How to Calculate Inventory Turnover | Inventory Management and Logistics Metrics
One of the most vital metrics to track for your supply chain and logistics performance is Inventory turnover. This is the number that tells you how quickly you are getting your goods to a retailer where they are selling and restocking inventory during a specific time period (usually annual). Essentially, this metric will tell you how many times your have sold through, or, turned your inventory.
For competitive and lean organizations, Inventory turnover ratio is watched closely and is used for specific insights into how efficient your operation is and another way to measure your ROI for stock purchased or a specific product. Savvy logistics and supply chain leaders consider this metric one of the top inventory management metrics and if you are not tracking this yet, this post if for you.
How to Calculate Inventory Turns / Inventory Turnover Ratio
As with most analysis, the right sample size is critical to give your organization the best business intelligence from using this metric. To do this, use as many data points as possible. As previously mentioned, this is measured annually so we will use 1 year for this example.
The Inventory Turnover Ratio Formula
Now that we have the time period (1 year). all you need is the average inventory on hand and the cost of goods sold (COGS).
Average inventory tells you how much stock you had on hand for that time period. This should be a dollar amount of the value of the inventory similar to what would be used for accounting.
COGS in simple terms is how much it cost you to get and sell the goods for that time period. Be sure to include the manufacturing, warehousing, and wholesale costs of purchasing your inventory or the labor expenses associated with creating your own products.
Next, divide COGS by average inventory to get your inventory turnover ratio. Remember, this number will help you gauge how efficient your operation is and can be used to benchmark your performance off competitors – understanding how many times you sell through all of the inventory you had during the year is powerful!
Use this inventory turnover ratio formula:
- Inventory turnover = COGS / average inventory
- And here’s how to calculate COGS and average inventory:
- COGS = beginning inventory + purchases during the period – ending inventory
- Average inventory = (beginning inventory + ending inventory) / 2
How to Calculate Inventory Turnover Quickly
If you can not access this information very easily, do not worry. There is another alternative that is also very insightful and a quick way to get a good snapshot of the health of your operation. Use the following instead:
Quick Inventory Turn Ratio
Inventory turnover = sales / inventory
Although gross sales and inventory as dollars are not that difficult to get, remember that this is just an estimation with the best information you had. It’s improtant to understand that this is not the most accurate way to calculate inventory turnover. This is because often sales are higher than the COGS because customers pay more for the products so that retailers can make a profit. Again, this is best for only a quick snapshot.
Let’s try it for ourselves!
In 2020, you had net sales of $18 million and your COGS was calculated to be at $4 million. Average inventory for the year was $1.8 million.
Inventory turn = $18 million / $1.8 million = 8.3 times. Not bad!
This translates into: You brought in and sent out your inventory over 8 times during the year. Another way to say it is that every 44 days you sold through and flipped or turned your inventory.
Understanding Your Inventory Turnover Metrics
It’s important to look at the numbers holistically rather than in a vacuum like all analytics. This same principle applies to inventory turnover ratio
Take this case: Your ratio is higher, that’s typically a good sign, right? Your selling products quickly and restocking so you can assume that there’s sufficient demand. On the other hand, if you are constantly stocking out and disappointing customers, you have a whole other type of problem. Now with the internet and sophisticated tracking, this can cause damage on multiple levels. A counter measure to this could be to check your reorder points and look at your sourcing and procurement processes.
Now, consider the inverse where a lower inventory turnover rate indicates that stock isn’t moving very quickly, and demand could be lacking. This might mean that it’s time to pull the lever on marketing efforts and get inventory moving again. The important part is having an agile team that is focused on important metrics like this.
Another great advantage of becoming data driven and tracking inventory turnover is that over the course of a couple of cycles, you can measure period-over-period results. This tells a story of how you are doing and also is a measurable lagging indicator.
In most cases you will want to go for a high inventory turnover rate, and work to increase that number over time. This means you not only sell inventory faster but your operation should become more efficient.
Inventory Turnover and Inventory Management or WMS
Inventory turnover should impact your decisions at all points along the supply chain to help form purchasing decisions to marketing. You will start to look at the cost of holding inventory and the opportunity cost of less cash flow while you inventory sits on the shelf. The cost of storage is often much higher than planned for or anticipated.
Need help with your supply chain? Talk to our professionals with over 20 years of experience. OA LOGISTICS LTD is a fully integrated North American 3PL provider with Distribution Centers strategically located near the ports in the USA on the East and West Coasts.