Inventory Turnover 101: What It Is And How to Get It Right

As a retailer, you’re always looking for ways to increase sales and profits, as well as manage the space you have for inventory. There is a delicate balance between having too much or too little stock on hand. Too much inventory leads to high holding costs, while too little stock means possibly missing out on sales.

For the most part, inventory management is all about finding that balance and ensuring that you have the right products at the right time.

One of the key metrics that can help you figure all that out is inventory turnover, which as you’ll learn below, plays a critical in planning and managing your stock.

What is inventory turnover?

Also referred to as “stock turn,” “inventory turn,” or “stock turnover,” inventory turnover is a measurement of the number of times inventory is sold in one year. In accounting practices, it is usually calculated for the year but could also be done on a monthly or quarterly basis.

When you compile the average inventory for a year, you get a clearer picture of the financial standing of your business. Throughout the year, there will be peaks and valleys of inventory due to holidays, back-to-school, and seasonal apparel shopping that will skew your numbers.

Inventory turnover formula: How do you calculate stock turn?

The formula for calculating inventory turnover ratio is:

Cost of Goods Sold (COGS) divided by the Average Inventory for the year

For example:

High Five Streetwear sold $500,000 in products this year and had an average inventory of $250,000.

$500,000 in sales divided by $250,000 worth of inventory = 2

Their inventory turnover is 2, meaning they had to replenish their full inventory twice over the past year. This number shows that products are selling at a profitable rate.

In a second example:

Luxe & Company sold $100,000 in goods this year and had an average inventory of $350,000.

$100,000 in sales divided by $350,000 in average inventory = 0.29

Their inventory turnover is 0.29, indicating that they are spending too much money on holding costs (storage costs), and items are lingering on the shelves. Being overstocked potentially points to inefficiencies in marketing, sales, and purchasing or to an economic downturn on a local, regional, or national level.

What is a good inventory turnover ratio for retail?

The sweet spot for inventory turnover is between 2 and 4.

A low inventory turnover may mean either a weak sales team performance or a decline in the popularity of your products. In most cases (read: not always), the higher the inventory turnover rate, the better your business goals are being met.

That said, an extremely high turnover rate is not always positive. If your retail store is going through its inventory 9 times a year, your purchasing levels might be too low – potentially leading to lost sales if the product is sold out.  

Why do you need to measure inventory turnover?

If you’re not measuring inventory turnover yet, here are a couple of reason to consider doing so:

It puts you in a better financial position

Inventory turnover is a key performance indicator (KPI) for managing and growing your business. The measurement also shows banks how liquid your assets are. Since inventory is often put up as collateral for a loan, banks want to make sure the inventory is easy to sell and can quickly be turned into cash.

You’ll make smarter business decisions

Closely monitoring stock turn also gives you a better handle on your inventory so you can make smarter purchasing decisions, keep merchandise moving, and sell more of the products your customers want.

Specifically, this metric can inform your decisions on:

• What items need to be ordered  – If the stock turn for a particular item is too high, it could be an indication that you need to order more of it.

• What units need to be relegated to the sale aisle – Stock not turning fast enough? It may be time to put them on sale before they become dead stock.

• What has to be ordered in advance to allow ample time for manufacturing/production/shipping – By knowing how many times a product turns per year, you’ll be able to plan ahead to ensure that you don’t run into untimely stockouts.

Clearly, when you have a solid handle on inventory turnover, you’ll be able to answer — and take action on — the above questions more quickly.

Now that you know why you should measure stock turn (and how to do it) let’s look at some of the ways to improve your inventory turnover ratio.

Get yourself a solid inventory management system

You can’t optimize your inventory turnover without measuring it in the first place. That’s why it’s important to arm your business with a good POS and inventory management platform that enables you to track your sales and stock levels in real-time.

These retail platforms allow you to easily manage your inventory and report fluctuations so you won’t have to do any manual calculations.

Know your benchmarks

Being aware of your business’ stock turn number is important, but it will be doubly helpful to know how your business compares with others in your industry. For instance, the Houston Chronicle cites that “the average merchandise turnover in the retail clothing industry for the 12-month period ending June 2011, was 3.91.”

If your apparel store has a stock turn rate of 4.0, it means that your store is quite in line with your industry’s average. On another hand, if your inventory isn’t moving as quickly, then you may need to evaluate your sales, marketing, and inventory practices to see how you can improve.

The Business Development Bank of Canada has an inventory turnover calculator with benchmarking capabilities. If you’re curious about how your store’s stock turn measures up compared with similar merchants, check out the tool here.

Get your team in sync

Your sales team, purchasing managers, marketing executives, and senior management need to share information about inventory. Keep each other in the loop regarding what products are flying off the shelves and which items are not generating any interest.

Here are some of the ways the various teams can work together:

• The salespeople are the front line of retail and can gauge whether a product is a hit or a flop with your customers.
• The marketing department may have to work on increasing foot traffic through events or improving your online visuals for certain products.
• Management and the purchasing department need to review inventory turnover to determine what items generate the most profit and what items are not worth ordering anymore due to a lack of consumer interest.

If you have a smaller retail operation, it still helps to keep your employees in sync. Catch up with your partners and/or employees on a regular basis and make everyone has a handle on how fast your products are moving.

Come up with ways to move inventory faster

If your inventory turnover is on the slow side, it may be time to spruce up your sales and marketing efforts to ensure that you’re selling more merchandise.

As each retail store is different, there isn’t a one size fits all strategy on how to improve your sales. The best thing to do is to explore the various strategies and tactics and see what works best for your store.

Here are a few ideas:

Final words

Knowing which products to stock and how much to order are game-changing insights to your retail business. Having a solid handle on your inventory turn allows you to stay on top of those decisions so you can continue carrying the products at the right time.

Hopefully, the tips in this post bring you closer to doing just that.

Good luck!