Being a pro retailer means more than knowing how to sell the right products to the right customers. You need to be an expert in inventory management as well—and you need to know how to marry sales and inventory to optimize your business.
That’s where knowing your inventory turnover ratio comes in. Knowing this number can inform how you plan your purchasing, how you sell your goods and more.
In this guide, we’ll cover:
- What an inventory turnover ratio is
- How to calculate your inventory turnover ratio
- What a good inventory ratio looks like
- How to increase your inventory turnover ratio
Let your inventory fly off the shelves with our guide
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What is inventory turnover ratio?
Inventory turnover ratio is a way of measuring how many times you’ve sold through and replaced your inventory in a given period—how many times it’s turned over, in other words. Knowing your inventory turnover ratio gives you key insights into your business’ performance. A higher inventory turnover ratio indicates a healthy business, while a lower ratio can spell trouble.
Holding on to inventory for a long time is bad for business. If you’re not selling your stock, you’re not bringing in revenue to cover your operating costs, turn a profit and—crucially—buy new stock. As inventory becomes dusty, dead stock, it holds you back from investing in new products customers might be interested in. Ultimately, you stand to be left behind by your competitors.
Calculating your inventory turnover ratio means you can avoid getting blindsided by slow-moving stock. You can measure the health of your business, take a look at the impacts of new selling strategies, adjust your pricing and reassess your purchasing strategies as needed instead of waiting to react after it’s too late.
It is important to note that some industries will see more inventory turns than others simply by the nature of the products that are being sold. Apparel and perishable goods, for example, will turn faster than automobiles; fast fashion will turn faster than luxury fashion.
How to calculate inventory turnover ratio
There are two ways to calculate inventory turnover ratio: by using your sales or your cost of goods sold (COGS).
If you use your sales, the formula looks like this:
Sales / Average Inventory = Inventory Turnover Ratio
Using your cost of goods sold to calculate your inventory ratio can be more accurate. Sales figures include a markup, which may inflate your ratio and give you a higher number.
If you have your cost of goods sold on hand, you should use that number instead of sales.
If you use your cost of goods sold, the formula looks like this:
Cost of Goods Sold / Average Inventory = Inventory Turnover Ratio
Either way, you’ll need to know your average inventory. You can calculate that by using this formula:
(Beginning Inventory + Ending Inventory) / 2 = Average Inventory
Inventory turnover examples
Let’s look at an example to better understand. Say we wanted to calculate how quickly our apparel store was turning over its shoe inventory.
First, we need to know the cost of goods sold. We check our reports and see that the shoes sold in a year had a cost of $5000.
Quick tip: using Lightspeed? Find your cost of goods sold using the built-in totals report.
Next, we need to know the cost of our beginning and ending inventory during the year. Once we have that information, we add the costs together and divide them by 2 for a total of $1300.
With those numbers on hand, we look at our inventory turnover ratio formula.
5000 / 1300 = 3.8
We turned over our shoe inventory 3.8 times last year.
Alternatively, if we didn’t want to do the math ourselves, we could simply run the Turns report in Lightspeed Analytics and find the shoes top level category. The ratio will be listed on the report.
Calculating days sales of inventory (DSI)
Another formula you can add to your arsenal to gauge inventory turnover is the Days Sales of Inventory (DSI). Sometimes referred to as Days Inventory Outstanding (DIO) or Days In Inventory (DII), it helps you measure the average length of time your cash is tied up in inventory and also puts inventory turnover into daily context.
To find your measurement, you’re going to take your year-end inventory value, divide by your COGS, and then multiply by 365 for the number of days in a year (Inventory Value / COGS) x 365 = DSI.
For example, let’s say your end-of-year inventory value is $80,000 and your COGS is still the same $500,000 we’ve used in the previous examples. If you plug those numbers into the DSI formula, (80,000 / 100,000)365 = 58.4. That means every 58.4 days your inventory will turn. Cash is tied up in inventory for a little less than two months.
One thing to note is that regardless of how you choose to calculate inventory turnover, the important thing is to remain consistent to ensure you’re comparing apples to apples.
What is a good inventory turnover ratio?
A higher inventory turnover ratio is typically better. A high ratio generally tells you that:
- You’re purchasing enough stock. Your purchasing budget is set right and your inventory forecasting is accurate. You’re purchasing enough to have full shelves to meet demand, but not so much that you’re overstocked.
- Your employees are effectively selling your inventory. Your customers are responding well to your sales tactics and your employees are providing good service.
However, it can also mean you’re not putting in big enough orders when you restock. If your inventory turnover ratio is exceptionally high, your customers may be frequently running into empty shelves as they wait for you to reorder goods. Since this can drive customers away, it’s important to keep an eye on how often you end up totally out of stock.
Quick tip: in Lightspeed, set reorder points for all your items and run the built-in reorder list report to avoid stockouts.
If you have a low inventory turnover ratio, you could be dealing with one or more of the following problems:
- You’ve been overstocking. You’re purchasing too many units in your orders, and customers aren’t responding with the same demand.
- Your inventory isn’t resonating with customers. Whatever you’ve got on the shelves—even if you don’t feel like you’ve overstocked—isn’t what your customers want from you. They may be going to competitors for their needs instead.
- Your sales tactics aren’t strong enough. You could have the most cutting edge, desired products in stock… but if your customer experience is no good, you risk losing sales.
Comparing your inventory turnover by industry
What exactly is a low or high ratio varies by industry. Fashion retailers average between 4 to 6 turns, for example, while car dealerships average a lower 2 to 3—but car components can have turnovers as high as 40. Once you have your ratio, research your industry’s average number of turns to compare yourself to the competition.
How to increase inventory turnover for your retail business
If your inventory turnover ratio is lower than your industry’s average, you’ll need to take action.
Adjust your purchasing plans
Get your stock in order with accurate inventory forecasting.
Compare the turnover ratio of various categories to their sales figures and see where you could start ordering less. If sales of a particular product or category have started to drop off, you could combine ordering less of them with bringing in new products that are more in line with your best sellers.
Review your pricing strategies
Pricing can drive customers away, even if the quality of the products and their experiences land. If your sales aren’t strong, you could consider implementing some of the following pricing strategies:
- Bulk pricing: this is where customers save money based on how many units they buy (1 for $3, 2 for $5, 3 for $7, etc).
- Seasonal discounts: if your retail business has a seasonal edge—apparel seasons, for example—start discounting incrementally earlier in the season. Instead of having blowout end of season sales where you try to move a lot of inventory at steep discounts, start with much smaller discounts about halfway through the season and increase the discount from there.
- Bundle pricing: like bulk pricing, customers get more while paying less. Here, though, you bundle different items together to move stock. It’s much like upselling, but with some of the sales legwork already done if you make the product bundles yourself.
Try new sales tactics
You can improve weak sales by making shopping with you exciting. Beyond just selling products, your employees can make your store a memorable brand that customers want to keep coming back to.
Consider taking personal shopper appointments. You don’t need to be a luxury goods retailer to give your customers a white-glove experience. Appointment shopping can be done during regular hours or after hours, in-person or online through video calls. It gives customers a more intimate shopping experience, which provides your employees with more chances for upsells.
Healthy business from higher turns
Your inventory turnover ratio is an important KPI that you should be keeping an eye on. Think of it as the canary in your retail coal mine—if it starts to drop, you know there’s crucial work to be done optimizing your purchasing and adjusting your sales tactics.
Managing retail inventory? That’s what we do best. If you want to chat about how Lightspeed’s built-in reports and tools could help you become an inventory management and forecasting wizard, get in touch.
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