A business’s inventory turnover ratio refers to how much the company sells in relation to its average inventory quantity on hand. This ratio is a crucial performance metric, especially if you want to know whether you’re selling enough, producing enough orders, or holding too much inventory at any point in time.
It can also provide valuable insights regarding manufacturing and carrying costs. To calculate your inventory turnover ratio, you first need to get the values for the following:
- Cost of Goods Sold (COGS) = Beginning Inventory + Purchases in Current Period – Ending Inventory
- Average Inventory = (Beginning Inventory + Ending Inventory) / 2
Then, compute your inventory turnover ratio using the following formula:
Inventory Turnover Ratio = COGS / Average Inventory
What you essentially get from this value is a measure of efficiency– a picture of how much your business is selling as a percentage of your total inventory.
The ideal value of your inventory turnover ratio may vary, but a high inventory turnover ratio is usually desirable, because it connotes strong sales. Contrarily, a low turnover ratio usually means weaker sales and excessive inventory.
However, a healthy turnover ratio for your business is highly dependent on your industry and your product mix, and it can have seasonal fluctuations.
How to remedy a low inventory turnover ratio
There are several ways to optimize your inventory turnover rate, and they come with many benefits. First, you’ll get to improve how you manage your inventory overall. Second, you might find ways to reduce manufacturing costs and improve product pricing, eventually leading to higher sales. Here are some best practices:
Beef up marketing efforts
If you previously thought marketing was an unnecessary expense, you should now consider it an essential part of running your business. Try to create campaigns that will boost sales and grab the attention of potential customers. If you haven’t gotten around to setting up a professional-looking website and social media profiles yet, consider getting started immediately, as improving online visibility will increase your chances of attracting new customers.
Look for ways to increase inventory demand
This is related to the previous point, but it’s not quite the same tactic. In addition to bolstering your marketing strategy, you can add more sales channels to increase demand for your products. This includes looking into selling on multiple e-commerce platforms (Squarespace, BigCommerce, Shopify, etc.), attending trade shows and events, and looking into newer channels, like live selling and shoppable content on social media.
Analyze your pricing strategy
Analyzing your pricing methods is an often overlooked, but effective, way to boost sales and reduce inventory turnover times. Ensure you’re offering competitive prices and consider whether discounts, or other promotional offers, could help shift any stagnant stock. It’s also worth considering whether changes in payment terms, or raising the overall price of items, would make a difference.
Optimize inventory management
If you’re still doing things manually, consider upgrading to a cloud-based inventory management software that can automate inventory management processes and provide real-time data. By adopting a more agile inventory management style, you can be more confident that nothing falls through the cracks. With historical data at hand, you can also learn to anticipate exactly how much of something you’re going to need to meet your customer’s demands.
A low inventory turnover ratio isn’t a death sentence to your business; it only means there are critical areas that need improvement in your operations. By assessing and optimizing key areas, you should be able to bring your inventory turnover ratio up to a healthier level.
If you are interested in learning how Fishbowl’s flexible inventory management solution can help your business now, you can book a demo.