Calculate your rate of inventory turnover to maximize cash flow
Your rate of inventory turnover is a key metric to understand if you want to optimize your cash flow, working capital, and inventory costs.
By calculating your rate of inventory turnover, you’ll have a better grasp on the market demand for your products, on the amount of obsolete stock you may be carrying, and what steps you need to take to sell or stock more inventory, depending on your turnover rate.
In this article, we’ll explore what inventory turnover is and how to calculate it before discussing a few ways to improve it. By the end, you’ll know what your rate of inventory turnover means and how to use that knowledge to increase the efficiency and profitability of your business.
What is the Rate of Inventory Turnover?
The rate of inventory turnover is a measurement of the number of times your inventory is sold or used in a given time period, usually per year.
It signals to your company’s managers and executives – along with your company’s investors – how well you’ve been converting your inventory into sales. It can also tell you how well your inventory is being managed, and whether or not it’s being mismanaged.
Here’s how to calculate your inventory turnover rate:
How do You Calculate the Rate of Inventory Turnover?
There are usually 2 ways you can calculate the rate of your inventory turnover:
- Sales divided by Inventory
- Cost of Goods Sold (COGS) divided by Average Inventory
Most analysts don’t use the first method of calculation because it can yield inaccurate results. Sales include a markup over costs, which could inflate your inventory turnover rate.
COGS divided by average inventory can give you a more accurate rate of inventory turnover. To calculate your inventory rate, you first need to calculate your average inventory.
Calculating Average Inventory
If you want to calculate your average inventory for a single fiscal year (12 months), you’ll first want to find the inventory counts from the end of each month (in dollar value) and add them all together.
Then, divide your total amount of inventory by the number of months you’re calculating (12 in this example) to get your average inventory for that period.
For example, let’s assume that the past 12 months you had varying inventory costs that added up to $168,000.
Divide $168,000 by 12 months and you get an average inventory of $14,000.
Calculating Rate of Inventory Turnover
Calculating your Cost of Goods Sold is a bit complicated and depends greatly on your products and business. Check out this post to learn more about the general methods for going about this.
For our example, let’s assume your COGS for the past 12 months is $130,000.
To calculate your inventory turnover rate, divide your COGS by your average inventory, which in this case gets us a rate of 9.29. That means 9.29 times out of the year, your inventory completely turned over.
What’s a Good Rate of Inventory Turnover?
Once you know your rate of inventory turnover, you can assess how to improve it.
To know whether your inventory turnover rate is high or low, you’ll want to compare it to your industry’s average.
Here are a few industry averages that might apply to you, as found on market research and analysis website CSIMarket:
- Internet, Mail Order, & Online Shops: 9.54
- Wholesale: 9.39
- Food Processing: 8.23
- Miscellaneous Manufacturing: 5.07
For the rest of this post, we’re going to assume you’re struggling with low inventory turnover since high inventory turnover typically just means you need more stock to cover consumer demand. Low inventory turnover, however, can lead to a host of problems.
What’s the Problem with a Low Rate of Inventory Turnover?
A low rate of inventory turnover could mean a lot of bad things for your business:
- You’re spending too much on holding costs like rent, insurance, etc.
- Goods that aren’t turning over are becoming obsolete in the market
- You’re ordering too much stock, too frequently
- You may have cash flow problems because you’re tying up too much capital in inventory
In order to prevent these problems from occurring, here are several ways you can raise your turnover rate.
Ways to Increase Your Rate of Inventory Turnover
There are many strategies you can use to sell and manage your inventory effectively.
Not all strategies will be applicable or work for you, but try a few and use those that work best for you.
Change your Pricing and Marketing Campaigns
The first thing to try is finding a way to sell more products – since this will not only improve your rate of turnover but also generate cash.
Brainstorm a few new marketing campaigns to find creative and clever ways to engage your target market and differentiate yourself from your competitors.
You might try playing around with your pricing strategies. Don’t just lower your prices – this can obviously cost you quite a bit.
Instead, test various tactics like:
- Seasonal sales
- Rush delivery service
- Flash sales
- Different pricing for different customers
- Product bundles
- Pricing structure ($47 vs. $50, or $49.50 vs. $49.99)
Keep testing until you find something that works, and then replicating and expand on the winning strategies.
Liquidate Obsolete Stock
If you suffer from a low rate of inventory turnover, you may have obsolete stock sitting in your warehouse. This could be due to a couple reasons, such as:
- Ineffective forecasting of customer demand
- Too much excess stock ordered
Either way, you need to focus on reducing your inventory as quickly as possible, and developing stronger inventory tracking systems so you know in real-time what is selling and what isn’t.
Forecast Customer Demand Better
Analyze every product’s past performance and level of demand in order to predict future sales trends. Pay attention to market changes, product innovations, and new competitors to stay on top of your market.
Redistribute Your Inventory
If you have multiple warehouses, then consider redistributing your excess inventory to a location with greater demand for those items.
This can reduce the need to order inventory in some locations while lowering your stock levels in those that consistently carry too much.
Track Your Inventory to Stay in Control
Through better tracking, you’ll able to know exactly how much inventory you have in real-time, what customer demand has been in the past, and eliminate inaccuracies in your stock count.
And if you’re tracking inventory in multiple locations with multiple warehouses, you need a system that can pull all that data together under one central dashboard so you can generate up-to-the-minute reports on the state of your business.
Tracking your inventory helps you use the other 4 strategies listed here more effectively, and allows you to accurately calculate your rate of inventory turnover.
Ready to Increase Your Inventory Turnover Rate?
Cloud-based inventory management software can automate your sales tracking, let you monitor every item as it moves through your business with RFID barcode technology, and integrate your inventory data into the rest of your business systems such as your ecommerce store or accounting software.
Get started with your free 14-day trial of DEAR Inventory today!
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