When you’re running a B2C business, having products that sit around inside a warehouse because nobody wants them is a bad sign.
It’s the classic case of low inventory turnover ratio.
For your business, that could mean high carrying costs, lost sales opportunities, possible deterioration of inventory if they’re stored for extended periods of time, negative impact on cash flow, tied-up capital, and a negative impact on your financial metrics.
In this article, we’ll take a look at what inventory turnover ratio means and its significance, how to calculate inventory ratio, strategies to improve a low inventory turnover ratio and how to implement them, and how to overcome common challenges that your business might face while managing inventory turnover ratio.
What does inventory turnover ratio mean and why should you care about it?
Inventory turnover ratio measures how many times your inventory is sold and replaced over a specific period. It’s your indicator for how efficiently your business manages its stock.
A higher ratio means that your inventory is moving quickly, which usually points to strong sales and effective inventory management. On the other hand, a lower ratio is a sign of weak sales or excess inventory.
Now you might ask, “How do I calculate inventory turnover ratio?”
Stock turnover calculation will require two key figures: the cost of goods sold (COGS) and your average inventory value. The formula looks like this:
For instance, if your COGS for a year is £500,000 and your average inventory value is £250,000, your inventory turnover ratio would be 2. This means that, on average, you’ve sold and replenished your inventory two times during the year.
Understanding the Importance of Your Inventory Turnover Ratio
The turnover ratio of your inventory plays an important role in assessing your business’s efficiency in inventory management.
A high ratio lets you reduce storage costs and improve cash flow, so you can reinvest that money in other areas of your business. Conversely, a low ratio could suggest that your products are not selling as fast as they should, and it leads to higher storage costs and other financial issues that could hurt your business.
6 Factors that Influence Inventory Turnover
There are factors both inside and outside of your business’ control that affect inventory turns. But regardless of their origin, every one of these factors underscore the need for effective inventory management planning. Factors that you need to consider include the following.
1. Product Life Cycle
Inventory turns change as your products move through the four phases of the product life cycle. Turnover rates are usually high during a product’s introduction and growth phase. It reaches its peak as the product enters the maturity phase.
Saturation in the market, new technologies, and ever-shifting customer preferences contribute to an inventory turnover decline.
2. Sales Volume
Higher sales typically lead to a higher inventory turnover ratio because more products are moving through your inventory. Pricing, marketing effectiveness, and your products’ overall demand hold sway over your sales volume. Businesses that have consistent or growing sales see a higher turnover rate because their stock is being replenished more frequently.
On the flip side, if sales are low, your inventory ends up sitting on the shelves longer, which translates to a lower turnover ratio and higher holding costs.
3. Product Type
The type of products you sell plays a role in determining a business’ inventory turnover rate.
Perishable goods, like food items, beverages, or pharmaceutical products, usually have a higher turnover because they need to be sold before they expire. On a similar vein, trendy or seasonal items, like fashion apparel or electronics, tend to move quickly when they are in high demand. A good example is how a clothing retailer might experience rapid turnover of summer apparel during the summer months but slower turnover for out-of-season items.
On the other hand, products like furniture, appliances, or machinery might experience slower turnover rate because they are typically higher-priced, long-lasting items that are purchased less frequently.
4. Market Demand
Demand is influenced by seasonality, economic conditions, consumer trends, and external events like new regulations or technological advancements.
Businesses that experience seasonal peaks — such as holiday decorations or back-to-school supplies — will have fluctuating inventory turnover rates. If demand is increasing, you may need to order more frequently to keep up, and when demand drops, inventory may linger and reduce turnover.
5. Inventory Management Procedures
Both high and low turnover rates indicate a need to evaluate the ordering and management procedures.
Sometimes high turnovers mean that you’re not ordering enough products and that might lead to stock-outs and eventually unhappy customers. By contrast, there are times when low inventory turnovers might mean that you’re ordering too many products. This can be problematic if you’re shipping out perishable items.
