Quick — what does your inventory turnover ratio (ITR) say about your business? You might think:
- Faster turnover indicates better health and efficiency.
- If I sell out quickly, I recover the upfront investment sooner. I can then do more with the cash that would otherwise be stuck in the warehouse.
- It’s a measure of how well my sales and marketing teams are doing. Knowing how quickly things sell can help those teams improve their processes.”
If you’re thinking either of those things, you’re right — but that’s not all there is to it.
Once you know your ITR, both overall and for each product, that data becomes a crucial asset. It’s information you can apply to improve your company’s strategy and tactics.
Getting in tune with your inventory turnover ratio can help you supercharge your business model to drive growth and profitability.
We’ll dive into five creative ways to harness the power of this knowledge using real-life examples.
Calculating Inventory Turnover
First, let’s dig into the turnover ratio formula.
To find your ITR for the year, divide your total cost of goods sold by your average inventory value. (Ideally, your point-of-sale system or inventory management software reports your average inventory value for you.)
Inventory Turnover Ratio (ITR) = Total Cost of Goods Sold (COGS) ÷ Average Inventory Value
So, let’s say your sales for the year totaled $500,000, and your average inventory value on any given day was $100,000.
By applying the turnover ratio formula, you’ll find that your ITR was 5. That means you sold and replaced your inventory five times.
If you divide the number of days in the year (365) by your ITR, you’ll get your days’ sales of inventory. That is, the period it took you to turn over your inventory. In this scenario, your days’ sales of inventory would be 73.
Days’ Sales of Inventory (DSI) = 365 ÷ Inventory Turnover Ratio (ITR)
While software is the most accurate way to calculate inventory turnover at a high level of detail, all the information you need for a quick calculation is available on your financial statements. Your total cost of goods sold (COGS) will be found on your financial statements, and both beginning and ending inventory can be found on your balance sheet.
5 Smart Ways to Apply Turnover Data
Although there’s no one-size-fits-all inventory management plan, knowing your ITR is fundamental to your plan’s success. Once you know your ITR, you’re better positioned to move forward based on your company’s business model and inventory trends. Here are a few examples of how well-known companies incorporate an understanding of inventory turnover into business decisions.
1. Connect Stores and eCommerce, Like Home Depot
If your inventory isn’t moving fast enough, but you don’t want to change your product offerings, you might be able to take this tip from Home Depot.
From 2010 to 2015, Home Depot improved their turnover ratio from 4.2 to 4.9, and it’s stayed around there through 2019. This ratio improvement reduced Home Depot’s DSI by 12 days.
They accomplished this by implementing two new options for shoppers: “Buy Online, Ship to Store” and “Buy Online, Pick up in Store.”
If you do business via both digital and brick-and-mortar channels, this is a brilliant move for two reasons. First, it plays into customers’ desire for instant gratification. Second, it brings online shoppers into your store, where — if you’re doing it right — they’re likely to buy more.
This option also makes for happier customers, as data suggests 73% of consumers want to avoid shipping costs by picking up purchases in-store, and shipping costs remain a top driver of cart abandonment.
73% of consumers want to avoid shipping costs by picking up purchases in-store
2. Offer a Convenient Subscription, Like Quip
“Recurring subscription revenue” is one of today’s holy grails of retail — and for a good reason. When you offer a subscription service, customers commit to receiving a specific product on a regular cadence.
As long as your team keeps churn down, you’re in an optimal position to know what to order, how long to hold it, and when to ship it out. This quickly results in faster turnover and lower DSI.
Several companies have succeeded in this. One great example is Quip, which makes it easy to maintain good oral hygiene by sending toothbrush head, battery, and toothpaste refills to customers every few months. We’ve also seen the subscription model work well for Death Wish Coffee, one of Skubana’s customers.
Death Wish helps coffee enthusiasts make sure they never run out. Death Wish also uses generous discounts and rewards to retain loyal customers.
