Inventory Turnover Ratio

What is TURN or Inventory Turnover Ratio?

Inventory primarily refers to the finished goods available for sale; it also includes the raw materials and the work in progress materials used for production.

Inventory management is critical for retailers, more so for ecommerce retailers whose products can be viewed and bought from anywhere in the world with just a click of a button. Compared to physical stores, the stocks of these businesses tend to move out at a much faster pace. 

Now move on to the metric you need to be watching out for a while managing your inventory - Inventory Turnover Rate or Stock Turnover Rate or simply TURN.

It is the rate at which an ecommerce company converts its inventory into sales over time, in most cases a year. In simpler words, the inventory turnover rate is an indication to the company if its products are being sold quickly or not.

So what’s the ideal ratio that we’re looking at? Typically anywhere between 4 to 6 is considered a healthy inventory turnover rate for an ecommerce business.

How to calculate Inventory Turnover Ratio?

The inventory turnover ratio is calculated by simply dividing the total cost of goods sold for a specified time by the average inventory for that designated period.

Inventory Turnover Ratio = Cost of Goods Sold ÷ Average Inventory                                  

As you can see, to measure your inventory turnover ratio, you need to know your COGS or Cost of Goods Sold and your Average Inventory.

The cost of goods sold is the cost incurred to obtain the inventory. It includes the cost of materials, the cost of labor, and the fixed costs directly associated with the production of the goods. Here’s how you arrive at your cost of goods sold:

COGS = Beginning Inventory + Purchases during the period - Ending Inventory

Average inventory is calculated by taking the average of the inventory levels initially and at the end of the designated time. Here’s the formula for average inventory: 

Average inventory = (Beginning Inventory + Ending Inventory) ÷ 2

Let’s say your company has a beginning inventory of $7000, and purchases are made of the value of $5000, and you are left with an ending inventory of $2000 for a given period.

COGS =  7000 + 5000 - 2000 = $10,000

In this case, Average Inventory = 7000 + 2000 ÷ 2 = $4500

Let’s now use the formula to calculate the inventory turnover ratio for the above example:

Inventory turnover ratio = $10000 ÷ $4500 = 2.22

Why should ecommerce business owners be concerned about Inventory Turnover Ratio?

Inventory that is managed well can result in long-term success for your online venture. Calculating the inventory turnover ratio aids the management make effective decisions on pricing, purchasing, production, and marketing.

Let's have a glance at why you must pay heed to inventory turnover ratio:

  • It tells you the pace at which your inventory is getting sold, and if at all, you need to liquidate excess inventory.
  • It tells you where you stand in comparison to other ecommerce business owners.
  • It helps you measure the overall performance of your online store.
  • It gives you a broader perspective of the sales performance of your online venture.
  • It lets you have a deeper understanding of inventory, costs, and sales.

How to increase Inventory Turnover Ratio?

Inventory turnover ratio tells ecommerce business owners how well their stock is flowing through their online business. A low inventory turnover ratio means your business is headed for trouble, and you need to look for ways of getting the excess stock to sell out soon.

You can improve your inventory turnover ratio by bringing down costs, discarding obsolete inventory, managing production, and doing sound marketing analysis. Here are some key strategies that will help you do this :

  • Efficient sales forecasting: Not all products are equally popular with customers. A closer look at the sales data will help you see which products are fast-moving and not. These can be added to your yearly sales forecast.
  • Inventory Automation Software: Having software in place is vital to inventory management. It will help you track a sale and alert distributors for re-stocking as well.
  • Improved Marketing strategy: New and effective marketing techniques will help increase sales and improve the inventory turnover ratio.
  • Offer special discounts and offers to clear old stock.
  • Get your customers to pre-order products. By doing so, you have ensured the sale of your stock.

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