6. Pricing Strategies
More often than not, it’s hard to balance the need for profit versus providing good value to the customer. If the objective is to raise prices for maximum profit, inventory turnover rates might slow down as customers search for better value elsewhere. But if the prices are lower, you might see an increase in inventory turnover rates.
4 Actionable Strategies to Optimise the Rate of Inventory Turnover
Improving your inventory turnover ratio requires a combination of strategic planning and practical adjustments, and here are 6 strategies that you can implement without damaging your stock availability.
1. Understand your inventory items’ position in the product life cycle
Product demands change as items move through their product life cycle. As your product is on its way to being recognised in the market, there will be a natural upward trend. Demand levels often go down as a product matures, and during its decline, the demand becomes more inconsistent before falling off.
So if your products are at their decline stage, it would make sense to monitor their demand more closely and respond with strategies that are geared towards reducing stock levels before the items become completely obsolete and have zero demand.
Strategies commonly implemented include reducing your reorder quantity and levels of safety stock, and launching marketing campaigns combined with pricing tactics to increase demand and move the stock faster before your target consumers lose interest completely.
2. Get accurate demand forecasting
One of the keys to improving inventory turnover is accurate demand forecasting. Inventory planners and purchasers must only order items that have a demand in the marketplace.
Using simple moving averages to calculate demand based on a certain number of stock days is great, but it’s not going to be enough. Calculations like these are just too simple to deal with the often complex demand-and-supply fluctuations of today’s markets. Doing it wrong leads to over-forecasting and in turn, a low inventory turnover rate.
Instead of relying on basic calculations, understand statistical demand forecasting principles.
- Factor a product’s demand type into your forecasts based on its position in the product life cycle and adjust your forecasting accordingly.
- Identify the items that have seasonal demand patterns and notable market trends and add that bit of information to your forecasting.
- Refine your forecasting parameters to reflect demand volatility in the market. For instance, you can set longer forecasting periods for slow-selling markets and much shorter ones if market demand is volatile.
- Don’t ignore qualitative demand insights. Adjust forecasts for promotions and based on your competitors’ activity.
3. Be smart about reordering
It’s tempting to purchase items in bulk in the name of getting supplier discounts, but you have to understand the impact that decision will have on your inventory turnover.
Remember that inventory costs money to carry. It ties up your working capital.
What are you going to do if the bulk items you ordered aren’t best sellers?
They end up as excess, they take up space in your warehouse, and you have stock that’s slowly deteriorating the longer you store them in the facility. Worst of all, your business loses money.
Ideally, you’d want to place small order quantities regularly so stock keeps turning and your investment is minimised.
But a situation like this isn’t always possible (sometimes because of shipping costs, suppliers’ order restrictions, or inefficient processes). You need to weigh the costs against each other and decide which products you should prioritise for replenishment first.
4. Use automation to improve insights and make informed decisions
A good inventory management system lets you track your stock levels and provides an accurate base to do calculation for inventory turns. A warehouse management system (WMS) or an inventory module of an enterprise resource planning (ERP) system can do this for you.
The automation systems you use need to be capable of calculating and monitoring inventory turnover ratios down to SKU level, which lets you identify products that are not delivering sufficient ROI.
Implementing Inventory Turnover Strategies in Your Business
Incorporating inventory turnover strategies into your business to improve inventory rotation ratio needs careful planning and consistent execution. You want these strategies to yield tangible improvements, so here are some practical steps you can follow:
- Use Inventory Management Software (IMS). An accurate and up-to-date view of your inventory helps you make informed decisions about restocking, order quantities, and pricing strategies.
- Regularly monitor and analyse inventory turnover data. This practice highlights trends, identifies potential issues, and provides insights into how well your strategies are working. For example, tracking how different products perform across different seasons or sales channels can help you adjust your stocking decisions accordingly by running promotions or adjusting prices to boost their turnover.
