A firm needs to keep a check on the inventory it holds and scrutinize whether it is circulating, getting cashed out, and replaced with fresh goods timely. Here we will discuss what is Inventory Turnover.
It is also necessary to keep an appropriate amount of stock because overstocking will result in wasted space and soaring storage expenses while customers will be left empty-handed and unhappy if there is insufficient stock.
What Is Inventory Turnover?
In accounting terminology, it is a measurement of the number of times inventory or goods are sold throughout a period such as a year, a month, or a quarter.
Put in another way, it measures how quickly a corporation sells its products. Inventory turns, product turnover, stock turn, stock turns, turns, and stock turnover is used to describe inventory turnover.
Importance of inventory turnover
- Making Smarter Choices and Decisions
It can assist firms in making better pricing, production, marketing, and inventory purchase decisions.
Companies can identify underperforming products and can come up with strategies to improve their performance by providing discounts etc. They can also keep a check on the market trends and can make necessary changes by producing products in demand and can become ahead of their competitors.
- Raising Profitability
It can also serve as a guideline and provide scope for improved profitability. Businesses with a good stock turnover can devise plans to reduce holding costs and respond to changing customer demands.
How To Calculate Inventory Turnover?
Although there are several accounting tools and applications available in the market which can help you calculate stock turnover, there is an old–school way of calculating it as well. There are two ways of calculating it; one is based on sales while the other is based on the cost of goods sold (COGS).
INVENTORY TURNOVER = NET SALES
AVERAGE INVENTORY
OR
INVENTORY TURNOVER = COST OF GOODS SOLD
AVERAGE INVENTORY
AVERAGE INVENTORY = INVENTORY AT BEGINNING + INVENTORY AT END
2
Interpreting Inventory Turnover Ratio
Low turnover indicates sluggish sales and, possibly, excess inventory (also known as overstocking). A high ratio, on the other hand, suggests large sales or insufficient inventories.
Although the former is preferred, the latter may result in a commercial loss. But it varies from business to business. While a supermarket’s product turnover would be high, an automobile showroom’s would be sufficiently low.
A company’s ability to make quick sales is a major indicator of its success. Retailers who transfer inventory out more quickly surpass their competitors. The higher the holding cost of an item, the fewer reasons buyers will have to return to the store for new things.
What Is a Good Inventory Turnover Ratio?
As discussed earlier, the ideal ratio is different for different industries, for some a smaller ratio is a good ratio like for car dealers or businesses selling expensive goods.
While on the other hand, a larger ratio is a good ratio for supermarkets or businesses selling everyday goods like food, grocery, clothing, etc.
Nonetheless, an optimum ratio for retailers is between two to six.
High Stock Turnover Good or Bad?
The perks of a high ratio are:
- Inventory holding costs rent, utilities, insurance, theft, and other costs associated with maintaining a stock of goods to be sold are reduced with a high inventory turnover.
- As long as the revenue from selling the item remains constant, lowering the holding cost enhances net income and profitability.
- Faster-turning products improve responsiveness to changing client needs while also allowing for the replacement of outmoded items. This is a huge concern in the fashion industry right now with the introduction of “Fast Fashion”.
However, in some circumstances, a high inventory turnover can be caused by a company’s insufficient inventory, which means it is missing out on prospective sales which is not a good sign for any firm.
Inventory Turnover and Dead Stock
Inventory turnover and especially a high stock turnover is particularly useful for maximizing the efficiency of perishable and non-durable goods such as eggs, bread, milk, fruits & vegetables, etc.
Oversupply of such goods leads to missed profits and unsold stock. Such unsold stock is known as dead stock. This kind of stock is highly seen in seasonal businesses of sweaters or umbrellas where the products are seasonal and come in high demand only during a particular time of the year.
Conclusion
Any retailer should have a complete understanding of their ratio, as well as how that ratio fits into the subtleties of the industry and market they operate in.
Understanding and tracking inventory turnover is critical for ensuring that inventory levels are consistently optimized, allowing one to make better and more informed decisions about price, seasonality, marketing, manufacturing, and new stock purchases.
Frequently Asked Questions
- What is the normal stock turn period?
The average inventory turnover period is usually 1 year yet some businesses may calculate it monthly or quarterly as required.
- What is a good turnover rate?
Anything between 5 – 10 is a good and ideal ratio for almost all industries which means that every one to two months, the corporation will sell and restock its goods.
- Is low inventory turnover good?
Low turnover may be good for certain businesses like car dealerships or heavy machinery businesses but for most of the part, it indicates poor sales or excess inventory.
