Inventory turnover is a critical ratio that retailers can use to ensure they are managing their store’s inventory and supply chain well. It is one of the crucial KPIs used to measure the overall performance of your business. Put simply, it is how many times during a certain calendar period you sell and replace your entire inventory.
Most small retailers are not thrilled when they find out they have excess inventory. Storage costs, insurance, damage, obsolescence, taxes and loan interest can add up to almost 30% of the cost of our inventory annually! These costs will only continue to rise as your excess inventory numbers climb. This is why inventory management is one of the best investments you can make for your business. When you trim away your excess inventory through inventory management, you leave your business running better than ever. So why is inventory turnover crucial to this process?
What Is Inventory Turnover?
Inventory turnover is the number of times that a retailer sells and replaces its inventory. It is a measure of the rate at which merchandise flows into and out of your store. For example; if a retailer has an annual inventory turnover of eight, it means that they have completely sold out its entire inventory eight times over the whole year. In 2015, Amazon had an annual turnover of eight and Walmart had 7.8, whereas Costco has an inventory turnover of 11.2.
How Do We Calculate Inventory Turnover?
Inventory turnover can be calculated for the entire business as well as by department or item category. Assessing inventory turnover by item category would also be helpful to compare the performance of different items. This is important because not all turnover rates are the same; some items might turn more slowly than others. Consider, for example, that you have an online store where you sell T-shirts. Basic plain T-shirts could have a higher inventory turn than designed T-shirts. After all, people wear basic T-shirts more often, and they need them more than patterned ones.
In order to calculate inventory turnover, we need to know two dollar amounts for the calculated specific period: Cost of Goods Sold (COGS) and Average Inventory.
You can calculate your COGS for a specific period through the below formula:
COGS = Beginning Inventory + Total Purchase – Ending Inventory
These numbers should include the purchase prices for your inventory, and also any additional costs such as shipping, storing, or handling. Make sure to subtract the cost of any scrapped or lost inventory.
You can also calculate COGS by looking at your Profit & Loss Report.
You can calculate your Average Inventory for a specific period through the formula below, or by looking at your Balance Sheet:
Average Inventory = Beginning Inventory + Ending Inventory / 2
Finally, we can calculate Inventory Turnover based on the below formula: