An essential job for many businesses is ensuring that they have ample inventory of the items they sell so that there will be no delays in fulfilling orders. One metric which measures how your inventory keeps up with sales is the inventory turns. In this article, we will learn about how inventory turns is calculated, analyzed, and how we can improve it.
Inventory turns, or inventory turnover, is a metric measuring how fast the inventory is replaced over time. It is calculated as the cost of goods sold divided by the average value of inventory during the period covered:
The cost of goods sold (COGS) can be calculated as the total cost of the items sold throughout a specified period of time. You can read more about COGS here. One way to calculate the average value of inventory is shown below:
The beginning value refers to the total value of the inventory at the start of the period and the ending value refers to the total value of the inventory at the end of the period. If you plan to calculate for a longer period of time, you should use the AVERAGE function in Excel or Google Sheets. Learn about AVERAGE function in Google Sheets here.
While the obvious choice in defining the inventory turns is to use the total sales for the given period, the disadvantage of using the total sales is that it can fluctuate easily due to several factors and events throughout the time period. For example, a business can run promos a few times a year, and these can have significant effects on the total sales for that period. Considering the cost of each good is preferable, because the costs have less fluctuations for a given period of time than the sales for each good.
The inventory turns is a powerful metric that you can use to check the state of your business. A slow inventory turn (low number) means that the sales are too little compared to the amount of goods being acquired for the business. The ideal, therefore, is to have a fast inventory turn (high number), which means that your business is doing well. If, however, your inventory turn is too fast, it means that you need to expand your business! You might be losing out on additional sales that you were not able to fulfill due to inventory limitations.
As inventory management is an elaborate science and art, you need to consider the following to improve your inventory turns, as listed by Oracle Netsuite:
Increasing sales will result in increasing the speed of your inventory turns. In fact, your ability to deliver the items that your customers are buying will make or break your business! Therefore, the cost of the supplies offered by your suppliers should not be the sole criteria in selecting them. You should look at how reliably they can deliver the supplies you need! The best suppliers aren’t always the ones with cheapest supplies, but the ones who can most reliably deliver the supplies, especially when you need them.
One big reason why a business has a slow inventory turn is because of so-called dead inventory. Dead inventory refers to goods that stay in the warehouse for a long time simply because they are not sold. To deal with dead inventory, one effective method is to sell them at a discounted price. While one may see this as taking a hit in the expected revenue, this is still better than insisting on the original price and still not selling them.
You will benefit from analyzing the inventory turns of your competitors in your industry, because they can serve as benchmarks to what can potentially be achieved. If they have fast inventory turns, it means that they are doing something right. Is it the sales pitch? Is it inventory management? Or is it the new products?
Your inventory size should depend on the market demand, which can change over time. You should look at how the demand changes over time. Several industries feature seasonal changes; for example, the demand for light clothing will peak at summertime and will be lowest during winter. Uncovering these patterns will help you improve forecasting of expected demand for the items you sell.
Finally, automating your systems for processing orders and inventory tracking will also help you improve your inventory turns. How? You will get a real-time overview of your inventory as it gradually sells. This will help you order new stock of your best items and also quickly discover which items could potentially become dead inventory, allowing you to make discounts for those items at the right time before their overstay in the inventory impacts your capacity to adjust to increased demands for the other items.