Managing your inventory effectively can be a challenge: whilst you want to make the most of your inventory, you don’t want to oversell your stock. At the same time, you don’t want to undersell and then have a lot of revenue tied up in your goods.
How to Calculate Inventory Turnover
For most retailers, striking that fine balance can be difficult. The figure you need to calculate to determine how you can optimise your cash flow and meet your customers’ needs whilst maximising profits, is your inventory turnover ratio.
There are two ways you can calculate this ratio – you may prefer one to the other, depending on your business model.
Inventory turnover ratio = sales / inventory
Inventory turnover ratio = cost of goods sold / average inventories
Inventory turnover measures the number of times that your inventory is sold and replaced in a specified period of time (usually a year).
Whichever calculation you choose, it’s important you stick to it, so that when you analyse the ratios, calculations are consistent.
Option One: Sales / Inventory
This is typically used from an outside comparative analysis perspective. It can sometimes be distorted by fluctuating sales value, although this doesn’t really implicate your inventory’s actual movement.
Option Two: Cost of Goods Sold / Average Inventories
This calculation in comparison, is considered more reasonable; because not only does it use the actual cost of goods that have been sold, it also levels out seasonal fluctuations – for instance, you may find sales increase massively in December in the run up to Christmas, but slump in January.
Once you’ve chosen which option and calculated your ratio, you should compare this against your industry’s average. You ideally want to have the highest ratio, as that represents strong sales. However, this will vary from industry to industry. For instance, a retailer selling perishable foods will have a higher inventory turnover compared to a luxury fashion brand; simply because their products won’t last as long.
When you compare your inventory turnover month on month, you want to see it increase. A low ratio indicates a lack of sales, which means that your revenue is tied up in products, when it could have been better spent elsewhere.
These 8 tips will help you to optimise your business’ inventory turnover, which will have a direct positive impact on your ratio.
1. Choose the Right Software
Are you still inputting your stock levels on a spreadsheet? That’s the first mistake you’re making. There are many types of cloud inventory management software available for businesses, no matter how small your budget is.
You’ll save so much time, as you’re able to access crucial information including how many items you have in stock, how much of it has been assigned to orders, and how much is available to sell. Plus, human error is eliminated, so you can be sure the figures are correct.
We would encourage all businesses to ditch the spreadsheets and invest in cloud-based software, so that you can spend more time optimising your inventory turnover.
2. Develop a Winning Marketing Campaign
Customers aren’t just going to come to you. You need to give them a reason. Plan and execute a well thought out marketing campaign to either drive new customers, or encourage repeat purchases.
There are multiple marketing channels you’ll want to consider: SEO, PPC, social media, email marketing, PR and so much more.
Create a buzz and see demand for your products rise, which will help to increase your inventory turnover.
3. Review Your Pricing Strategy
If your sales are low, it may be because of your pricing. But don’t be tricked into thinking your problem will be solved if you simply reduce them. Premium products for instance, won’t perform very well if prices are slashed, because of a perceived reduction in quality.
Alternatively, whilst lower pricing may lead to an initial increase in purchases; customers may be reluctant to buy from you again, unless you have a sale.
If you are considering changing your pricing structure, you may wish to undertake some market research to see how customers will react.
4. Review Supplier Purchase Prices
Once you’ve signed the contract with a new supplier, it can be all too easy to auto-renew at the end of each year, without thinking about how much you’re spending.
You’re well within your rights to review purchase prices, and ask your supplier for discounts when you’re placing orders.
Many suppliers are happy to come to an agreement for things such as bulk orders, extended credit options or pre-paid freight. Having saved an additional amount of money, you’re taking steps towards improving your inventory turnover.
5. Purchase Smaller Quantities
One issue many businesses face – regardless of size – is cash flow issues, which can affect the bottom line. Storing inventory costs money, and cash will stay tied up there until it’s sold.
To eliminate this issue, you could do the total opposite of bulk buying, and order smaller quantities from your supplier instead. This will mean you have more revenue to invest in your business in other areas; and as your stock will need to be replenished faster, you’re effectively improving your inventory turnover.
You just need to ensure that you still purchase enough, so you can still meet demand – unless you’re a highly exclusive brand, with a waiting list.
6. Stock Inventory That Sells
You’ll never improve your inventory turnover if no one wants to buy it. Before you set up your business, you will no doubt have drawn up a business plan and conducted extensive research to see if there was a gap in the market.
If your inventory isn’t shifting, you have a problem. By analysing inventory reports, you can see which items are selling well and which aren’t. From there, you can drop the items that aren’t selling, and focus on your bestsellers.
7. Eliminate Stagnant Stock
You can optimise your inventory turnover by getting rid of stock that isn’t selling. If stock is deteriorating (such as perishable food), or is holding valuable storage space that could be better used, then get rid of it.
If this is continually happening, then this highlights a problem; and you should identify the reason(s) why no one wants to buy.
However, it’s fine to get rid of stagnant stock every now and then, as long as you look into the reasons why people aren’t buying, so you won’t make the same mistake again.
8. Encourage Pre-Orders
Encourage loyal customers to pre-order inventory in the future. Offer them an exclusive discount as an incentive, or even insinuate a demand.
By having a number of pre-orders, you are in a better position to predict your stock levels required; meaning you have less chance of products unnecessarily sitting around in storage. This is just one other way that can help you to optimise your inventory turnover.
Conclusion
Predicting levels of stock required may be tricky, but there are several ways in which you can optimise your stock turnover. These 8 tips will help to increase your inventory turnover ratio, leading to additional sales.
Our cloud-based inventory management software will take the stress out of inventory management, and help you to make educated decisions regarding your stock. Alternatively, for more information, get in touch with us today.