Demystifying inventory turnover: a simple formula and tips for success
A couple of years ago, a viral TikTok video exposed just how long some items can sit idly on store shelves.
The culprit was an Olay moisturizer, which had been taking up space in the cosmetic section of a TJ Maxx store for over a decade. While extreme, the video exposed a common pain point that retailers still experience today: slow-moving inventory.
Needless to say that as an online store owner, you want your items to sell quickly. Items that struggle to sell can hurt cash flow, take up valuable space in your warehouse, and make it difficult to plan ahead.
To avoid becoming the next viral TikTok video, it’s important to understand what inventory turnover ratio is and how to plan for it. Keep reading for essential tips.
What is an inventory turnover ratio?
An inventory turnover ratio represents the amount of times your inventory is sold and replaced within a specific period of time. This could be monthly, seasonally, annually—or any other increment of time that’s meaningful to you.
When your business sells its entire stock—excluding items lost to damage or shrinkage—this is considered one complete turnover.
The inventory turnover ratio formula can be used to better understand how well your company’s sales are going. It can also be used as a forecasting tool to estimate how often you’ll need to restock, based on how long it will take to sell your existing and not-yet-purchased inventory.
Why is it important to calculate inventory turnover?
Inventory turnover is an important indicator of the health and performance of your products and overall company.
Lower-than-average turnover can signal a slump in market demand for items that may have sold well in the past. It could also mean that you’re lagging behind your competitors in terms of sales and/or marketing performance.
By contrast, higher-than-average turnover can indicate that you’re selling out of things too quickly and that you may need to plan better to meet consumer demand.
Whether your ratios are high or low, knowing the inventory turnover ratio for your products can help with inventory management. It can also inform how you price your products, offer incentives (such as limited-time sales), and choose what mix of items to sell.
Benefits of calculating your inventory turnover ratio
Understand how well you’re managing your inventory (a higher ratio means you’re moving goods faster than a lower ratio)
Reduce waste in your warehouse
Ensure that you’re stocking enough inventory to meet customer demand
Gauge liquidity of your business (e.g., if you have sufficient cash available on hand or in the bank)
Negotiate better deals with suppliers by purchasing just the right amount of inventory
Adjust your pricing strategy to keep products moving and profit margins high
How to calculate inventory turnover ratio
The inventory turnover ratio formula looks like this:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) ÷ Average (or Total Value of) Inventory
COGS refers to the cost of manufacturing or sourcing the products that are sold within a given time period. This is what appears on your annual income statement. It is calculated using the below formula.
COGS = Beginning Inventory + Total Purchases – Ending Inventory
Beginning inventory is the monetary value of your inventory at the start of the accounting period that you’re measuring, which should be the same as the ending inventory of the previous period. This covers both finished goods, raw materials, works in progress, and suppliers related to your products.
Total purchases are all the costs associated with purchasing or producing your products, otherwise known as direct costs. It includes material costs, labor charges, and other investments directly related to manufacturing or buying new products. It does not include indirect costs like utilities, payroll, shipping fees, or sales and marketing.
Ending inventory is the monetary value of the inventory that hasn’t been sold during the given period. So, if you have 30 units leftover, you would multiply 30 by the cost of sourcing each unit.
Average inventory, on the other hand, refers to the average value of your inventory within the same period (i.e., two or more accounting periods). It is calculated using the below formula.
Average Inventory = (Beginning Inventory + Ending Inventory) ÷ Number of Periods
It works the same as any other average. In other words, if you’re looking at a three-month period, you would get the sum of your inventory at the end of each month and divide that by the number of months. Alternatively, you could get the average over two years or two quarters.
Inventory turnover ratio example
Let’s say you sell soap, candles, and herbal apothecary products from your online store and brick-and-mortar location. You make the soap on site in a small manufacturing area of your brick-and-mortar store, but you order the candles and other items from third-party suppliers.
You want to calculate your inventory turnover ratio for one year to understand how often you exhaust and replenish total inventory during that time.
You started with $30,000 worth of inventory, the same amount you ended the previous year with. Throughout the year, you purchased $70,000 worth of new inventory. By the end of the year, you sold $30,000 worth of inventory—leaving your business with $40,000 of leftover inventory.
You would calculate COGS by:
COGS = $30,000 + $70,000 – $40,000
This gives you a COGS of $60,000. You then calculate average inventory:
Average Inventory = ($30,000 + $40,000) ÷ 2
Which gives you $35,000. Finally, you can calculate your inventory turnover ratio:
Inventory Turnover Ratio = $60,000 ÷ $35,000
This gives you an inventory turnover ratio of 1.71. Meaning, you sell out of your inventory 1.71 times in one year. Translated into days (365 ÷ 1.71), you sell out every 214 days (about every seven months).
