Your inventory turnover ratio can help you determine your business profitability by assessing how frequently you are selling and restocking your merchandise.
In this blog, we’ll cover:
- What is an inventory turnover ratio?
- How to track your inventory turnover ratio
- Optimizing your inventory management
- Paying attention to returns in your inventory turnover ratio
Let’s start by talking about how to calculate and improve your inventory turnover ratio.
What is an inventory turnover ratio?
If you run an ecommerce business, you don’t want to sit on your beginning inventory over a period of months or years.
If business is going well, you should have a high inventory turnover ratio—referring to the number of times that you have sold and restocked your inventory within a set period of time.
A high inventory turnover ratio means that you’re accurately predicting customer demand and efficiently selling and restocking your excess inventory. A low inventory turnover ratio often means that you’re overstocking products, which may need to eventually be discounted or liquidated, leading to lower profits.
The right inventory turnover ratio will vary based on your company, and how important it is for you to manage inventory levels in accordance with customer demand.
Read more about how inventory turnover ratio affects your brand’s profitability in the Future of Reverse Logistics
For example, a chocolate business with perishable goods will want to ensure that they are highly accurate in predicting sales and don’t end up with too much excess inventory, as there is a risk of spoilage.
An apparel shop, on the other hand, may have plenty of “evergreen” products that can be sold at any time, although they will still want to clear out old inventory over time to make room for new products. Additionally, the more unsold inventory you have on hand—especially for bulky items—the higher your holding costs are.
How to track your inventory ratio
To calculate your inventory turnover ratio, use a simple formula: cost of goods sold divided by average inventory during a period of time (typically a quarter or a year).
If you own a swimwear company, for example, and you sell $12,000 in goods over Q2 and have $5,000 in current inventory, then your inventory turnover ratio would be 2.4. While this is in an acceptable range, the ideal inventory ratio is between 5 and 10 in most industries.
You can improve your inventory ratio in this situation by raising brand awareness through advertising and promotion to generate more sales—which may include offering steep discounts on last season’s merchandise. You can also pay attention to analytics to forecast demand, ensuring that you are stocking merchandise that’s likely to sell based on historical and seasonal trends.
Optimizing your inventory management
Many ecommerce shops sell their products across multiple channels, including a direct storefront, Amazon, Instagram, and other distribution channels, making it difficult to track inventory levels easily. This leaves merchants with a lack of visibility to know when and what to restock, which may lead to either oversupply or inventory shortages.
Using an inventory management solution can help you to integrate all of your sales channels into one holistic view, so that you have clear tracking of status and can set up auto-replenishment. If you have multiple warehouses or are working with a 3PL, you can also shift inventory from one warehouse location to another to ensure that you have adequate stock in each region you serve.
If your inventory turnover ratio is too low, high holding costs can impact your cost of goods sold (COGS) and store’s profitability. In this situation, it may make sense to modify your pricing on your overstock items so that you can sell them more quickly.
If your inventory turnover ratio is higher than 10, that may mean that you’re having trouble meeting your shoppers’ demands, which can lead to back orders and dissatisfaction—so in this case, it’s important to improve your predictive analytics so that you can manage your inventory levels to meet your customers’ needs. Pay attention to which items sell the best at which times of year, optimizing your inventory to ensure that you have plenty of customer favorites on hand without overstocking, while also introducing new product lines that you think will sell well based on existing sales patterns.
Depending on your brand, you may see seasonal swings in sales trends, so keep that in mind when planning your orders, and make sure that you’re adapting to your inventory based on regional needs. For instance, if you’re an apparel shop, you might need plenty of stock on heavy sweaters in your New Jersey warehouse, but lighter apparel in your Florida warehouse. Your average inventory levels may vary based on season and your company’s growth patterns, but by ensuring you have a strong supply chain and detailed analytics on what’s selling, you can keep your inventory turnover ratio in a healthy range for your business.
Pay attention to returns in your inventory turnover ratio
It’s also important to understand as an ecommerce business that once you sell an item, that doesn’t necessarily mean you’ve seen the end of it: As many as 30 to 40 percent of ecommerce sales can end up as returns, whether because of defect, poor fit, style, or the shopper just changed their mind.
A high return rate can end up with excess retail inventory that can’t always be easily resold, leading to lower profit margins. However, by making use of a returns management solution like Loop, you’ll be able to increase profitability by converting many of these returns into exchanges, using a seamless platform that helps shoppers easily trade in one item for any product in your store without needing to return to their shopping cart.
Using a returns management solution can help merchants increase revenue by up to 40%, by incentivizing customers to choose another item in exchange for the one they’re returning, often with the potential for upsell revenue if the new item has a higher price. The solution also makes it easy to provide other refund options, such as donation or recycling, if you already have a lot of unsold inventory for the product in question, and the cost of goods sold is not worth the costs of processing a return.
By taking steps to ensure that your average inventory levels are in line with benchmarks for your industry, you’ll be able to lower your holding costs and increase profitability, helping to improve your overall business performance.
Want to improve your inventory turnover ratio by reducing refund rates? Get a demo of Loop today.