So how do you optimise your inventory turnover rates? Optimising inventory turnover However, there is a fine line between having a high inventory turnover ratio and running out of stock! Having insufficient inventory levels can lead to lost sales opportunities, unhappy customers and a damaged reputation over time. Ideally you’d look to benchmark your turnover against similar businesses in your industry, but if this proves challenging, then look internally at your trends and seek to better them. Usually, businesses with low gross margins need to turn their inventory more often, so they can offset their low per unit profit with higher sales volumes. For example, an ideal stock turnover ratio for a fast-moving consumer goods retailer will be much higher than a company that sells high-end furniture. When analysing your stock turnover ratio, remember it will be relative to the stock you sell and the industry you trade in. There’s less chance of excess stock becoming obsolete and being sold off at a loss.Businesses can remain responsive to the marketplace and react to changes in demand.Cash is constantly freed-up for reinvestment.Items that turn faster have lower carrying costs, positively impacting the bottom line.In summary, a healthy turnover of stock can improve profitability because: Cash will be tied up in inventory for longer and there will be a higher risk of items becoming obsolete with profit margins diminishing as the stock fails to sell. They will see over-stocking of slow-moving inventory and escalating carrying (holding) costs e.g warehouse costs, insurance, utilities etc. In contrast, companies with a low inventory turnover ratio will often be more inefficient in their replenishment activities. Instead, it’s selling what it buys and it’s bringing cash back into the business to cover the cost of goods sold. The company isn’t over-buying stock nor is it wasting money on warehousing space. In general, a high stock turnover ratio indicates that a business is managing its inventory effectively. Using an inventory turnover ratio helps businesses better understand how efficient they are at doing this. It’s therefore important to keep selling these items and converting the investment back into accessible cash. Most stock-holding businesses will have a significant amount of money tied up in inventory. The importance of having a good inventory turnover ratio To calculate the average number of days it takes to turn the stock concerned, we divide 365 days by the 5.4 turns, obtaining the result of 68 days: Using the inventory turnover calculation we get 5.4 turns per annum: At the end of this period, the stock was valued at £163,000 and the opening value was £140,000. The cost of goods sold over this period was £815,000. The ABC Doors and Windows Company wanted to calculate its inventory turnover for the last 12 months. Let’s look at an example for a company in the building materials industry. Here’s an example of the inventory turnover calculation: Average inventory value is calculated by adding your opening inventory value to your closing inventory value and dividing by 2. The inventory turnover ratio is calculated by taking the total cost of goods sold (COGS) over a specific time period and dividing it by the average inventory value during the same period. How do I calculate inventory turnover ratio? The inventory turnover ratio is defined as the ratio of cost of goods sold to the average stock held. It is often used to measure the efficiency of warehouse or stock control processes. Inventory turnover ratio (also known as stock turn) is an accounting and inventory management KPI used to measure how many times stock is sold (used or replaced) within a fixed period of time. Inventory turnover (also known as stock turnover) is a measure of how well a business manages its inventory.
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