Optimising Inventory For Growth

Calculating Inventory Turnover

In the world of ecommerce, there are countless KPIs to monitor, but inventory turnover is one metric that most retailers prioritise. So, what exactly is inventory turnover? How can it be calculated, and what elements—such as the nature of your products or your return process—can influence the rate?

In this guide, we’ll explore what inventory turnover entails, how to compute the turnover ratio, provide examples, and explain how to understand the results in relation to your specific business model.

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How Do You Calculate Inventory Turnover?

While you could calculate inventory turnover by dividing the sales' market value by your ending inventory, supply chain experts prefer a more precise method:
Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory

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This approach focuses on COGS, which removes the effect of market price fluctuations. Using average inventory instead of ending inventory accounts for seasonal differences in buying behaviour.

Let’s break it down with an example. Suppose you want to know your retail business’s inventory turnover for last year. First, check your income statement for your total COGS—let’s say it’s $200,000. Then, find the average inventory value from your balance sheet—let’s say it’s $40,000.

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Using the formula:
COGS ($200,000) / Average Inventory ($40,000) = 5

That means you sold and replaced your inventory five times last year.

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What’s a Good Inventory Turnover Ratio?

The ideal turnover ratio depends on your industry, but ecommerce businesses generally aim for a ratio between 4 and 10. If you’re looking for more specifics, ReadyRatios offers industry benchmarks, though they express turnover in days instead of ratios. To convert your ratio to days, just divide 365 by your turnover ratio. For instance, a turnover ratio of 5 becomes 73 days:
365 / 5 = 73
In this case, your inventory would turn over every 73 days.

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High vs. Low Inventory Turnover Ratios

A higher inventory turnover ratio is often a good sign, especially for businesses selling perishable items like groceries or flowers. It means lower storage costs and faster sales. However, artificially high ratios could indicate unsustainable sales tactics or bad purchasing habits, which can lead to shortages and missed future sales.

On the flip side, a low turnover ratio could raise red flags. It might mean you’re holding onto inventory for too long, which ties up cash and adds storage costs. But for businesses like luxury retailers or vintage car sellers, lower turnover isn’t necessarily a bad thing. Fewer but higher-value sales can still mean big profits.

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Let’s dive deeper on inventory turnover

Here’s where it gets interesting—you don’t have to look at your overall turnover rate and call it a day. You can break it down even further:

Per-Product Turnover

Let’s say you sell three different product lines and have an overall turnover rate of 5. Not bad, right? But what if you look closer and find:

• Product A: Turnover ratio of 3
• Product B: Turnover ratio of 5
• Product C: Turnover ratio of 7

Suddenly, that average doesn’t look so good for Product A. It might be time to reconsider whether selling it is worth the trouble.

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Per-Location Turnover

If you operate multiple stores, you can also analyze turnover by location. Compare newer stores with older ones to see where your inventory is moving and where you might need to step up your game.

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Inventory Turnover and Return Rates

Lastly, don’t forget to factor in returns. While returns are indirectly included in turnover calculations, it’s helpful to track them separately. If you have a high turnover rate but an equally high return rate, your sales numbers might not be as strong as they seem. