February 28, 2024

The Role of Inventory Turnover Ratio in Building a Successful Business

The retail industry constantly strives to find the right balance between inventory and sales. Whether it is done through effective forecasting, marketing expertise, or inventory management, the end goal is to increase sales. Worldwide, inefficient inventory management processes cost businesses a whopping $1.9 trillion

In the United States, 43% of SMEs operate without an inventory tracking system or use manual methods, and the complexity faced by businesses in managing inventory cannot be stressed enough. For instance, overstocking items that are not high in demand can lead to overloaded warehouses containing expired products that take up unnecessary space. Not only that but spending too much on inventory is also not beneficial for growing businesses. The capital should rather be spent to boost sales and generate revenue. To less inventory leads to stock outs and poor customer experience.

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What is Inventory Turnover?

Inventory turnover is defined as the amount of time a particular item spends in a company’s inventory, from its purchase till when it is sold. The financial unit known as the inventory turnover ratio depicts how many times a company sells its entire inventory in a given period. For omnichannel retailers, inventory turnover is a benchmark that measures how quickly a company sells its products. It enables them to efficiently manage assets, as well as help, decide when and how to invest in new items. 

Modern businesses realize the importance of supply chain visibility and developing an efficient inventory turnover strategy. Knowing how often they need to re-stock, or which items sell faster, allows them to take better decisions for the future. On the surface, it seems that inventory management is just one of the aspects a business has to consider. However, taking into account the areas affected by a weak inventory management system, it is important for companies to assess where they stand. For instance, keeping an eye on inventory helps get a hold of the next pricing strategy, purchasing, manufacturing, and marketing.

Inventory Management - Key Statistics

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Inventory Turnover from a Business Perspective

Keeping track of inventory is important to ensure timely order fulfillment, which in turn leads to higher customer satisfaction. Businesses that do not have effective inventory management systems tend to experience stockouts and delays in order deliveries. Manual methods of inventory turnover management take up a lot of time and expertise, which is simply not feasible for today’s modern business environment. That being said, technological advancements have contributed to the development of omnichannel solutions that provide retailers with the ability to get inventory forecasts while eliminating the risks of human error.

Make your business more profitable

A well-designed inventory management system enables companies to grow in the right direction by optimizing stock orders, warehousing, and distribution. Achieving growth in the retail industry requires a decent number of sales and profitability. Inventory turnover is the definitive key performance indicator (KPI) for the retail sector as it helps businesses plan ahead in order to increase profitability. 

When a business has a high inventory turnover ratio, they become agile and respond effectively to constantly changing customer needs. It’s no secret that adopting a customer-centric approach accounts for success, which is one of the aspects enabled by a good inventory turnover. Apart from ensuring profitability and providing better insights into customer demands, inventory turnover also helps reduce holding, shelf space and clearance sales costs.

Improve your decision-making

Inventory management is one of the key aspects that reveal how any business will perform in the coming years. Understanding the rate of product sales and customer demands is essential to ensure timely purchases of items and improved decision-making. Similarly, businesses must know when, what, and how many items to order. The inventory turnover ratio helps form a clear picture of all units in stock and allows businesses to create strategies knowing which of their products remain in the inventory for too long and which ones sell quickly.

As a result, the company is also able to work around product pricing and discounts in a more efficient manner. In general, when the term inventory turnover ratio is heard in an emerging retail business, it is assumed that the calculations will be mind-boggling. However, that is not the case with modern inventory management solutions in your arsenal. The right inventory control system helps you take care of stocks, purchases, and manufacturing without going through Excel sheets. For instance, an automated inventory management solution can help companies ensure that they have enough stock in locations where customer demand is higher. Similarly, the number of items to be supplied can be reduced for a location that sees products on the shelves for long periods of time. Utilizing financial data from bank statements and inventory turnover ratios, a robust omnichannel inventory management solution can provide a detailed overview of entire retail operations.

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Calculating Inventory Turnover Ratio for Your Business

Every business faces ups and downs in sales, meaning the inventory turnover ratio should be calculated considering the peaks, troughs, and outliers in sales trends. For a particular period, say a month or a year, the inventory turnover ratio is calculated by dividing the cost of items sold by the average number of items in the inventory. Taking an average of the number of items in the inventory allows for a definitive measure of the inventory turnover ratio. For instance, items that sell only at a particular time of the year and need to be ordered in an irregular fashion are also included in the inventory turnover ratio. 

Inventory Turnover Ratio formula

That being said, the inventory turnover ratio is often calculated with the inventory numbers at the end of the period for which the cost of goods sold is considered. Regardless of what formula a retail business adopts for calculating the inventory turnover ratio, they need to have raw data from balance sheets and have a clear idea of what each number depicts. The cost of goods sold includes the price of raw materials used as well as other working costs involved in its production. Then, taking the average of the items in the inventory over a period of time provides the business with a clear figure to be used in calculating the inventory turnover ratio.

