What Is Inventory Turnover?
Knowing Your Turn Will Make You Money, Not Knowing Your Turn Will Cost You Money
Inventory turnover is a measure of how fast a retailer sells through its inventory and needs to replace it. The faster you "turn" your inventory, the more inventory you will need in a year. The formula is a simple one:
Sales / Inventory
For example, if your store sold $100,000 in goods and had $50,000 worth of inventory, then your inventory turn would be 2, meaning you turn over your inventory two times for that time period measured. Inventory turn is typically looked at on a calendar year basis. Meaning that you are calculating how many times you will turn that item in a year. Even though you may be looking at it in a shorter period, you can extrapolate that time period out to equal a year.
Another way to calculate is with Cost of Goods Sold (COGS). in this formula:
Cost of Goods Sold / Average Inventory
And some POS systems measure turn as:
Number of Units Sold / Average Number of Units (both during a specified period of time)
Inventory turn is a very important calculation for retailers. While one might think that the higher the turn, the better, the truth is too high of a turn may mean you are not stocking enough of the SKU. For example, if you have a 52 times turn on an item, then you are selling four to five per month. If it takes three weeks to replenish that stock, then you will have missed sales during that period since logically you are selling at an average of one per week.
The point here is to raise your backstock and lower the turnover to make sure you do not miss any sales.
On the other end, if you have a turn of 1 on an item and you have 12 of that item on hand in backstock, then you have way too many of that SKU. In this scenario, you have a 12-month supply. For most retailers, a turn of 2 to 4 is ideal. It is because it matches the replenishment of the item within the sales cycle. This means that you get the new one in before you need it. Remember, inventory in the back room is cash in jail. Having inventory does you no good until you sell it.
Too many retailers make the mistake of being over-inventoried. This is when they have way more inventory than what they need. A telltale sign of this condition is to examine inventory turnover. If the turn for the store is 1, then you can safely assess that there is more inventory on hand than is needed.
Often times, this happens because a vendor enticed the retailer on a special "closeout" deal on the merchandise. Keep in mind that the vendor's job is to get it out of its warehouse NOT out of your store. This means that his or her concern is about selling it to you, not about you selling it to your customer. They make their quota often times at the expense of the retailer. The best vendors are ones who act like a partner with your business and help you control your purchases to meet your demand.
They put your business' interests equal to their own.
In retail, cash is king. You must manage the cash flow of your business. You do this by using an open-to-buy system with your inventory planning. With a good open-to-buy system, you can plan the turns you want for an item by category and classification. In other words, there is no need to set the turns at the same level for every product in your store. Some will turn slower and some faster. But with an open-to-buy system in place, you can manage that easily.
Another solid way to manage your inventory is with dating on your purchases. Dating is the amount of time you have to pay the vendor for the merchandise. Many retailers get strapped for cash because they bought inventory that has a low turn but has to be paid for within 30 days. It means that you are paying the vendor before you have sold the items. Walmart is the king of inventory turn. Their entire success has been linked to controlling inventory turns. In fact, many of their turns are greater than the dating terms on the invoice So, they are selling the merchandise BEFORE they have to pay for it - in some cases, up to 30 days before.
Knowing your inventory turns will also help you when you go to market to buy your goods. It is the sanity check for how much to buy.