What is the best inventory turnover ratio?
The short answer: it depends.
Generally, the higher the inventory turnover ratio, the better. A higher turnover ratio number means that you’re selling and restocking your inventory more frequently. (Though there is such a thing as turnover that’s too high, indicating that you need to keep more inventory in stock.)
In the example above, you would be replenishing your entire inventory once a year. But let’s say that your hypothetical soap boutique had a stellar year and you sold way more products this year, lowering the average inventory value to $20,000. Your inventory ratio would increase to 4.5, indicating that you’d have to replenish your inventory around every three months.
That’s great for soap, but probably not realistic for other product categories like fine jewelry. Private jewelers only turn their inventory, on average, about .7 times per year and generally don’t carry much inventory in their stores. That’s a far departure from products like clothing, soap, and groceries.
For extra precision, you can calculate the turnover ratio for each category of products you sell, for particular products, and/or for particular seasons. This allows you to better anticipate when to order certain items, plus compare the performance of certain product lines and categories against each other.
5 tips for optimizing your inventory turnover ratio
Maintaining the right amount of stock at the right time is every store owner’s goal. But anticipating customer demand and stocking up accordingly is no easy task, especially for SMB owners who wear many different hats.
Your inventory turnover ratio is a powerful metric that can serve as a compass for how to better meet your customers’ needs, while minimizing your overhead.
Here are a few ways you can improve your inventory turnover ratio.
01. Monitor trends that impact demand
Before you can optimize your purchasing strategy, you need to have a good grasp of normal buyer behaviors and external factors that could impact their decisions. Which products do your customers normally gravitate towards? What are your best sellers and not-so-good sellers in a given category, region, and/or season?
Beyond this, are there economic or social factors that might impact customer behaviors? Are your findings consistent with how similar items are performing across other channels or audiences?
Compare your top sellers with Amazon’s best sellers’ list, eBay’s best selling items, and other relevant sources. Use tools like Exploding Topics or social media to simultaneously keep ahead of viral trends and surges (or dips) in demand.
While inventory turnover is a good indicator of performance over time, it doesn’t give the full picture; you’ll need other tools and processes to be able to fill in the blanks.
02. Take a look at your product positioning
If inventory turnover is low, it’s possible that your product messaging and/or overall listing isn’t resonating.
Take a look at your product descriptions and check that they’re honing in on the right benefits of your product. Consider whether you’re providing enough information and effectively building trust, or if you’re trying to force it through generic superlatives (“our products are excellent”) and biased statements.
Look at your product page as a whole and compare it with other high-converting product pages. Are you missing high-quality, impactful photos? Do you need to better showcase your differentiators? What are your top customers saying about you and how are you surfacing those positive reviews on your page?
03. Experiment with new channels and strategies
There are many other reasons as to why your inventory turnover ratio may be what it is. It may just take some experimentation to figure it out.
For starters, you could tweak prices for your items; you could increase prices for high-demand items while marking down slow-moving inventory to keep sales flowing. Alternatively, you may launch ads (with Wix eCommerce’s built-in marketing features, at that) or branch out to marketplaces in order to increase your products’ reach.
Read Also: Multichannel selling: boosting sales while protecting your brand
You could even try bundling your products, accepting pre-orders, or offering a subscription service to keep cash flow consistent and predictable.
04. Optimize your supply chain
In order to sustain a certain level of inventory at any given moment, you need an adaptable and reliable supply chain. Work with trusted suppliers, source locally (where possible), and cultivate long-term relationships with vendors who know you and your business.
You can additionally insulate yourself from disruptions—like when cargo ships roll and lose dozens of containers—by streamlining and diversifying your supply chain.
Always have a backup supplier if your primary one isn’t able to keep up with production. And consider techniques like dropshipping to minimize the amount of inventory that you have on-hand and to free up more capital.
05. Take advantage of automation
Automating key inventory management tasks will help ensure you don’t run out of stock on popular items or—if you do—you can restock quickly.
For example, using a platform like Wix eCommerce, you can automatically sync inventory across your various sales channels, ensuring that you don’t oversell or lose visibility over your products.
You can also forward orders to your suppliers and fulfillment partners, monitor sales performance, and notify customers when a sold-out item is back in stock to keep inventory moving.
Find your sweet spot
Too high or too low of an inventory turnover ratio isn’t good for business. While low turnover can lead to a stockpile of goods at your warehouse, high turnover can lead to frequent stockouts and angry customers.
Make sure to stay ahead of your rate for optimal inventory efficiency. Find your ideal ratio and proactively take steps to ensure that inventory works in your favor.
Editor, Wix eCommerce
Allison is the editor for the Wix eCommerce blog, with several years of experience reporting on eCommerce news, strategies, and founder stories.