Achieving the Ideal Inventory Turnover Ratio

In simple terms, achieving the ideal inventory turnover ratio depends entirely on the nature and scale of the retail business. However, growing businesses can adopt a highly reliable inventory management solution to get a competitive advantage. An inventory management solution provides helpful insights into weekly, monthly, and yearly sales, and allows efficient management of product demand and supply.

Apart from streamlining the process of inventory management and providing all the information a retailer needs on one dashboard, XStak’s omnichannel inventory management solution automates stock management, meaning you no longer have to worry about stock levels and inventory.

What is a good inventory turnover ratio?

Inventory management is not something every growing business can manage without the required expertise. Knowing what a good inventory turnover ratio is for your particular business is a similar challenge, as it varies from company to company. According to industry experts, the best inventory turnover ratio for businesses in the retail sector is between two and six. 

This implies that a business that has an inventory turnover ratio in the range of two to six has achieved a balance between sales and inventory. Such a business does not fail to manage supply and demand as it has just the right number of items in its inventory at the right times. Neither does it have to keep excess items in its inventory for longer periods, nor does it face the concerns of running out of stock.

What is a bad inventory turnover ratio?

For most businesses in the retail industry, an inventory turnover ratio below two is considered unfavorable. The reason is - such a low inventory turnover ratio represents unsatisfactory numbers of sales and product demand. This situation results in an empty inventory, which means the company has bought or rented a warehouse for absolutely nothing. For a growing retail business, wasting resources and space is a sign of shutting down. Obviously, no business owner would want that.

It’s not just a very low inventory turnover ratio that is bad, as the numbers above six also represent a situation that no business would want. An inventory turnover ratio above six means that the company is unable to meet the demand of customers due to low inventory levels and is unable to make any sales. It can also mean that customers are shying away from the company’s products or services due to poor quality or delays in delivery.

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Techniques for Optimizing Inventory Turnover

Considering the retail industry, achieving the best inventory turnover ratio is more than just a game of calculations and expertise. For the majority of sectors, a ratio between 4 and 6 doesn’t represent a significant difference, meaning a company is selling its entire inventory at an average of once in two months. But when it comes to optimizing the inventory turnover ratio for your particular brand, there can be no comparison with another company unless it is operating on the exact same scale and selling products that fall under a similar category. Quite surprisingly, inventory turnover varies with numerous factors including the target market and what products a company is selling.

To understand the concept better, let’s consider a sector that deals with fast-running items such as a supermarket or a pharmacy, which require re-stocking and sales quite often. Such retail businesses would require a highly optimized inventory turnover management system to achieve peak efficiency. Similarly, industries that have higher holding costs like sellers of electronics and cars also strive for a high inventory turnover ratio to ensure minimum expense and higher profits. The sectors that can work with a low inventory turnover ratio are sellers of luxury items like precious metals, where there is a huge margin for profit.

Inventory turnover and open-to-buy systems

When it comes to retail businesses that use ‘open-to-buy’ systems for their inventory, managing stock levels, and purchases are much easier. Open-to-buy systems allow businesses to manage budgets and enhance their process of purchasing stock at the right time. These systems work by presenting the inventory levels and finances in front of the business manager under one omnichannel platform.

XStak’s Order & Inventory Management allows retailers to set their own units and parameters for the costs of products. In this way, retail businesses can get highly optimized budgets for purchases in every category. It indicates when to buy an item based on its sales pattern. As a result, the business can get accurate estimates of inventory levels, including when they need to make purchases, and how much space they have left.

Inventory turnover and dead stock

For a retail business, whatever its scale, having expired or dead items in the inventory is the worst thing that can happen. Purchasing and storing extra items in your inventory means they will either go to waste or take up unnecessary space. Items that are specific to particular times of the year, like Christmas, are highly risky. These products can become the reason to disturb the inventory turnover ratio of a business if not handled with the right inventory management solutions.

An excess of items that are not sold throughout the year in a company’s inventory account for wastage of capital. This is why the need for calculating the inventory turnover ratio of your company cannot be stressed enough. Knowing the ideal inventory turnover ratio for your particular business allows you to develop a balanced supply and demand mechanism, which in turn helps avoid loss of money due to dead stock.

That being said, today’s inventory management solutions for the retail sector come packed with modules to help businesses plan their stock purchases smartly. Implementing such a solution as a key driver of your business operations gives you the ability to manage your inventory in the most efficient way. In essence, you will know when to order new items, and in what quantities.

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How XStak Helps Improve Inventory Turnover

XStak offers an omnichannel retail operating system for streamlining inventory management in modern businesses. Our inventory management solution enables your retail business to manage stock levels and purchases for any given number of branches and locations. With XStak, your business can access real-time inventory data and get insights into each product’s performance.

XStak delivers real-time forecasts of inventory to enable supermarkets and fashion retailers to manage their operations seamlessly. All inventory items can be tracked with an SKU, and you will receive an update when the item(s) leaves your inventory. To the benefit of your retail platform, you can efficiently manage inventory, purchasing, warehousing, accounting, shipping, and much more without having to go through manual processes.

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