How To Calculate Inventory Turnover

How To Calculate Inventory Turnover

COGS is often listed on the income statement; inventory balances will be found on the balance sheet. With these two documents, you just need to plug the numbers into the formula. Still, an ideal target for inventory turns across industries and markets does not exist. Instead, each has challenges and requirements that determine the best level. Typically companies look to industry averages as a touchstone of whether they’re gaining a competitive edge.

First, determine the total cost of goods sold (COGS) from your annual income statement. Next, calculate the average inventory value by adding together your beginning inventory and ending inventory balances for a single month and dividing by two. Brightpearl users can access a centralized, 360-degree view How to Calculate Inventory Turnover and Inventory Turns of their entire operation, including financial statements, income statements, and—of course—inventory turnover. By managing inventory, orders, warehouses, accounting, fulfillment, shipping, and purchasing this way, retailers are all set to avoid those problematic manual errors or disjointed systems.

Gather Data

By design, turns need to be averaged over long periods of time representing a multiple of the lead times in order to be statistically significant. Furthermore, the period of measurement frequently needs to be as long as one year to provide meaningful results due to demand patterns like seasonality. Measuring turns is a complex undertaking as most naive measurements are simplistic and yield nonsensical results.

• That is why you can view it as an indicator to understand the health of your business.
• The ideal ITR for your business depends on the size of your operation, your cash flow, how quickly you can liquidate your assets, and which products you’re selling.
• If your business has a strong seasonality, be careful when interpreting the value of your inventory turnover KPI.
• By hanging onto that old inventory, you could be missing the opportunity to sell another product several times over.

If you’re using barcodes or thinking of implementing them, inFlow can help with that too! Read our Ultimate Barcoding Guide to learn more about barcodes including how to get started barcoding your business. If you’re already applying all of the other tips in this list and you’re still not making sales, your pricing could be too high. Compare your prices with similar businesses and products in your industry.

Inventory Turnover Days

Indeed, if you use the data of the last few weeks, you will not be able to anticipate strong sales variations. You will tend to overestimate your stock coverage before a peak in sales and underestimate it before a drop in demand. To find the inventory turnover ratio, divide the value of COGS by the value of average inventory. In this example, I will calculate the inventory turnover ratio for a car dealership, as well as how many days a turn takes. If you’re off target, consider incorporating the supply chain and customer-facing solutions we recommended for your business. Still, with reliable processes in place and a long-term inventory management strategy, you’ll be able to strike that balance sooner than you think.

We believe everyone should be able to make financial decisions with confidence. While COGS is pulled from the income statement, the inventory balance comes from the balance sheet. Aim to increase inventory purchase amounts to bring your ratio down to a more moderate, and profitable, range. For example, high-end goods tend to have low inventory turnovers.

Determining the right inventory turnover ratio for your business

You’re probably asking, “What’s a good inventory turnover ratio? The optimum inventory turnover ratio for retailers lies between two and six. In general, high inventory turnover is good unless your products are turning over so fast that you can’t keep up. You want to make sure you have inventory levels high enough so that you can fulfill all your orders.

Understanding your inventory turnover is a one-way ticket to increased profitability. This key performance indicator (KPI) is one of the single most important retail growth indicators as increasing your inventory turnover drives profit. Businesses with high inventory turnover enjoy reduced holding costs and can respond with far greater agility to evolving customer demands. Average inventory can be calculated by adding up the beginning and ending inventory numbers, and dividing them by two.

Brightpearl’s retail operations platform helps retailers stay on top of their data. You’ll be able to manage multichannel and multi-location retail operations with ease. As mentioned above, higher-cost items tend to move off the shelves more slowly. Customers tend to do their research and take their time before investing in big-ticket items like cars and electronics. You need to do your research and be sure that these items are worth the potential wait on the warehouse shelf.

The method you choose depends on which provides a better view of your company’s inventory and sales performance. Thus, inventory turnover — and the related inventory turnover ratio — is a powerful key performance indicator. Your Average Inventory (AI) is a calculation (or a very good estimate) of the value of your company’s inventory over a set period of time. You can obtain this information by looking at your closing inventories and opening inventories. Increased turnover is often due to high demand for a particular item, thanks to a strong marketing campaign, a promotion, or a celebrity using your product.

Alternatively, it could be the result of insufficient inventory. As problems go, ensuring a company has sufficient inventory to support strong sales is a better one to have than needing to scale down inventory because business is lagging. When you have low inventory turnover, you are generally not moving products as quickly as a company that has a higher inventory turnover ratio. Since sales generate revenues, you want to have an inventory turnover ratio that suggests that you are moving products in a timely manner. Grocery stores and other businesses that sell perishable goods often have a higher inventory turnover ratio because their products expire. Inventory turnover rate helps you understand how fast inventory moves through your warehouses.

A company’s inventory turnover measures the number of times stock is sold and replaced throughout the year. Turnover of 12 means that the average inventory moves through the store once a month. In practice, lead times are usually the driving force behind the observed inventory turnover ratios. Indeed, distant suppliers (possibly oversea suppliers) entail high stock levels, as the stock needed to cover the whole lead demand is higher, which mechanically lowers the inventory turnover ratios. Other factors like batch sizes, MOQ (Minimal Order Quantity), or EOQ (economic order quantity) also affect these ratios.

However, turnover ratio may also be calculated using ending inventory numbers for the same period that the cost of goods sold (COGS) number is taken. This gives you an idea of how well you’re managing each of these two categories of inventory. Since supply chain professionals use this metric to measure how well they manage inventory, their interest lies in the speed at which product is shipped out to customers. That means their focus is on unit quantities and not selling price. Average inventory is the average cost of a set of goods during two or more specified time periods.

Then multiply that number by 365, and you’ll know how many days it takes to sell your inventory. This information can help a company decide whether to raise prices, increase its orders, diversify suppliers, feature a product prominently in its marketing or buy additional related inventory. Because the inventory turnover ratio uses cost of sales or COGS in its numerator, the result depends crucially on the company’s cost accounting policies and is sensitive to changes in costs. For example, a cost pool allocation to inventory might be recorded as an expense in future periods, affecting the average value of inventory used in the inventory turnover ratio’s denominator. The inventory turnover ratio can help businesses make better decisions on pricing, manufacturing, marketing, and purchasing. It is one of the efficiency ratios measuring how effectively a company uses its assets.