How to Calculate Inventory Turnover Rate
Inventory turnover is a ratio that shows how often a business gets replaced and sold inventory during a specific period. A business can then multiplied by the total days in the sales period by the inventory turnover ratio to calculate how many days it actually takes to replace the inventory in stock. Assuming the current inventory level is one day out of nine, the inventory turnover ratio would be approximately 2%. This is considered to be a very conservative way to determine inventory turnover because it assumes that the stocks held are all used and accounted for. If not, then the inventory turnover ratio can be calculated using the average number of days for inventory turnover for every nine full years.
If there is not enough inventory in stock to support the sales or that the sales are seasonal, inventory turnover may be lower. For example, if there is heavy seasonal demand for particular items, most manufacturers sell all of their products that are not used during that season to retain their supply of raw materials to fulfill future orders. Some manufacturers use the excess inventory to make new goods that will sell quickly. In some cases, a manufacturer might sell some of its products that it has made only recently to get rid of old stock fast. In both situations, the business will incur expenses to transport the raw materials from where they are harvested to where the finished goods are packed.
Inventory optimization software programs can calculate inventory turnover based on sales data. To do this, the program divides the original number of sold items by the number of new products sold, then multiplies that quotient by each of the business owners' inventory percentages. The end result, minus the number of days the product was in inventory, is the percentage of inventory that remains in a physical plant. Because of this calculation, the program can identify trends or regions where inventory is high and discounts material by creating a "sku."
The amount of time spent inventorying is very important to businesses that depend on fast-moving inventory. Inventory turnover that is too high can drive up inventory costs and reduce profits. On the other hand, too little inventory turnover can lead to reduced profit levels because customers expect to receive the same quantity of goods every time they order them. It is important for businesses to calculate their inventory turnover based on their actual sales volume over a given period of time. By measuring inventory turnover over such a period, businesses can determine which areas need improvement in order to improve profitability. For instance, if they sell five items per day in a region but only sell one per day in that same region, they will need to improve their shipping procedures to move their inventory more efficiently. Check out inventory turnover formula for more insights.
A positive inventory turnover ratio is the ideal combination of quality sold products, but fewer replacements needed to maintain the inventory balance. Ideally, there should be one to two percent replacement cost for each item sold. A good rule of thumb is to calculate three to five times the replacement cost to arrive at the replacement ratio. This calculation gives a range for optimal inventory turnover ratios and will vary depending on the particular business or industry being evaluated. For instance, businesses that produce medical supplies often face issues associated with overstocked medical kits. Read also inventory turnover calculator to learn further.
Calculating the inventory turnover ratios used by different businesses is not simple due to the various factors involved in the calculation. However, there are industry averages as well as other variables that can help businesses better understand their own inventory turnover ratios. When businesses do not know their own inventory turnover ratio, they may want to contact an expert who can help them understand their inventory turnover rates and improve their processes. Once businesses understand their inventory turnover ratios, they can use this information to help improve their operations and reduce operating expenses.