The (not-so-secret) secret to subscription success is providing convenience. As it turns out, customers are happy to pay a recurring fee for something that takes a recurring item off their to-do list.
3. Augment Customers’ Reality, Like Lacoste
If you need to sell more of your products and reduce return rates, augmented reality (AR) might be for you.
AR is exciting because it’s both novel and cost-effective, thanks to highly accessible solutions like Shopify AR and ROAR. On top of that, AR has been proven to work in real scientific studies. In one consumer survey, an astonishing 72 percent of consumers said they’d bought items they didn’t plan to buy because of augmented reality.
AR is being adopted by high-profile brands, including Magnolia and Lacoste, but that doesn’t mean it’s out of reach for smaller brands. Augmenting your customers’ reality doesn’t cost as much as you think. If it’s a good fit for your products, it could make a big difference.
4. Explore RFID Tracking and VMI, Like Walmart
When you look at your turnover data, you might find that fast sellouts are affecting your total turnover ratio. That’s because while the products might sell quickly, the lead time to restock is too long. If you have this problem, you might be able to take a tip from Walmart.
Recently, Walmart began handling this problem using radio frequency identification (RFID) tags. This has resulted in a 16% decrease in out-of-stock counts.
Researchers have also found that products with electronic product codes are replenished three times as fast. When it comes to large-scale inventory, this is an elegant and brilliant way to control stock.
However, RFID might not always be the best option for every business. There is still merit to using barcode technology, especially if it is central to your warehouse and inventory operations.
To keep inventory cycles in check, Walmart also famously pioneered Vendor Managed Inventory (VMI). This means the vendors are responsible for delivering new shipments every time a product reaches its reorder point. You may be thinking, “That’s easy for Walmart, but what about a smaller company?”
The secret is that vendors also benefit from VMI arrangements. When your inventory data is transparently available to your vendors, their forecasting, raw materials management, and supply chain management is also stronger. A VMI arrangement might even allow your suppliers to offer you a better deal that helps bring down your total cost.
The global retail industry loses more than $360 billion every year solely due to overstocking and then discounting inventory to turn it over.
5. Grease the Squeaky Wheels
If you’re new to inventory management, or if you want to take more conservative steps, a granular analysis of your turnover rate for each SKU could be your golden ticket.
High-level turnover problems can often be traced to specific products that don’t budge, also known as your non-performing SKUs. A good practice is to track how each SKU influences your income statement in terms of both profit margin and turnover time.
You also want to calculate your turnover ratio not only across your business but also for each product so you can see which SKUs are skewing your turnover rate.
In the supply chain and inventory world, this is often called ABC analysis. Like many systems and processes, inventory has a Pareto rule (or 80/20 ratio). Specifically, 20% of your SKUs (the “A” group) are going to be the most profitable and important, and 80% are going to be less important.
If you have a large inventory, these are the products for which you’ll want to track an individual inventory turnover rate. Refining your process to prioritize these products effectively is key to growing gross profit.
So what do you do if you find an individual product with low turnover?
Sometimes, the answer is to stop selling it. However, there might be a good reason to continue offering that product. For example, it might come with a big profit margin, is seasonally popular, or is a favorite among your most loyal customers — in which case you’ll want to look closely at your data to recalibrate your cycle.
This is a great way to apply inventory turnover data to improve your inventory management system.
Bottom Line: Get the Data
Inventory management has a lot of moving parts. If it seems like harnessing inventory turnover data to increase gross profit is an uphill battle, you’re not alone. Unfortunately, the global retail industry loses more than $360 billion every year solely due to overstocking and then discounting inventory to turn it over.
At Skubana, we’ve found that even small steps toward inventory optimization drive stable, long-term savings and profits (i.e., growth potential). Inventory data can also fuel more powerful tactics and strategies, like the ones we shared above.
The first step is to get the data into your hands with a system that calculates inventory data, then applies the turn ratio formula automatically. Then, you’ll be able to analyze your trends, identify your squeaky wheels, and discover the paths toward growth that are available to you.