Inventory management is the most telling indicator of how successful your business will run in the future.
Having a clear understanding of inventory turnover is the key to running a successful business. The inventory turnover ratio is the indicator that can tell how efficiently a company manages its supply chains for its inventory management.
Let's take a deep dive into inventory turnover ratio, one way to determine if your business is running smoothly enough.
1. What is the inventory turnover ratio?
The ratio shows the frequency of conversion of inventory into sales in a given financial year. By the definition, it is an important measure of how well a business is doing or selling products.
In other words, it refers to the ratio of inventory volume to shipment volume of goods over a period of time. In particular, inventory volume here refers to the average monthly inventory volume. For example, the ratio of 500% indicates that the stock has rotated 5 times in a given period.
Simply put, it is the rate at which all inventory is sold and refilled over a period of time. Just think of it as a turnover rate at a restaurant where tables are filled and emptied.
2. How to calculate the inventory turnover ratio?
The inventory turnover ratio formula is the cost of goods sold divided by the average inventory for the same period, and it is common to mark it as “turns” rather than as a percentage (%).
If you want to know the details about how to calculate inventory turnover, here they are.
1. Get the total number of items sold in a given period. The period can be a year, a month, or else.
2. What are the beginning and ending numbers of inventory for a period?
When applied to a year, you need the beginning and ending inventory numbers of the year; when applied to a month, you need to obtain the beginning and ending numbers of the month. Just remember to use the numbers from the same period as the period from Step 1!
3. Add the beginning and ending inventory volume, then divide the number by 2; the result is the average inventory.
4. Finally, divide the total number of items sold (from Step 1) by the average inventory (from Step3); that is the inventory turnover ratio.
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3. How can the inventory turnover ratio be used in business?
A high inventory turnover?
Having a high inventory turnover ratio means the business has a lot of “turns” of inventory. It means the increased return on capital, prevents the loss of inventory of the goods, as well as lowers insurance premiums and warehouse fees. The ideal inventory turnover ratio is between 4 and 6, but this cannot be true for every business. It is critical to understand the characteristics and attributes of the industry you are in. A business can have a high or low inventory turnover just by its nature; thus, it is necessary to compare your number to those of the businesses that have similar turnover ratios to yours.
Having a high inventory turnover is not necessarily good for business, however. If the turnover is excessively high, there may be a shortage of raw materials or products, which may cause supply chain issues. Or if you find yourself constantly reordering, it could be an early sign of out-of-stock, meaning that the inventory is too low to meet consumers’ demand. On the other hand, if you have too much inventory stored in the warehouse for too long, you will end up wasting money on handling products or warehousing. This is where inventory turnover helps you figure out the way to optimize inventory to meet your business need!
So, why need inventory turnover with BoxHero?
Knowing inventory turnover is crucial to the success of your business for numerous reasons. Once you understand and start using inventory turnover ratio to your advantage, you won’t find yourself wondering if your inventory levels are adequate again. You don’t have to waste your time worrying about understock or sink down money handling overstock. What’s the best with BoxHero is that you don’t need to do any of the calculations.
BoxHero does it for you! With BoxHero’s inventory turnover analysis feature, you will get all the reports hassle-free and real-time!