An organization’s inventory turnover ratio calculates the frequency in which it sells its entire inventory within a given financial reporting period of time. For example, you can use the fiscal year, calendar year, month, 30-day period, and many other lengths of time to calculate your inventory turnover ratio in. This ratio can be calculated for every type of inventory, including raw materials that get used up during the manufacturing process, goods that are a work in progress (WIP), and finished products. There is one exception with finished product inventory because the calculation only applies to service and manufacturing companies.
A HEALTHY INVENTORY TURNOVER RATIO
For the most part, the higher your inventory turnover ratio is the better off you are. It is important to find a healthy balance between too low and too high of a turnover ratio because both can get you into trouble. Here’s why.
Having too low of a ratio means that you have too much inventory on hand, and you run the risk of increased instances of product spoilage. It also means that you are most likely not using your warehouse and shelf space as efficiently as possible and your carrying costs may be hurting cash flow. Too high of a ratio means you may not have enough inventory on hand, and this could potentially lead to shortages and lost sales because your customers will look elsewhere for items that are not currently in stock at your stores or warehouses.
A healthy inventory turnover ratio ultimately comes down to the industry you are in and the type of business model you wish to use. Food distributors want to ensure that their inventory turns over dozens of times a year because they are dealing with products that have expiration dates. Electronics manufacturers have a different type of inventory, so their ideal ratio will differ significantly from a food distributor’s.
HOW TO IMPROVE YOUR INVENTORY TURNOVER RATIO
So how can you get your inventory turnover ratio to the best level possible? This is often overlooked, but first you need to take an end-to-end view in addressing your inventory. You need to optimize your supply chain, and an important thing to remember is to always make sure that the production processes are lean. When you solve inventory turnover issues from a lean perspective your company will benefit in the long run.
You can improve your inventory turnover ratio by using an inventory system, such as Fishbowl Manufacturing or Fishbowl Warehouse. In order to go lean, you need to define the value from a customer’s point of view. Map out your current value stream, the process flows and establish pull by the customer. This will help by eliminating waste from the value stream. It will shrink your lead-time and minimize your inventory at every point. Your margins won’t shrink and will improve as each unit’s cost is reduced.
By following these steps, you will notice an improvement in your inventory turnover ratio, and you will have a leaner inventory system that will save your company money.
The inventory turnover ratio is the number of times all of a company’s goods are sold over a certain period of time. It is calculated by dividing the total cost of goods sold by the average cost of goods in stock in the desired timeframe. Inventory turnover ratios can be increased by storing fewer items, selling more, or both.