How to Calculate Inventory Turnover: Ratio, Formula, & Calculator
Stitch is a retail operations management platform for high-growth brands seeking inventory and operational control.
Table of Contents
- What is inventory turnover?
- How to calculate inventory turnover
- Analyzing your inventory turnover metrics
- Applying inventory turnover to inventory management
What Is Inventory Turnover?
Inventory turnover is a number that tells you how quickly a retailer is selling and replacing inventory during a period of time. The number indicates how many times stock has been “turned over,” or sold and replaced, in that given time period. The higher the number, the less time stock sits on shelves — which also translates to lower holding costs.
Inventory turnover is a valuable inventory management metric for fast-growing multi-channel retailers to monitor and analyze over time. Specifically, it provides insight into how efficient your operations are and how healthy your return on investment (ROI) is.
Other terms for inventory turnover include:
- Inventory turns
- Inventory turnover ratio
- Stock turn
- Stock turnover
How to Calculate Inventory Turnover
There are a few different ways to calculate inventory turnover, which we’ll outline below. For the most accurate calculations, you’ll want to use as many data points as possible. Let’s say we’re analyzing a year-long time period. Rather than averaging the beginning and ending numbers, consider pulling an average of twelve numbers, one taken from each month.
The Inventory Turnover Ratio Formula
As noted above, if you want to know how to calculate inventory turnover, you’ll need to determine the time period for which you’d like to measure. You’ll then use the average inventory and cost of goods sold (COGS) for that time period to calculate inventory turnover.
- Average inventory tells you how much stock you typically have on hand; this number is a dollar amount, accounting for the value of the inventory.
- COGS calculates how much it cost you to provide the goods that you sold during that time period. This includes manufacturing, holding, and labor expenses associated with creating your products.
To get your inventory turnover ratio, divide COGS by average inventory; that number will help you understand how many times you sell through all of the stock you have on hand during that time period.
Here is an inventory turnover ratio formula you can use:
Inventory turnover = COGS / average inventory
And here’s how to calculate COGS and average inventory:
COGS = beginning inventory + purchases during the period – ending inventory
Average inventory = (beginning inventory + ending inventory) / 2
How to Calculate Inventory Turnover Quickly
Looking for a quick calculation on the fly? An alternative to the inventory turns calculation above would be a simpler formula.
Inventory turnover = sales / inventory
Sales and inventory numbers are typically more readily available, and you can often pop into your inventory management software to quickly pull those metrics. But be warned: This calculation is NOT the most accurate way to calculate inventory turnover. Sales are often higher than the COGS because customers pay more for the products so that retailers can make a profit.
This approach is best for basic reporting or status checks. If you’re conducting an analysis on your business, you’ll definitely want to use the former formula.
Inventory Turns Calculation Example
Now that you have the inventory turns formula, let’s put it to work with a hypothetical scenario.
In 2017, you generated net sales of $10 million; your COGS coming in at $4 million. Average inventory for the year was $2 million.
Inventory turn = $10 million / $2 million = 5
This means that over the course of the year, you sold and replenished your total inventory 5 times — that’s 73 days.
Analyzing Your Inventory Turnover Metrics
As with any data analysis, it’s important to look at the numbers holistically rather than in a vacuum. This same principle applies to inventory turnover.
For example, if your inventory turnover ratio is higher, that’s typically a good sign. This means that you’re selling products quickly, and there’s a sufficient amount of demand. However, you’ll want to check out how many times you’ve had out-of-stocks or backorders. If that’s a common occurrence, you may not be reordering fast enough to keep up with demand, which could hurt your bottom line. Out-of-stocks cost retailers almost $1 trillion, according to IHL Group.
On the other hand, a lower inventory turnover rate indicates that stock isn’t moving very quickly, and there isn’t much demand. Perhaps you overstocked or haven’t run effective marketing and advertising campaigns to drive sales. Retail Touchpoints reported that overstocks cost retailers $471 billion in 2015 alone.
A comparative analysis of your inventory turnover can also provide great insights into your business. You can compare this to your industry average to see how you measure up against the competition. CSIMarket.com has a resource where you can view average inventory turnover ratios broken down by sector. Strategos also has data pertaining to merchant wholesalers.
After calculating inventory turnover for a couple of cycles, you can also compare yours period-over-period. This tells you whether or not you’re improving with time.
Usually, you want to aim for a high inventory turnover rate, and work to increase that number over time. This means you sell inventory quickly.
Every industry is different though. For example, when considering a luxury jeweler, there probably isn’t as high of a turn as there is for a grocery store. Grocers have products that expire more quickly and are in constant demand by a wide audience, whereas luxury jewelry experiences less demand and less-frequent purchases. That’s when a comparative analysis comes into play, as well as considering the context in which spikes or drops happen.
For a quick glance at whether your inventory turnover ratio is good or not, multiply it by your gross profit margin (in percentage). You’ll want 100 percent or more; anything less indicates that there may be an issue with your inventory turnover rate, and further diagnosis is needed.
Applying Inventory Turnover to Inventory Management
Inventory turnover can, and should, inform purchasing decisions. With it, you can see which products have the most demand, and which ones are sitting on the shelves and costing you money. Stop ordering the ones that don’t move, run additional promotions to generate demand, or take another look at your pricing strategy.
For the items that have higher turnover rates, look at ways to capitalize on this success. Maybe you introduce additional color variants, or craft marketing campaigns to reach new audiences.
Note our example from before: It takes an average 73 days to sell all of the stock you have on hand. Combine this number with demand forecasting data and lead time to determine the ideal reorder point and minimum stock level or safety stock. A lot of inventory management software can automatically reorder for you, based on these metrics.
Remember: It’s important that all internal teams collaborate effectively, as well as communicate key findings cross-departmentally.
With a cloud-based inventory management software like Stitch Labs, your team can all access the same data and stay in sync. Plus, automated reporting will help you keep an eye on retail reporting and metrics, control inventory, and spend more time focusing on growing your business.