There are many moving parts when it comes to efficiently operating an ecommerce business and e-commerce fulfillment can be especially overwhelming. Knowing how to keep track of Inventory is one of the key areas involved, as it’s the central connection that binds together costs, profits, logistics, and customer satisfaction. There are strategies available to help forecast results to better manage inventory. This includes knowing how to calculate inventory turnover rate/ratio.
We’ve outlined the definition of inventory turnover, how to calculate it, and ways to improve it to benefit your business. We’ve also identified common challenges and what solutions will guide you in managing inventory effectively going forward.
What Is Inventory Turnover?
So, what is inventory turnover and how is it calculated? Inventory turnover rate/ratio is a formula that measures how efficiently inventory is managed. It’s the rate at which a company replenishes inventory in any given time period due to sales. The figure is calculated by dividing the cost of goods by average inventory. This calculation can be used to identify excessive inventory levels compared to sales during any given time period.
Costs of Goods Sold / Average Inventory = Inventory Turnover Ratio
The cost of goods sold reflects the total production costs of all goods sold, which include cost of materials, labor costs, warehouse and storage expenses, and other fixed costs related to production. Average inventory equals the average value of inventory level through a set date range. As an example for comparison, Walmart reported $385.3 billion in annual costs of goods sold in 2019 and an average inventory of $44.05 billion. When calculated, its inventory turnover ratio equals 8.75.
Factors Affecting Inventory Turnover Ratio
There are several factors to consider when learning how to calculate inventory turnover ratio. Low inventory turnover may be indicative of poor inventory management or purchasing practices. It could also mean poor decision-making and goods that don’t sell as well. Although, typically speaking, industries with low margins and high volumes, as with most e-commerce businesses, tend to have the highest inventory turnover formula outcome.
This is primarily in areas including retail, grocery, and clothing stores. On average, the inventory turnover for the grocery store industry is 13.56, an objectively high rate, which means most grocery stores are replenishing their stock over 13 times per year, which is indicative of how much and how often customers are buying goods. This high inventory turnover rate suggests that they should keep their stock levels higher with certain finished goods.
In general, a higher inventory turnover ratio is favorable as it indicates reduced storage and holding costs. If your organization reflects a low ratio, this may imply dwindling sales, overstocked inventory, and/or an inefficient inventory management system. Fortunately, there are multiple strategies to improve inventory turnover and benefit the long-term success of your business. Another calculation to be familiar with is the safety stock calculation, for more details we share everything you need to know about how to calculate safety stock.
Ways to Improve Inventory Turnover
Once you’ve learned how to calculate inventory turnover, you can then make strategic decisions for how to reduce warehouse costs and improve sales. To increase the inventory ratio, here are a few strategies that address inventory management efficiency.
Stock Inventory for Everyday Use
It may sound obvious, but to have a successful operation with consistent sales, stocking products people need and use everyday is one of the best ways to improve inventory turnover. Additionally, monitor items that sell the slowest and order only the minimum amount necessary to restock, as to not have an overflow supply.
Implement Inventory Tracking Automation
Looking to create a good inventory turnover ratio? One of the best strategies to improve your inventory turnover ratio is implementing inventory tracking automation. As your business grows, manually calculating the amount of inventory needed can be increasingly hard to keep track of. Inventory tracking technology monitors all SKUs, across all locations, thereby alleviating this time-consuming task and providing a clear look at your inventory flow.
Focus on Demand Forecasting
Demand forecasting is another effective strategy that also can be automated through specialized software. Understanding the historical nature of your customer base and the average number of items sold through data can help predict needs for inventory stock and customer demands in the future.
For example, if your company experiences an influx of orders during the summer months, it’s best to prepare in Q1 for this spike in sales so as to not miss any opportunities in meeting the demand of what customers expect during a period with strong sales.
Maintain Effective Marketing
A focused marketing strategy is important, particularly if there’s varying demand for products in different regions. By reviewing data and creating location-specific marketing campaigns, marketing efforts can support inventory management by ensuring each warehouse is stocked with the items that are selling best and can be shipped the fastest to meet customers’ demand.
Furthermore, effective marketing can also boost your visibility in new markets to increase sales over time and engage previous customers for repurchase. A mix of SEO, social media, content marketing, and paid advertising are all strategic ways to reach your target audience and keep top-of-mind for repeat customers.
