The inventory turnover ratio is one of the most telling indicators of how successful your business will run in the future.
Having a clear understanding of the inventory turnover ratio is the key to running a successful business. The inventory turnover ratio is an indicator that shows how efficiently a company manages its supply chain and sales activities.
Let's take a deep dive into the inventory turnover ratio.
1. What is an inventory turnover ratio?
The inventory turnover ratio shows the frequency of inventory turning into sales in a given financial period. By definition, it is an important measure of how well a business is doing selling its 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, a 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 do you calculate 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 using a percentage (%).
Here are the details of calculating the inventory turnover ratio.
1. Get the total number of items sold in a given period. The period can be a year, a month, or a specific time frame you choose.
2. What are the beginning and ending inventory for a given period?
When applied as a year, you need the beginning and ending inventory for the year; when applied as a month, you need to obtain the beginning and ending inventory for the month.
3. Add the beginning and ending inventory volume, then divide the number by 2; the result is the average inventory for that period.
4. Finally, divide the number of items sold by the average inventory; that is the inventory turnover ratio.
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3. Use inventory turnover ratio in business
Having a high inventory turnover ratio means that the business is moving its products quickly to its customers. It also entails increased return on capital, as well as lower insurance premiums and warehouse fees. The ideal inventory turnover ratio is between 4 and 6 for a year, 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 businesses in the same or similar industry.
Having a high inventory turnover ratio is not necessarily good for business, however. If the ratio is excessively high, there may be a shortage of raw materials or products, which may cause supply chain disruptions. Or if you find yourself constantly reordering, it could be an early sign of impending stockout, meaning that your inventory level is too low to support customer 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 product handling or warehousing. This is where the inventory turnover ratio helps you figure out the way to optimize inventory to meet your business's needs!
So, why BoxHero?
Knowing your business's inventory turnover ratio is crucial for its success for various reasons. Once you understand and start using the 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 waste precious resources handling overstock. What’s best with BoxHero is that you don’t need to do any of the calculations yourself.
With BoxHero’s inventory turnover ratio analysis feature, you will get all the reports hassle-free and in real-time!