Do you know how to calculate inventory turnover? This critical business metric informs your day-to-day inventory management decisions and strategies to help you continue to scale.
Reviewing inventory turnover is an essential step in effective inventory management, which helps you fulfill orders, keep inventory in balance and plan for business milestones such as adding locations or product lines. And when you know the key calculations, you can benchmark your industry turnover against your industry’s specific circumstances.
Learn more about inventory turnover, how it applies to your business, common calculations and how you can improve this metric.
What is inventory turnover?
Inventory turnover is known by several names, including inventory turnover ratio, stock turnover, inventory turn or stock turn. They all refer to inventory ratios reflecting the number of times your products are sold and replaced in a given period. While you can measure inventory movement over a month or quarter, many inventory turnover calculations rely on yearly inventory data.
In essence, inventory turnover measures how fast you sell inventory during a given period. This metric helps you make decisions about inventory levels and drive other business decisions related to warehouses, fulfillment, marketing and customer service.
For example, products with high inventory turnover ratios should be optimally positioned in warehouses for quick fulfillment. Slow-moving inventory, meanwhile, can be discounted to make room for more profitable items. That prioritization could affect your spending on active and planned marketing campaigns, while your customer service team receives fewer complaints when high-turnover products are readily available.
Why does inventory turnover matter to your ecommerce business?
The goal for most retailers is to sell as many products to as many customers as reasonably possible. It seems simple, but anyone who’s tried to make sales forecasts knows it’s not always easy. Understanding the ever-changing needs of your customers requires careful planning and execution, and inventory turnover is a central part of meeting those needs.
Improving your inventory turnover ratio can directly contribute to greater profitability. Overhead expenses such as storage fees or expedited shipping costs can be limited or even eliminated with a better understanding of your stock turnover and improved inventory management. When you reduce holding costs and understand purchasing trends, you’re well-equipped to meet consumer demand and establish a competitive advantage.
This better positioning also helps with a variety of other business decisions. Thorough knowledge of inventory turnover informs how you optimize your operations so that the right products are in stock at the ideal levels to meet demand. You can recognize and respond to underperformance faster, which minimizes potential losses or supply issues. Tracking inventory turnover also helps you anticipate market changes and proactively adjust inventory levels, giving you more time to secure orders, renegotiate agreements or find alternatives.
How is inventory turnover calculated?
The good news is that you don’t need an elaborate system or a specialized inventory turnover calculator to determine inventory turns. You can apply a few simple formulas to your existing data, especially once you understand the best practices for turnover analysis.
Before we jump into the calculations, let’s review the two monetary terms you will need for this calculation — the cost of goods sold (COGS) and your average inventory.
How to calculate the cost of goods sold
COGS calculates all the direct costs involved in selling a product. In other words, the total cost of producing the products; materials, labor, and other related expenses. COGS excludes salaries and general administrative costs. Your COGS figure will also depend on whether you’re using
first in, first out (FIFO), last in, first out (LIFO) or another type of inventory costing method.
Your COGS formula looks like this:
Cost of inventory at the beginning of the year + additional inventory costs (purchases during the year) – cost of inventory at the end of the year = Cost of goods sold
Let’s assume you have $90,000 worth of inventory at the start of the year. During the year, you purchased $175,000 worth of additional inventory.
At the end of the fiscal year, you have $120,000 worth of inventory.
Your COGS calculation would be:
$90,000 + $175,000 - $120,000 = 145,000
How to calculate average inventory
Now that you know the COGS formula, you will need to calculate your average inventory.
Many businesses have stock levels that fluctuate by season rather than being consistent across every month. We recommend you use your average inventory value for the time period instead of the year’s ending inventory.
Calculate average inventory by adding the beginning and ending inventory costs for the year (or time period) and then dividing the cost total by two.
Your average inventory formula looks like this:
(Cost of inventory at the beginning of the year + Cost of inventory at the end of the year) ÷ 2 = Average Inventory
Using the same example as before, the calculation would be:
($90,000 + 120,000) ÷ 2 = $105,000
Once you have calculated the cost of goods sold and your average inventory, you will be able to calculate your inventory turnover.
Your inventory turns ratio is derived by dividing COGS by the average inventory value for the same time period — in this case, a year.
COGS ÷ average inventory = Inventory turnover
Using the same examples as before, your inventory turnover formula looks like this:
$145,000 ÷ $105,000 = 1.38
This would mean that your inventory turns ratio is slightly over 1:1. In other words, your stock rotates a little more than once a year.
You can also run this calculation using sales ÷ inventory.