Consider Restocking Efficiency
Not all items sell at the same rate. Some products have a low inventory turnover ratio while some products need higher stock levels due to the high turnover rate. Even if your company specializes in one type of product, different colors, sizes, and features that differentiate between product types will determine how much of each is necessary to reorder using the reorder point formula. Rather than ordering the same amount of inventory across the board, plan your purchase orders based on previous sales trends.
Additionally, frequent orders may result in receiving better rates from suppliers and ensure you have the balance of stock necessary to meet customer demand without falling into the trap of inventory that is stagnant.
Apply Smart Pricing Per Season
Another strategy to improve inventory turnover is smart pricing. Smart pricing allows you to apply pricing strategies based on the season or as a direct response to customer demand. For example, it’s typical for brands to offer free or faster shipping options during the holiday season, especially for larger orders and added delivery date assurance.
Alternatively, offering discounts for post-holiday sales can help you sell old and unsold inventory and make room for the next season’s offerings that could yield a more ideal inventory turnover ratio. Switching your pricing model to reflect the current demand is a smart way to move inventory through the system quickly and efficiently.
Partner with a Reliable Shipping Service
Reliable shipping services are essential for any e-commerce store. Items that arrive damaged or improperly packed can immediately cause a customer to complain, especially if they’ve had to wait an extended period of time for it to arrive. Find a shipping partner that follows your protocol for when and how items are packaged and shipped. This will promote better stability for your brand and instill trust in your customers.
Common Inventory Turnover Ratio Challenges
Implementing an inventory management system can help improve inventory turnover ratio and identify areas that may be prohibiting your sales. A few of the challenges that keep rates low are:
- Outdated inventory tracking systems
- Dead stock due to prolonged shelf lives
- Poor promotion or shipping strategies
Outdated Inventory Tracking Systems
There are several inventory tracking models used to identify SKUs and where products are in the supply chain. Expanding companies eventually grow out of the use of spreadsheets, which may be the easiest method to use when first starting out. However, as businesses grow to multiple warehouses with hundreds or thousands of items prepared for shipment each day, in addition to those items being returned, there’s likely to be more mistakes by manually inputting information onto a spreadsheet.
Dead Stock Due to Prolonged Shelf Lives
Inventory stored in warehouses that don’t sell is commonly referred to as dead stock. Since it’s not being sold, it costs businesses money because they aren’t likely to recoup costs of these unsold goods, regardless of whether they’ve manufactured the times themselves or purchased from a supplier.
Dead stock can definitely bring down the total inventory turnover ratio and lead to wasted products and valuable storage space of items that are selling well. To overcome this common challenge of excess inventory, the first thing to do is stop adding dead stock items to new inventory lists and try to sell what’s in storage. Offering a gift with purchase or bundling these lesser-sold items are a few ways to try to sell what’s left, although many times this is marked as a lost cost.
Poor Promotion or Shipping Strategies
In addition to having the right amount of stock in-house to meet customer demand, there must be a promotional strategy in place to inform customers of what’s available. This is especially important during seasonal sales when people are starting their holiday shopping or at the tail-end of summer when college students are moving into the dorms.
Depending on your main customer base, identify the specific times of year where sales rise due to these annual events or big life moment scenarios, such as weddings, graduations, or buying a new house. Review your customer data to make promotional and shipping offers based on hot-ticket items during peak sales season to stay competitive and manage your company’s inventory effectively.
Managing Inventory in a Way That Equals Success
Managing beginning inventory and ending inventory and anticipating the proper support to meet increasing demand is challenging, especially as businesses grow quickly. Putting the right processes and people in place take time to coordinate and can slow down growth if not implemented correctly. Part of knowing how to calculate inventory turnover ratio involves using the tools and resources available to delegate tasks.
Fortunately, with Flowspace, the platform provides access to everything necessary for e-commerce and retail fulfillment. With inventory storage to aid in reducing shipping costs and meeting timely delivery options, plus integration with Shopify, Amazon, and other separate online stores, inventory management is managed automatically and can be viewed in real-time as items are picked, packed, and shipped.
Alleviating the logistics piece of the operation lifts a heavy burden and allows companies to focus efforts on their continual growth through product development, marketing, and expansion to build and maintain a strong, successful brand.
For more information about how Flowspace can help your business, submit a quote today!