- Train your team on inventory best practices or outsource inventory management to seasoned professionals. Whichever route you decide to take, your business stands to benefit from a staff that understands how to handle stock, manage orders, and utilise inventory management tools.
- Establish clear goals for your inventory turnover and set measurable metrics to track progress. Having defined targets in place will help you stay focused and measure success.
- Adjust and adapt continuously. Inventory turnover ratio is not a static metric — it fluctuates based on market conditions, customer demand, and other external factors. Continuously reviewing and adjusting your strategies helps your business stay competitive.
How to Overcome Challenges in Managing Inventory Stock Turnover Ratio
Improving inventory turnover ratio comes with pros, but also its fair share of cons. It requires a delicate balance between meeting customer demand, controlling costs, and maintaining operational efficiency.
Here are some challenges that you can expect to encounter as you manage your inventory turnover ratio and how to get around them.
1. Demand Variability
Demand fluctuates — it’s one of the most challenging aspects of inventory management. Sudden spikes or drops in demand can disrupt your inventory turnover ratio, leading to either stock outs or excess inventory.
Solution: Utilise demand forecasting tools effectively to predict future sales trends. Analyse historical data, market trends, and external factors, to make more accurate predictions about future demand. In addition, also consider maintaining a buffer stock of high-demand items to help mitigate the impact of unexpected surges in demand.
2. Supply Chain Disruptions
Shipping delays or production issues can negatively impact your inventory turnover ratio. Whenever supply chains are interrupted, it can lead to stock shortages or delays in replenishing inventory.
Solution: Incorporate flexibility into your supply chain by sourcing from different suppliers and establishing contingency plans. Having multiple suppliers minimises your reliance on a single source, while contingency plans can help you respond quickly to disruptions. It’s also a good idea to maintain a safety stock of critical items to cushion the impact of supply chain delays.
3. Balancing Inventory Turnover with Customer Satisfaction
It’s true that a higher inventory turnover ratio is desirable, but it should not come at the expense of customer satisfaction. Stock outs or delays in order fulfilment can lead to unhappy customers and lost sales.
Solution: Strive to find the right balance between maintaining a high turnover ratio and ensuring that you have enough stock to meet customer demand. Use just-in-time (JIT) inventory management, where stock is replenished as needed, to reduce holding costs while still meeting customer expectations.
4. Managing Costs while Improving Turnover
Improving inventory turnover often requires investment in new technologies, staff training, or changes in supplier agreements. Costs like these can be a barrier for some businesses, especially small to medium-sized enterprises.
Solution: For small businesses, it’s best to start with low-cost, high-impact strategies, such as optimising order quantities or renegotiating supplier terms. As your business grows and your budget expands, think about gradually investing in more advanced solutions, like inventory management software. Set your sights on strategies that provide the best return on investment (ROI) and prioritise improvements that will have the most significant impact on your turnover ratio.
5. Navigating Economic Uncertainty
Consumer behaviour and market demand is affected by economic downturns or unexpected global events. This uncertainty is an unavoidable concern that makes it challenging to maintain a stable inventory turnover ratio.
Solution: Adopt a flexible inventory management approach that lets you quickly adapt to changing economic conditions. It might involve scaling back inventory during uncertain times or exploring new sales channels to offset declines in traditional markets. Diversifying the product range and sales strategies can also help mitigate the impact of economic fluctuations.
Frequently Asked Questions
What is a good inventory turnover ratio?
There is no one-size-fits-all when it comes to defining a good inventory turnover ratio for every business. A good inventory turnover ratio differs by industry. But in general, a higher ratio indicates efficient inventory management. However, extremely high ratios might also suggest insufficient stock to meet demand.
A few examples:
- Retail: A turnover ratio between 4 and 6 is often considered healthy; it indicates a balance between restocking and sales.
- Grocery stores: Due to product perishability and high demand, turnover ratios of 10 or more are quite common.
- Luxury goods: Lower turnover ratios are expected because of higher-priced items and slower sales cycles.
