What is Inventory Turnover Ratio?

An inventory turnover ratio is the rate at which your inventory is sold. The time taken to sell the inventory from when it was purchased is what referred to as the inventory turnover ratio. Basically, it’s an indicator of how quickly your products are sold and how much time they spend on the shelves.

A high turnover ratio symbolizes that you are good at managing and tracking inventory. Whereas, if you see a low turnover ratio, it signifies undermined sales. Say, example, if you are selling luxury items like diamond-studded watches, you may see a low turnover rate because they take longer than usual to get sold.

Similarly, you are likely to see a high turnover ratio if you are selling groceries or other kitchen essentials. This is because these products usually have high demand.

How to Calculate Inventory Turnover Ratio

Calculating the inventory turnover rate isn’t as difficult as it seems. You only need a couple of things to populate the inventory turnover formula before you figure out what’s your turnover ratio. Alright, let’s take a look at the detailed steps and understand how it works.

1. Determine Cost of Goods Sold (COGS)

First, ask your operations manager to share the cost of goods sold(COGS). Or else, if you want to do it on your own, simply take off the remaining inventory from the total inventory (beginning inventory + purchases). Now, the resulting amount that you get is your COGS.

Let us show you how it works through an inventory turnover ratio example.

Suppose you sell auto parts to mechanics or popular car brands. Your inventory is worth $90,000. Later, you brought inventory worth $15,000. And you have $5,000 of the remaining inventory at the year end.

Next, utilize the COGS formula:

COGS = Beginning Inventory + Purchases – Ending Inventory

COGS = $90,000 + $15,000 – $5,000 = $1,00,000

Hence, $1,00,000 is your cost of goods sold (COGS).

2. Find the Average Value of Inventory

Thereafter, look for average inventory value, which further tells how much inventory you typically hold over a defined period. Here, the inventory at the beginning and at the end of the period are necessary before you move forward.

Let’s continue with the same example above and assume your auto parts inventory is $7,500 at the start and $2,400 at the end. Later, use the following formula.

Average Inventory value = (Beginning Inventory + Ending Inventory) / 2

As a result,

Average Inventory = ($7,500 + $2,400) / 2 = $4,950

Now, it is clear that the average inventory held during the given period is $4950.

3. Use the Inventory Turnover Ratio Formula

Assuming you have determined both COGS as well as average inventory, now comes the final step, i.e., inventory turnover calculation. At this stage, you can put the previously derived results into the formula given below.

Inventory Turnover Formula:

Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory

Inventory Turnover Ratio Calculation Example

Let us clear your doubts by taking an ideal example of a grocery store. Say, you derived the COGS $1,00,000 and simultaneously, the average inventory is $55,000. Since you have figured out both COGS and average inventory, put the data into the above formula.

Inventory Turnover Ratio = 1.82

So, it indicates that 1.82 times your inventory is converted into sales.

Now, what do you reckon – is it really a good turnover ratio? Let’s know in the next section.

What is a Good Inventory Turnover Ratio?

A good inventory turnover ratio falls anywhere between 3 and 7, depending on which industry you serve. If the ratio is in this category, it hints at a balance between restocking items and sales. This further emphasizes the need to restock your inventory every month, approximately.

Businesses associated with other industries may have a ratio higher than 7 due to frequent purchases of daily-use items. For example, the retail industry may see an 8.0 or 9.1 ratio, as there are businesses that often sell items that are usually higher in demand. Conversely, it may dip below 3 for businesses selling luxury items like branded watches or clothes.

Industry-Backed Tips to Improve Inventory Turnover Ratio

In case the inventory turnover ratio turns out to be low, then worry not, follow these expert-written tips to increase it gradually.

1. Automation is the Key

A key to unlock the desired turnover ratio is to prioritize automation in inventory management. With the variety of online tools in the market, you can bring in a trusted inventory POS system that adapts to your business requirements. It helps you identify the top-selling items and products that really need your attention, eventually improving the turnover ratio.

2. Accurate Forecasting

Invest time in forecasting the ever-changing demands of your target audience. This way, you will anticipate what will sell and in what quantity. Thus, eliminating the need to overstock the items. So, when the items do not sit ideally on shelves, it will slowly increase the turnover ratio.

3. Observe Current Trends

Keep a tab on what’s trending in your industry and filter out the products with greater demand. By doing so, you understand what the buyers are actively searching for and accordingly adjust your product stocks. As a result, you can see inventory moving faster, giving a significant rise to the turnover ratio.

4. Review Pricing

Consider changing your pricing strategies following competitors’ analysis. Reviewing it frequently will make sure you attract more buyers and fulfill your sales goals. The less the inventory stays on the shelves, the higher the turnover ratio you can anticipate.

5. Purchase Order Automation

Make a switch to purchase order generation, where you can generate a purchase order following the real-time inventory levels. By doing so, the inventory will shift faster, and you will see no slow-moving items in the warehouse. Eventually, helping you enhance the turnover ratio.

Conclusion

Inventory turnover ratio is the indicator of how quickly your inventory converts into sales. The higher turnover ratio symbolizes efficient inventory management. On the other hand, the low turnover ratio flashes the warning sign.

Having said that, businesses should consider calculating the turnover ratio to understand what are the necessary steps required in a bid to move inventory faster.

If you are finding ways to get rid of a low inventory turnover ratio, we recommend advanced inventory POS Software. Not only to know what is inventory turnover ratio or how to improve it, but also to gain a competitive edge in the current market. Grab a risk-free 7-day trial now.

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