Which of the following is not associated with a high inventory turnover ratio?

What is inventory turnover ratio?

Inventory turnover is measured by a ratio that shows how many times inventory is sold and then replaced in a specific time period. Understanding the average inventory turnover is a critical measure of business performance, cost management, and sales, is inversely proportional to days in sales inventory, and can be benchmarked against other companies in a given industry.

Why is calculating inventory turnover ratio important?

Inventory ratio is one of the most versatile metrics a business can track. 

If you don’t bother calculating it, you are missing out on valuable data that you could use to optimize many of your existing operations, gain new insights, and improve your overall supply chain performance. 
Here are just some of the important use cases for calculating your inventory turnover ratio.  

Measure business performance

In the most general sense, the more sales your business makes, the more successful your business probably is. Because the inventory turnover ratio speaks to how quickly a business is selling through its inventory, some businesses use it to check the pulse of sales performance. 

While a high inventory turnover ratio is not always indicative of success (for instance, high inventory turnover is not good for businesses losing money on every sale), it is usually a sign that your sales are healthy. 

Evaluate market trends and customer demand

Calculating each product’s turnover ratio reveals which products are selling out the fastest, and which sit on shelves for longer periods. By identifying the most popular products, a merchant can better plan their inventory in the future, and stock up on items that will maximize sales. 

Tracking inventory turnover over the course of several months or years can also reveal seasonal trends or geographical pockets of demand. Knowledge of consumers’ buying habits makes it much easier to forecast demand accurately, and helps you optimize your inventory levels throughout the year and across locations.    

Reduce obsolescence and dead stock

If you’re not tracking inventory turnover, it’s tempting to keep reordering the same SKUs in the same amounts over and over again. 

However, doing so may lead you to invest in products that are very slow to sell — or worse yet, that won’t sell at all anymore. This results in obsolete inventory or dead stock that increases holding costs, and costs time and money to move out. 

Conversely, by calculating inventory turnover ratios for your products, you’ll know exactly which products to discontinue, as well as when and how many units to reorder for low-turnover SKUs.  

Minimize backorders

Just as calculating your inventory turnover ratio helps prevent you from amassing too much inventory, it can also help prevent you from ordering too little. 

When you know how fast items turn over, you can make sure to order popular items well in advance and in sufficient quantities to meet customer demand. This prevents stockouts, which results in fewer backorders and more happy customers.

How to calculate inventory turnover ratio

To calculate inventory turnover, complete the following 3 steps:

1. Identify cost of goods sold (COGS) over the accounting period
2. Find average inventory value [ beginning inventory + ending inventory / 2 ]
3. Divide the cost of goods sold by your average inventory

Here’s the simple inventory turnover formula:

Inventory turnover = COGS / Average Inventory Value

For example, if your COGS was $200,000 in goods last year, and your average inventory value was $50,000, your inventory turnover ratio would be 4.

You can also calculate your inventory turnover ratio by looking at units, rather than costs:

Inventory turnover = number of units sold / average number of units on-hand 

If you sell 1,000 units over a year while having an average of 200 units on-hand at any given time during that year, your inventory turnover rate would be 5.

How to analyze inventory turnover ratio

Fully understanding inventory turnover can provide invaluable insight into how your ecommerce business manages costs, how sales initiatives are performing, and how you can further optimize inbound and outbound logistics workflows.

Once you know how to calculate inventory turnover ratio, the next step is understanding what a high turnover rate versus a low turnover rate means, and what the ideal inventory ratio is so you can create an action plan on how to improve the higher inventory turnover ratio.

What is an ideal inventory turnover rate?

For most retailers, an inventory turnover ratio of 2 to 4 is ideal; however, this can vary between industries, so make sure to research your specific industry. A ratio between 2 and 4 means that your inventory restocking matches your sale cycle; you receive the new inventory before you need it and are able to move it relatively quickly.

Low inventory turnover

A rate of 1 or less means you have excess inventory. For example, if you sell 20 units over a year, and always have 20 units on-hand (a rate of 1), you invested too much in inventory since it is way more than what’s needed to meet demand. It’s important to maintain inventory levels by calculating how much the company sells and avoid dead stock which cogs your entire cash flow.

High inventory turnover

High inventory turnover can indicate that you are selling your product in a timely manner, which typically means that sales are good in a given period. Ecommerce retailers should strive for a high inventory turnover rate, which means they sell the inventory they have on hand quickly and repurchase fresh inventory often. This also helps save on inventory carrying costs.

What does a high inventory turnover ratio indicate?

Which of the following can be caused by a high inventory turnover?

Which industry has high inventory turnover?

Is it good to have a high inventory turnover ratio?