How to Calculate Inventory Turnover Rate and Maximize Inventory Turnover

Managing inventory effectively and efficiently is vital to the success ecommerce brands. Whether you store your products yourself or partner with a 3PL, understanding the data around your inventory and operations can help you reduce shipping costs, increase efficiency, and maximize cash flow.

What is inventory turnover rate?

Inventory turnover is measured by a ratio that shows how many times inventory is sold and then replaced in a specific time period. Inventory turnover is a critical measure of business performance, cost management, and sales, and can be benchmarked against other companies in a given industry.

How to calculate inventory turnover ratio

To calculate inventory turnover on an annual basis for units sold, complete the following:

  1. Identify total inventory value (or cost of goods sold) over the past year
  2. Combine inventory at the start and end of the year
  3. Identify total sales revenue over the past year
  4. Divide annual sales by annual inventory value

Here’s the simple inventory turnover formula:

Inventory turnover = sales / inventory value

For example, if your store sold $200,000 in goods last year, and had $50,000 worth of inventory on hand on average throughout the year, your inventory turnover ratio would be 4.

You can also calculate your inventory turnover ratio by looking at units, rather than costs:

Inventory turnover = number of units sold annually / average number of units on-hand at any given time during the year

If you sell 1,000 units over a year while having an average of 200 units on-hand at any given time during that year, your inventory turnover rate would be 5.

How analyze inventory turnover ratio

Fully understanding inventory turnover can provide invaluable insight into how your ecommerce business manages costs and how sales initiatives are performing. Once you know how to calculate inventory turnover ratio, the next step is understanding what a high turnover rate versus a low turnover rate means, and what the ideal inventory ratio is so you can create an action plan on how to improve.

What is an ideal inventory turnover rate?

For most retailers, an inventory turnover ratio of 2 to 4 is ideal; however, this can vary between industries, so make sure to research your specific industry. A ratio between 2 and 4 means that your restocking matches your sale cycle; you receive the new inventory before you need it and are able to move it relatively quickly.

Low inventory turnover

A rate of 1 or less means you have way too much inventory. For example, if you sell 20 units over a year, and always have 20 units on-hand (a rate of 1), you invested too much in inventory since it is way more than what’s needed to meet demand.

High inventory turnover

High inventory turnover can indicate that you are selling your product in a timely manner, which typically means that sales are good. Ecommerce retailers should strive for a high inventory turnover rate, which means they sell the inventory they have on hand quickly and repurchase fresh inventory often. This also helps save on inventory carrying costs.

While a high turnover rate is generally considered an indication of success, too high of an inventory turnover rate can actually be problematic. An influx of sales can cause you to constantly have to replenish inventory, and if you can’t keep up with demand, you may experience stockouts.

This is especially true if it takes weeks to replenish the stock for a specific SKU; that can mean weeks of lost sales on what is clearly a popular item.

How to maximize your inventory turnover rate

Whether your inventory turnover is too high or too low, learn the measures you can take to try and combat or regulate the issue.

To solve for (very) high inventory turnover

High inventory turnover is easier to solve than low inventory turnover; you either need to order more inventory or make fewer sales. Typically, this boils down to needing more stock on average to meet your customer demand. Proper demand forecasting can help.

For products with a high inventory turnover ratio, make sure to keep a back stock. Using inventory management software can help you analyze your inventory.

To solve for low inventory turnover

If your inventory turnover ratio is too low, you need to decrease the average amount of inventory on hand. There are several strategies you can use, but the bottom line is that you need to order less and/or sell more. Here are some great ways to make your inventory turnover more efficient:

  • Offer promotions to deplete inventory by increasing sales. Beyond clearing inventory, discounts can be an effective way to drive customer loyalty, boost word-of-mouth marketing, and help your business grow.
  • Buy less stock, more often. By purchasing inventory to meet a month’s demand, rather than the whole year’s, you take on less risk and invest less capital in products that may not necessarily sell. This can be especially prudent when stocking a new product for which you don’t have prior sales data.
  • Negotiate discounts with your manufacturer or supplier. If you’ve built a strong rapport with your supplier, you may be able to negotiate a lower price for recurring orders.
  • Encourage pre-orders. Pre-orders can be a beneficial tool for businesses looking to gauge demand, generate excitement, and raise funds.

Keep in mind that inventory turnover ratio is just one metric, and is focused at the SKU level. It’s important to consider additional numbers, such as manufacturing and logistics costs and lead times, to get a full picture of your business’s efficiency.

Partner with a 3PL

If you are looking for a 3PL that will help you manage your inventory in real time, check out ShipBob. With ShipBob’s technology combined with nationwide fulfillment, you can gain a holistic view of your operations with just a few clicks. ShipBob’s built-in inventory reports let you view a trend analysis of your products and give you more control over the key metrics that drive business growth.

ShipBob also allows you to set automatic reorder point notifications to remind you when it’s time to replenish each item at each ecommerce fulfillment center. Choosing the right reorder notification point will ensure that there is time to send and restock more inventory before orders are put on hold for lack of inventory.

Conclusion

Inventory management is a vital part of e-commerce operations. You need to track your e-commerce store’s orders closely to ensure that you can manage your inventory in a cost-efficient way that maximizes your business’s cash flow while meeting customer demands. Calculating inventory turnover ratio is a great way to determine if you need to increase or decrease your inventory supply.

Like any metric, it’s not a one-time measurement, but rather a continuous evaluation. Your inventory turnover ratio can fluctuate over time, and you’ll want to make sure you respond accordingly.

 

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