There are a few things that can impact your inventory turnover rate, so it's essential to keep an eye on these factors and make changes where necessary. First, consider your product mix - are you carrying too many slow-moving items? Second, take a look at your lead time - if it's too long, you may need to reevaluate your suppliers.
Hopefully, this article has provided you with a better understanding of inventory turnover. If you need your business to grow, you should know how fast you sell your products. The faster your inventory turns over, the better. Find out how quickly your inventory turns over by using our inventory management software. Calculate now! It only takes a minute. Sign up for a free trial, and turn inventory into sales.
