How to Calculate Inventory Turnover
To assess sales performance, your business may want to know how to calculate inventory turnover, a ratio indicating how often inventory was consumed in a set time period (usually 12 months). To determine this amount, the business will divide the cost of goods by its average inventory. The inventory turnover ratio is expressed as a number of days, so if it takes x number of days to turn over the inventory in a year, the ratio is indicated as x/365. This amount reveals how many times that inventory is sold and replaced in a year’s time.
Inventory quantities in all stages can fluctuate over time due to holidays, weather, and trends. By using the average inventory amount, these highs and lows are averaged to account for variations.
The cost of goods includes all costs at all stages from raw materials, through production including labor and overhead.
Note on Calculating Inventory Turnover Ratio
The inventory ratio takes full account of all stock in all stages of production, including raw materials; it need not be finished to be included in the count.
Getting Your Numbers Up
The higher the turnover rate, the faster the company is selling its goods. The goal of every company is to increase turnover rate. Different factors come in to play when driving the rate up, including increasing sales efforts, eliminating stock that doesn’t sell and reducing waste. Yet, there are times when the turnover rate could be so high that the company is not keeping up with demand. Transparency in reporting is key and leads to making decisions about modifying reorder points or quantities to remain profitable.
Low turnover indicates weak sales and lower demand. If you find the inventory turnover ratio is trending downwards, you can make meaningful decisions regarding purchase of raw materials, sales staff, marketing and, perhaps, changes to the inventory. If the rate of sales isn’t in line with the inventory, product sits on the shelves. Turnover rate reflects a successful sales effort. (See the days in inventory formula here).
There’s no need to accumulate an excess of items that can be delivered in short order from your vendors. Consider lead times when adjusting your purchase order practices.
When you have the tools at your disposal to analyze demand, time at each workflow station, time in storage, etc. you can strategize methods to move product faster and update your settings in SOS Inventory to follow those protocols.
Insights gained from reviewing your inventory turnover rate can help you and others (like financers) make decisions about the direction of the company. If product isn’t moving fast enough compared to competitor’s similar products, perhaps a price adjustment is in order or a promotion to sell larger volumes.
Industry Norms in Calculating Inventory Turnover
The number of days it takes to turnover a certain category of inventory can vary from one industry to another. When assessing inventory performance, the individual running the report must look at the average number of days in his own industry to determine how well the business is performing compared to competitors.
For instance, food items, which are constantly consumed, will turn over faster than appliances, which are sold less frequently.
For a three-hundred sixty-degree view of inventory performance, the turnover rate and every comprehensive report in between, SOS Inventory equips business owners with all the tools they need to make wise decisions about costs, inventory quantities, waste, profitability and more. SOS manages inventory from end to end, integrating with third party applications such as QuickBooks Online, Big Commerce, Shopify and more to provide masterful controls over all business functionalities.