Inventory turnover analysis has transformed the way warehousing and logistics companies approach stock management.
Essential for tracking valuable stock and minimizing carrying costs, effective stock control is the key to consistently keeping up with increasing customer demand. So being able to better understand inventory turnover through analytical insights is vital for businesses looking to improve profitability and customer satisfaction.
What is Inventory Turnover?
Inventory turnover measures the rate that stock is sold, used, and replaced during a given period. You can calculate this rate, starting by determining your average inventory. This is done by adding the beginning and ending inventory during a specific period and dividing by the number of months in that period.
Then, calculate your inventory turnover rate by dividing the cost of goods sold (COGS) by the average inventory for the same time period.
So, for example, if your COGS was $500,000 for 2023 and your average inventory cost $100,000, your inventory turnover ratio (ITR) would be 5. So, you would have sold and replenished your inventory five times in the last year.
If your turnover rate is low, it’s worth conducting an inventory turnover analysis to determine the root cause.
Many modern businesses analyze large datasets stored in virtual warehouses using software like Apache Hive architecture. Similarly, companies that stock physical items must also analyze stock turnover to improve storage efficiency, pricing strategies, and future purchases.
What is a Good Inventory Turnover Rate?
What’s considered a good ratio will vary depending on the size and type of business as well as your industry. But in general, a higher turnover ratio is preferable as it reflects stronger sales and more efficient operations. It could also indicate an increase in product popularity or market demand.
On the other hand, lower ratios are often the result of weaker sales or a lack of demand for products.
The quicker you turn over inventory, the less time goods spend in storage. This results in lower carrying costs and reduces the risk of the inventory becoming obsolete.
What Does My Inventory Turnover Rate Tell Me?
So, you’ve identified whether you have a high or low inventory turnover rate, but what insight can you gain from it? To get a clearer picture, let’s look at a couple of examples.
A slow turnover rate for perishable goods can be influenced by quality concerns if they fail to meet certain quality standards. If this is the case, adopting FIFO (First In, First Out) or FEFO (First Expired, First Out) inventory management practices and optimizing storage conditions may be wise here.
A high turnover for seasonal goods typically indicates strong customer demand and high customer satisfaction levels. That said, it could also reflect underpricing issues or potential stockout disruptions that need to be addressed.
Remember that inventory turnover ratios can vary significantly across industries. So be sure to compare against industry benchmarks or historical data to assess inventory performance accurately.
Why is Inventory Turnover Analysis Important?
From freight to manufacturing and everything in between, inventory turnover analysis offers a wealth of benefits for companies in a variety of sectors, including:
- Monitoring Efficiency: Analyzing turnover highlights how quickly and smoothly goods move through your warehouse and which products may need to be discontinued.
- Optimizing Stock: Warehouse teams can make more informed decisions about restocking, improve the availability of popular products, reduce excess stock, and avoid overstocking.
- Improving Cashflow: You don’t want to tie up capital in excess inventory. An analysis gives you a clear roadmap for optimizing stock levels and speeding up turnover, which can translate into faster conversions and improved cash flow.
- Tracking Trends: In such a competitive market, the most successful companies anticipate customer needs and market demand and plan their inventory levels accordingly. You can use historical results from inventory turnover analysis to uncover significant trends and patterns in product demand.
- Identifying Operational Issues: Identifying low inventory turnover rates makes it easier to identify the underlying operational issues behind them, from inefficient picking processes to storage problems and ineffective marketing.
- Making Strategic Seasonal Adjustments: Inventory turnover rates can be used to analyze different seasons and adjust stock levels accordingly.
- Securing Better Supplier Relations: Understanding and improving turnover rates shows suppliers your product is in strong demand and at less risk of extra inventory carrying costs, e.g. storage space, labor, perishability, shrinkage, and insurance.
5 Inventory Turnover Optimization Techniques for Streamlined Stock Control
Ultimately, teams that can accurately restock quick-selling goods, avoid issues like backorders, and maintain a steady cash flow will always stand out in the crowd. Balancing your inventory levels mitigates costly overstocking and stressful stockout situations.
Here are five strategies to streamline your company’s inventory management strategy.
1 – Review Supply Chain Processes
Effective supply chain management can reduce costly risks, such as logistical errors or late shipments. It also improves communication and leads to accurate decision making.
