What is a good turnover ratio? And what does it mean for your business? Essentially, an inventory turnover ratio is essentially a number that tells you how quickly you can turn your inventory into sales. This is helpful because proper inventory management is necessary when operating an efficient supply chain.
Knowing which products will fly off of the shelves and which products will be harder to sell could take time to figure out at first. But with reports and data on your side, you can make sure you learn which is which sooner than later. Doing so will help you run a successful and profitable business that has a good turnover ratio.
How Does Inventory Turnover Ratio Work?
Inventory turnover ratio refers to the process of selling and replacing product inventory. The rate at which a company can sell and replace their inventory is known as the turnover ratio.
This value is calculated by dividing the total cost of products sold by the average product inventory for the same time frame. Figuring out the answer to the question of what is a good turnover ratio will vary, as does knowing how to ensure that your business is operating efficiently.
It all starts with determining an inventory turnover ratio that is fitting for your business and all of its specific demands.
What Is a Low Inventory Turnover Ratio Example?
A low inventory turnover ratio can often be a sign of excessive inventory. It can also potentially reflect weak sales or poor marketing, which can stem from overstocking.
Overstocking can usually be eliminated when you ensure that you are tracking your inventory accurately. This is typically considered a rate of two or less.
For example, if you sell 40 products in one year and you always have 20 products in stock at all times, you have an inventory turnover rate of two. This will likely mean that you have invested more than necessary in your inventory since you continually have more products on hand than your business needs.
While a low inventory turnover ratio can be a sign of improper supply chain management, it is better to have a few more than you need than it is to not have enough stock. For instance, if you are preparing for inflation or disruptions in the supply chain, having more than you need can give you an advantage.
Boosting your inventory before demand or prices increase can help you avoid a situation where you are scrambling for inventory when it’s either far more expensive or simply unavailable.
What Is a Good Inventory Turnover Ratio Example?
Different industries will have varying inventory turnover ratios. The ratio that is healthiest for your business will depend on your industry. For instance, jewelers often sell smaller items with high profit margins. As such, they can generally maintain a ratio around either one or two, which is often lower than businesses in other industries.
On the other hand, ecommerce businesses will have an average turnover ratio around five, but that is healthy, given the industry. Again, what is a good inventory turnover ratio for your business will depend on your inventory as well as your industry.
This rate of five means that your business is turning over inventory, or selling and replacing it, five times per year. Businesses that sell products that either expire or have shorter shelf lives will typically require a higher inventory turnover ratio.
Why Is a High Inventory Turnover Ratio Beneficial?
When you have a high inventory turnover ratio, this will generally mean that you have strong and effective sales. This could also indicate that your supply chain is not being managed efficiently, resulting in the consistent lack of sufficient product inventory for your product’s demand.
However, this is typically a better problem to have, especially compared to dealing with constant overstocking. It’s usually easier to increase your product inventory due to growing sales than it is to decrease your inventory because the demand isn’t there.
How To Calculate Inventory Turnover Ratio
Remember that a good inventory turnover ratio will differ from one industry to the next. You can calculate your specific ratio by dividing the cost of products sold, but make sure you are calculating the amount of inventory sold in the same time period.
Accurately determining the cost of products sold and the average inventory is necessary when it comes to ensuring that you have properly calculated your turnover ratio. Let’s say the cost of products that you sold for the year is $180,000 and your average inventory is $45,000.
From there, divide $180,000 by $45,000 to determine your inventory turnover ratio, which is four in this case. That means you sold and replaced your inventory four times over the course of a year. For many industries, a turnover ratio of four is good, as it indicates that you have a healthy supply chain and inventory management operations.
How Inventory Turnover Ratio Can Be Used
Operating an efficient and profitable business is the goal of every business owner out there. Knowing your inventory turnover ratio is critical if you are looking to optimize the efficiency of your supply chain and overall operations.
Examples of ways by which you can use your inventory turnover ratio to your advantage are as follows:
- Determine if inventory turnover ratio needs improvement.
- Plan for seasonality, if applicable to product inventory.
- Amplify marketing efforts to increase sales.
- Eliminate or resell old and excessive inventory.
- Determine if supply chain warehousing is operating efficiently.
- Look into whether or not improvements are required.
- Spot emerging trends.
- Determine when the proper time to restock is.
How Inventory Management Software Can Improve Inventory Turnover
Utilizing inventory management software can help to improve your inventory turnover ratio. It can provide you with the product visibility you need to make wise decisions about your business as well as your inventory levels.
With custom reports and real-time inventory management solutions, you can easily streamline your supply chain management with the right warehouse inventory management software.
By collecting both past and present sales information, you can easily determine trends, which allows for better forecasting for the future. These software programs offer features that help you optimize your operations in a number of other ways as well.
Prepare Your Business For the Demand Required
Preparing your business for the future doesn’t have to be exhausting. With the right inventory management software, you can easily determine what is a good inventory turnover ratio for your business, which can make the process of predicting the forecast of your industry a breeze.
Avoid overstocking as well as depleting your inventory completely. Manage a healthy supply chain that will ensure the satisfaction of your customers. When you can meet the demands of your customers, you can avoid waste and only keep the inventory that is required on hand.
All of these business-related tasks are easier to do when you have modern-day technology on your side. A good inventory turnover ratio is possible when you have the right tools in place.