Rate of Inventory Turnover: What it is and How to Improve it

5 minute read

Do you know what your company’s inventory turnover rate is? If not, you’re not alone. Many business owners and warehouse managers don’t realise the importance of this metric – but they should. The inventory turnover ratio measures how quickly a company sells through its stock of goods. A high turnover rate is generally good since […]

Published on: Feb 15, 2023

Datapel is a leading inventory management system trusted by thousands of businesses for critical functions & processes.

Do you know what your company’s inventory turnover rate is? If not, you’re not alone. Many business owners and warehouse managers don’t realise the importance of this metric – but they should.

The inventory turnover ratio measures how quickly a company sells through its stock of goods. A high turnover rate is generally good since it indicates the company is efficient at selling its products. In contrast, a low turnover rate means your products may take up valuable shelf space and collect dust. Whether you’re looking to improve your company’s turnover ratios or want to learn more, we’ll cover everything you need to know.

What is inventory turnover?

Inventory turnover is a critical financial metric for businesses, as it is an essential indicator of a company’s efficiency and financial health. Calculating turnover involves dividing the cost of goods sold by the average inventory – essentially dividing all sales made throughout a period into the total amount of stock purchased during that same time frame.

The turnover ratio offers insight into how productively a business can turn its products over, demonstrating its ability to anticipate customer demand and keep stock in line with market trends. In other words, companies with high ratios are thought to be well-optimised. At the same time, those with low numbers can signal issues managing stock or investing in unnecessary amounts of unsold merchandise.

So what is an ideal inventory turnover ratio? That depends on several factors, including your industry, maturity, and business size. For example, retailers may have a much higher turnover rate than manufacturers.

It’s essential to note inventory turnover ratios should be part of a more extensive analysis of your business operations. Benchmarking against other businesses in your industry can provide an accurate picture of how well you manage your inventory and how to interpret the inventory turnover ratio.

Factors that affect inventory turnover

inventory turnover warehouse management

Warehouse management is an often overlooked but critical part of managing inventory turnover. When the warehouse is managed well and has the right balance of processes and technology, it can help improve how quickly you turnover inventory. Conversely, excess inventory due to poor planning can seriously detract from a company’s ability to move through products rapidly, costing them money in storage costs and reduced liquidity.

Understanding how demand, sales velocity, material availability, and other factors affect performance and turnover is an essential step toward properly managing inventory in a business. By carefully monitoring these various inputs into the system, companies can better ensure they have enough stock on hand without disrupting their internal operations or negatively impacting customer satisfaction.

What causes a low inventory turnover ratio

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  1.   Seasonality: Seasonal fluctuations in demand can cause inventory levels to become too high or too low. Warehouses may want to use a more extended period when calculating this ratio to account for seasonal trends and peak seasons.
  2.   Bulk Purchases: Buying large quantities of products at once can be an opportunity to save on purchase prices or shipping but can also lead to excess inventory. 
  3.   Poor Forecasting: If warehouses don’t have accurate forecasts of future demand, they may have too much or too little inventory. To improve forecasting accuracy, warehouses should use data-driven methods such as predictive analytics and machine learning algorithms.
  4.   Reduced Demand: A decrease in customer demand can lead to overstocking and low turnover rates. To address this, warehouses should focus on understanding marketing efforts such as promotional campaigns and discounts to increase sales and reduce excess inventory levels.
  5.   Safety Stock: Having too much safety stock on hand can lead to low turnover rates since it takes longer for the warehouse to sell off the extra stock before restocking again. 

What causes a high inventory turnover ratio

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A high ratio means your products are moving quickly, and you can restock and replenish your stock on time. When the ratio is too high, it can cause additional strains on operations, such as stockouts, rushing orders, or increasing shipping costs.

  1.   Sales Promotions: Companies can increase sales by offering discounts and promotions, resulting in a higher ratio.
  2.   Discounting: Offering product discounts can increase demand, leading to a higher turnover ratio.
  3.   Increases in Demand: A sudden increase in product demand can cause the ratio to rise.
  4.   Poor Forecasting: Poor forecasting of customer demand could lead to purchasing too much inventory, resulting in a high turnover ratio.
  5.   Misalignment of Sales, Marketing, and Operations: When sales, marketing, and operations are not aligned, it could result in inefficient operations and a high and low ratio.

Improving turnover

Improving your business’ inventory turnover can be challenging, but luckily several vital strategies can help make a big difference. Proper forecasting and demand planning techniques ensure you have the right stock when needed. Additionally, reducing lead times in the production process will help ensure products don’t become obsolete too quickly.

Finally, improving accuracy when recording stock levels helps to minimise errors and avoid overstocking due to double-counting or misplacing track of certain items. With these strategies in mind, you’ll be well on your way to optimising turnover for your business.

1. Analyze

Have a clear understanding of the movement of your inventory. Identify top sellers, slow movers, and dead stock. This data can be used to make better decisions when ordering.

2. Optimise Purchasing

Adjust your purchasing strategy to order only what you need, when you need it. If turnover is a top KPI, businesses should reduce bulk purchases and find more cost-effective ways to purchase smaller quantities more frequently. 

3. Forecasting

Businesses should improve their forecasting accuracy to predict seasonal fluctuations and customer demand better. One popular method is Sales & Operations Planning (S&OP). The purpose of S&OP is to align sales and operations to ensure they can support each other in a way that executes the company’s overall strategy.

4. Implement a WMS

Use a warehouse management system to track your sales data, and inventory movement and identify customer trends. You will be able to adjust your fulfilment strategy to meet the needs of growing demand.

5. Promotions

Running specials can help you move slow-moving items and boost sales for specific products. This will allow you to clear out inventory and improve your inventory turnover ratio.

In Closing

It’s clear that turnover is a fundamental measure, and it’s essential to understand how to calculate it and what factors can influence it. By understanding these concepts, companies can gain an edge over their competitors in managing their inventory effectively.

Additionally, by utilising Datapel, businesses can take the next step in optimising their inventory management system and increasing the industry standard on turnover rate. Investing in an accurate system such as Datapel Cloud.WMS today has its long-term rewards: ensuring better rates into the future.

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