Did you know that there are nearly 8 million small businesses in the United States? If you’re one of them, you need to keep tabs on your inventory so you don’t overstock your warehouses — or run out of products. You’ll need to know your ratio to make informed business decisions.
Read on to learn what a good inventory turnover ratio looks like!
What Is an Inventory Turnover Ratio?
You can think of an inventory turnover ratio as how often a business needs to replenish its inventory in a set timeframe. Often, this timeframe will be a year. And you can find your ratio by using some simple math.
Take the cost of all products sold during that set timeframe. This sometimes is referred to as the cost of all goods. Look at your financial statements to track the income for your designated timeframe to find this number.
Then divide that number by the average value of all inventory. Ideally, the cost of all goods should be higher than the average value. If that’s the case, you’ll end up with a higher rate — and better business outcomes.
Know What Inventory Turnover Rate to Achieve
What makes a good inventory turnover ratio? Most often, the higher the number is, the better your business will be. Typically, you should aim for a rate that sits between 5 and 10.
A number in this range means that you’re moving inventory and making sales. You’ll be restocking your inventory every month or so with a number edging closer to 10.
For instance, suppose your inventory turnover rate is 7. If you divide 365, the total number of days in a year, by 7, you’ll end up with 52 days. This translates to needing to restock in just under 2 months.
A company with a rate of 9, for instance, is moving inventory at a rate of 9 times over a year. By contrast, a company with a rate of 4 only is moving its inventory 4 times over the same timeframe.
Ultimately, an inventory turnover ratio gives insight into how efficient you are as a company. Calculate inventory turnover rate numbers to see how your business stacks up.
Consider the Type of Business
Not every business moves inventory quickly. As a result, it’s critical to factor in what you’re selling to determine a reasonable rate.
For example, a business that specializes in selling high-end jewelry may not move inventory as quickly. But just a few bonus sales of engagement rings can boost the cost of goods.
And the inventory rate may fluctuate depending on the time of year. A jewelry shop might sell a lot of engagement rings before Christmas. But a flower shop might hit a higher rate around Mother’s Day.
Further, businesses that depend on a complex supply chain are susceptible to fluctuations. If you sell computers and tablets but shipments are delayed, you’ll pay the price with an unfavorable ratio. It’s wise to look at industry benchmarks or standards to know what to expect.
A High Ratio Isn’t Always Good
While aiming for a number above 5 tends to work best, sometimes a high ratio can indicate problems. Yes, a higher number does mean that you’re moving inventory. And that means you’re making sales.
But a high number also might mean you’re heading towards burnout. A high rate means that you’re busy restocking constantly. If you hit one massive order, you might not have enough inventory to fulfill it.
Depending on the customer, this could land you in hot water. Worse yet, you could lose a contract and create bad buzz about your brand.
For newer businesses without streamlined production processes, don’t stretch yourself too thin. If you sell toys for holiday gifts, stock your warehouses and make sure you can meet demand!
Spend Time Interpreting Your Inventory Turnover Rates
Remember that a stronger inventory turnover rate helps your bottom line in other ways, too. When you’re moving inventory, you won’t have to use up and pay for as much storage space. This means you won’t have to spring for more warehouse space.
You also won’t have to pay taxes, utilities, and other costs associated with storing goods. And in many instances, you can cut down on insurance costs by minimizing storage. Figure out what your comfort level is with inventory sticking around, and if you have the means to house it.
A high inventory rate also may suggest that you’re underpricing items. Bumping the selling price a bit higher can slow your sales just enough to keep your inventory stock comfortable.
When your inventory rate starts getting low or even too high, pull together your leadership team to take stock of your strategies. You may need to try bundling products to help avoid having one stagnant product in the warehouse. With this strategy, you’ll offer a deal on purchasing 2 or 3 products together.
You don’t want to run out of inventory at critical points in the calendar. But you don’t want to be stuck with inventory that no one is buying. Assess your product lines regularly to ensure you’re not continuing to produce items that don’t move.
Understand a Good Inventory Turnover Ratio
When you know a good inventory turnover ratio target, you can build a more efficient business. Aim for a number between 5 and 10 to ensure that you’re not hanging on to too much inventory — but make sure you’re not burning out from restocking. And work with your leadership team to figure out new marketing or sales strategies if your number starts getting lower.
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