In the end, the ideal inventory turnover ratio depends on specific business circumstances and industry benchmarks.
Is an inventory turnover ratio of 4 good?
In general, that is considered good, especially for retail businesses. A 4 indicates that inventory is sold and replaced approximately four times per year.
However, it is important to compare this figure to industry averages and your own historical data.
A ratio of 4 might be excellent for one business but not optimal for another.
Can inventory turnover ratio be less than 1?
Yes, it can happen. But an inventory turnover ratio that’s less than 1 is a sign that a business has sold less inventory than it purchased over a specific period.
A ratio less than 1 is generally undesirable as it suggests:
- Overstocking
- Slow sales
- Potential obsolescence of inventory
- Inefficient inventory management
How often should I review my inventory turnover ratio?
Ideally, they should be reviewed quarterly or monthly. This lets you identify trends and issues in a timely manner. But if your business has highly seasonal products or rapid sales fluctuations, more frequent reviews might be necessary.
What tools can I use to automate inventory management?
- Warehouse Management Systems (WMS): These systems track inventory levels, locations, and movements, providing real-time data for decision-making.
- Enterprise Resource Planning (ERP) software: Comprehensive systems that include inventory management modules.
- Inventory management software: Standalone solutions focused specifically on inventory control.
- Point of Sale (POS) systems: Integrate with inventory management to track sales and update stock levels.
- Supply chain management software: Optimise inventory levels based on demand forecasting and supply chain data.
What are some common mistakes businesses make when trying to improve their inventory turnover ratio?
Common pitfalls that you can avoid as you try to improve your inventory turnover ratio include:
- Not using inventory data analysis to make informed decisions.
- Overly aggressive inventory reduction (as it leads to stockouts and lost sales).
- Failing to accurately predict customer demand, because demand forecasting was ignored.
- Letting products sit on shelves for extended periods of time and ignoring it.
- Not collaborating with suppliers to optimise inventory levels.
- Failing to adopt inventory management software and automation.
What is the difference between inventory turnover ratio and inventory days?
Inventory turnover ratio is a metric that measures how efficiently a company is managing its inventory. It shows how many times inventory is sold and replaced within a specific period.
Here’s the formula stock turnover ratio:
- Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
On the other hand, inventory days (Days Sales in Inventory or DSI) measures the average number of days it takes to sell inventory. It’s the inverse of inventory turnover ratio.
The formula for computing inventory holding period:
- Inventory Days = 365 / Inventory Turnover Ratio
Inventory turnover ratio focuses on the frequency of inventory replacement, while inventory days focuses on the time taken to sell inventory. Both metrics are interconnected and provide valuable insights into your inventory management efficiency.
What is the rule of thumb for inventory turnover ratio?
There’s no universal “rule of thumb” for inventory turnover ratio, because it differs by industry. But some general guidelines that you can keep in mind are:
- Higher turnover ratios are generally desirable as they indicate efficient inventory management and strong sales.
- Industry benchmarks are a good reference point for comparison. For example, grocery stores typically have higher turnover ratios than electronics retailers.
- Consider the specific business model. Factors like product type, pricing strategy, and target market influence optimal inventory turnover.
Analyse your inventory turnover ratio in conjunction with other financial metrics and business performance indicators to get a comprehensive picture of your inventory management efficiency.
Final Thoughts
Understanding the ins and outs of and optimising your inventory turnover ratio is important for maintaining a healthy and profitable business.
Inventory turnover ratio is a metric that’s more than just a number — it’s a reflection of your business’ efficiency in managing stock, responding to market demands, and driving sales.
Striking the right balance between meeting customer demand and maintaining operational efficiency is a common challenge that businesses face, so if you think that’s another exasperating add-on on top of your to-do list, you don’t have to worry about accomplishing it halfway — just leave it to experienced professionals.
Green Fulfilment can help you leverage advanced tools and software to ensure accurate forecasting and implement smart inventory management practices to achieve a turnover rate that supports your business’ growth and sustainability.