There are various ways to analyze your supply chain performance. As well as your inventory turnover rate, here are three of the most common supply chain performance KPIs to keep an eye on:
- Supply Chain Costs / Logistics Costs: This includes shipping, warehousing, labor, and fulfillment costs.
- Perfect Order Rate: How many orders have been delivered to the right place? Calculate this using the following formula:
- Order Fill Rate: This is the percentage of orders that have been instantly fulfilled by available stock. To calculate this, the formula is:
(Total number of orders shipped) ÷ (Total number of orders placed) x 100
2 – Focus on the Product Life Cycle
Demand for a product or service evolves over its life cycle. So, being able to identify when your inventory is approaching the decline stage (when demand starts decreasing) is essential for taking appropriate action.
That could mean adjusting production levels, tweaking pricing strategies, or phasing out obsolete inventory. Regardless, focusing on your product life cycle means you can maximize operational efficiency and minimize costs with ease.
3 – Improve Sales Forecasting & Inventory Demand
Are your sales targets hitting the mark? Is there enough demand for your product?
Focusing on improving sales forecasting is a reliable way to give customers exactly what they want and increase your sales simultaneously.
There are several options to consider if you want to take your inventory demand forecasting to the next level. Here are three that will ultimately help your business predict future sales performance and make informed data-driven decisions.
- Inventory Software: Track inventory levels, orders, sales, and deliveries automatically. Gather and safely store inventory product information in a centralized location.
- Seasonal Trend Analysis: Examine historical sales information alongside inventory reports to pinpoint seasonal trends, resulting in more accurate inventory forecasting.
- Thorough Market Research: Collect valuable information about consumer preferences and behaviors, industry trends, competitors, geographical differences, economic indicators, marketing campaign impact, and more.
When it comes to creating accurate forecasts, it’s crucial to leverage the right expertise. Data engineers can enhance the process by ensuring effective storage, management, and reporting of data collected throughout your analysis.
You can hire external experts to help with this or invest in your existing staff by supporting them in obtaining a certification for data engineers. Doing so will help your business secure growth by equipping your team with essential skills for the future.
4 – Automate Purchasing Activities
Even with a formal purchase order system in place, many businesses experience issues in their purchase order system. With this in mind, more companies are utilizing warehouse automation systems to maximize space and productivity levels while reducing costly errors.
Automated purchasing systems speed up the purchase order approval process, streamline spend management, promote transparency, and even improve trust with suppliers.
To make automating your purchase order workflow as smooth as possible, consider implementing the following:
- Electronic purchase request automation
- Purchase order creation automation
- Purchase order approval automation
- Purchase order dispatch automation, e.g. Electronic Data Interchange (EDI)
- Purchase order integration with shipment tracking systems
- Goods receipt and inspection automation
- Invoice matching automation
5 – Develop Smarter Marketing Strategies
Marketing and promotions are an effective way to increase sales, which in turn keeps inventory turning over. Strengthen product demand by listening to existing and potential customers. What do they want and how can you deliver it?
Analyze customer buying habits and monitor behavioral trends. You can then build a solid marketing strategy tailored to specific interests to drive sales.
Transform Your Inventory Turnover Rates Today
Having a strong stock of your most popular products is the key to aligning sales targets and inventory turnover. Coupled with our inventory management and order fulfillment expertise, mis-shipments and poor-performing warehouses will soon become a distant memory. Contact us now to streamline your stock control and strengthen your supply chain performance.
FAQs about Inventory Turnover Analysis
What Does High Inventory Turnover Mean?
A high inventory turnover rate typically means that you sell goods quickly, which indicates high sales, efficient stock management, and a streamlined supply chain.
What Factors Affect Inventory Turnover Ratio?
Several factors can influence your inventory turnover ratio. These include your industry, changes in consumer demand, inventory management practices, fluctuations in pricing or sales strategies, supply chain efficiency, and inventory holding costs.
How Do I Determine my COGS (cost of goods sold)?
Typically covering funds spent on raw materials and labor, the cost of goods sold (COGS) is the value of products sold during a specific period of time. It can be found on your annual income statement or with the help of inventory management software.
What Should be Included in an Inventory?
The three main elements of your inventory should include raw materials and components, work-in-progress items, and finished goods. To effectively inventory stock control, implement streamlined item identification, such as with SKU or barcodes, and include a detailed description of each item, including size, color, and material. Additional considerations include supplier details, number of units of each item currently in stock, cost price and sale price, storage location, and historical data of inventory movements, for example, sales, returns, and adjustments.
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