Once you have your inventory turn ratio, take it further and calculate your inventory turnover period, otherwise known as Days Sales in Inventory (DSI).
DSI specifically measures how many days it takes for inventory to turn into sales.
Your DSI formula looks like this:
(Average inventory ÷ COGS) x 365
So, what does this all look like in practice? You can use the same numbers for calculating the inventory days needed to sell products.
Your inventory days calculation looks like this:
($105,000 ÷ $145,000) x 365 = 264.31
This means that it would take you just over 264 days, on average, to sell through stock.
What is a good inventory turnover rate?
Now that you know how to calculate your inventory turnover, you need to set performance benchmarks. These benchmarks are often inexact because each industry is different, and there’s no formula to apply.
One way to apply your turnover rate is by considering the type of products you’re offering, their longevity and the associated costs. If you sell fast-moving consumer goods (FMCG), your inventory turnover should be much higher than if you sell slow-moving consumer goods (SMCG).
Clothing or cosmetic products, for example, should have higher turnover rates due to the expectation that those products would need to be replenished faster than a slower-moving product, such as a personal vehicle.
CSIMarket research shows, for example, that retailers’ average inventory turnover ratio was close to nine in the third quarter of 2022, meaning these businesses are restocking their inventory up to nine times annually. By comparison, luxury purchases and other consumer discretionary brands replenish stock about six times per year. This reflects that they are desirable but nonessential products.
How can you use inventory turnover data to make decisions?
When you regularly review your inventory turnover data, you can quickly reduce overhead and respond to shifts in customer demand. These measures can increase profitability and operational efficiency. Here are two other ways to use inventory turnover in your business.
Understanding historical sales performance is essential to making accurate predictions about future sales. Inventory turnover metrics are one way to view that historical performance. Changes to your turnover ratio can also serve as a red flag for potential issues or opportunities, such as increasing inventory for busier time periods.
Supply chain management
Monitoring your inventory turnover can help you more accurately forecast the amount of safety stock needed for high-selling products. Labor and material shortages, delays and increased costs are just a few important considerations for effectively managing your business. Tracking your inventory turnover helps you understand the state of your supply chain and where you need to shore it up.
What do your inventory turnover ratio and DSI tell you?
With all this in mind, what exactly do the numbers tell you? Do you want a high or low inventory turnover?
Because inventory turnover measures how often you’re replacing inventory, you typically want a higher ratio. A high turn rate indicates efficiency, suggesting that you’re not buying more inventory than you need.
That said, a too-high inventory turnover ratio suggests you’re at risk for shortages and stockouts. An automated inventory management system and better inventory processes can help you prevent stockouts.
A low inventory turn rate could result from overstocking or an inefficient sales and marketing process. Your products could also be suffering from reduced market demand. In any case, it’s important to recognize products with low inventory turnover, understand the root causes and address excess inventory.
Well-run ecommerce businesses will explore inventory-reduction strategies that increase inventory turns while managing their inventory as efficiently as possible. To help with this, we’ve put together a list of techniques for effective inventory management.
How to improve inventory turnover
If your inventory turnover isn’t where it should be, the good news is that there are several ways to improve it. Look for opportunities at each stage of your sales cycle to get more products to customers in less time. Here are a few ways to get started.
One of the most effective ways to improve your inventory turn rate is by increasing the demand for your stock. Start by reviewing your ecommerce marketing strategy and current sales performance.
Could you realistically generate more sales? Are you promoting your brand and products well enough? Are you expanding your reach by selling on multiple marketplaces?
While it’s safe to say that all businesses could be doing more, consider these questions from an honest and realistic perspective. Ultimately, greater visibility into your business helps uncover opportunities to increase demand and eliminate poor-performing products.
How else could you reduce inventory costs besides cutting back on promotional tactics? Cost reductions don’t necessarily directly impact inventory turnover, but they position you to make other changes that convert inventory into sales.
For example, determining your best-selling products can open the door to negotiating cheaper bulk purchases from your suppliers, which lowers costs, meet demand and indirectly increase the turnover rate. Other ways to reduce costs in your supply chain include negotiating extended credit options.
Goodbye Unpredictable Inventory. Hello Linnworks.
Now that you know how to calculate inventory turnover and how this knowledge informs decision-making, you need the right technology to support your efforts. Linnworks inventory management software, for example, is ideal for ecommerce businesses that want to optimize their processes and scale with automation and real-time data.
Learn more about how Linnworks’ solution enables you to control your operations, avoid over- or underselling and provide a great customer experience, all from a centralized platform.