June 3, 2019 | Last Updated on: June 28, 2023
A high inventory turnover may sound great: Customers want your product so badly that it’s just flying off your shelves! What’s the problem? Using an inventory turnover calculator may reveal hidden issues in your business inventory chain. While a low inventory turnover has its own set of problems — just look at what H&M went through — a too-high inventory turnover can not only disappoint customer expectations, but also displays your lack of forecasting skills, which can ultimately be detrimental to your success. In retail, the key to your business’s success is having an inventory turnover ratio that is just right. You have to make your cost of goods sold worth your gross profit. You have to keep your inventory levels even across the month. You have to keep your holding costs low. Your beginning inventory and ending inventory need to make sense. Fortunately, there are tools that can help. This article will discuss the hows and whys of getting to a satisfactory inventory turnover ratio, then introduce you to an inventory turnover calculator and some other ways to get the balance sheet you’re looking for.
The cost of high inventory turnover can be devastating, especially for seasonal companies, said James Lamancuso, owner of Hello World, a lifestyle store in Philadelphia: “In my business, a huge part of my revenue comes from the holiday season. I need to make sure I have enough inventory in store. The only thing worse than a slow holiday season is a busy holiday season without inventory.”
Heasun Choung is a supply chain expert with over 20 years in the industry; she’s worked for companies with diverse, complicated retail lines like Gillette and Proctor & Gamble. According to Choung, getting the right inventory turnover ratio comes down to forecasting: “You have to know your customers by tracking all purchases to effectively forecast what supplies and products you buy.” Choung emphasized that the ideal inventory turnover is selling your inventory with enough lead time to reorder it. Each industry has different inventory turnover ratios. A retail establishment most likely has a higher turnover rate (i.e. faster) than a used car dealership. However, forecasting, added Choung, should be done on a monthly basis, not just annually. “Your cost of goods sold should be calculated at least monthly,” she said.
Here’s how to calculate inventory turnover by hand, so you know the logic behind the process. To get your turnover rate, take the total amount of sales and divide it by the value of your inventory. So if your denim company sold $10,000 worth of jeans with a $5,000 cost of raw materials/labor etc., then your inventory turnover is 2. Super straightforward. So now here’s how to calculate inventory turnover by letting a calculator do it for you. Most businesses calculate inventory turnover on a yearly basis, but you can really do it for any period of time. You can even calculate for a short time period (like a month) and then project that to an annual timeframe. Many small businesses don’t need to focus on inventory turnover as a priority, so doing it on an annual basis is all that is necessary, but several industries need to calculate more often. Lamancuso said about his seasonal business, “I’m a keystone operation. I try to maintain cost times 2 for my prices. If I plan on a revenue of $100,000, I know it should cost me $50,000, but I need to make sure I have enough inventory in store. . . I want to know how quick my turnover rate is, and the importance of that knowledge is amplified during the holiday season.”
There are various options for business owners to track and manage a company’s inventory. There is generic inventory management software like Quickbooks, which tech-savvy owners can tailor to meet their industry needs. However, there are also options that are industry-specific. Restaurant365 and Toast help restaurant owners organize their hectic inventory turnover; Mindbody helps yoga studio and salon/spa owners do similar. These types of applications can help reduce product waste, as well as compare your current cash flow with your projected revenue. They can also let you know your total inventory value, and point out which items may not be high sellers. With software, you’ll be able to see exactly what sells the most, and set pricing at the point that will keep your stock turnover steady.
According to Tom Berrafato, the owner of a restaurant group outside of Buffalo, NY, as you mature as a small business owner, you should naturally get a better handle on your inventory turnover. “You have to be organized. I have been in the business for several decades, so I have my own system for inventory, but I would suggest that newer owners use a software management system. This will also help you if you are looking for additional funding. Having all this information on hand can be the difference in getting the funding you may need to expand.”
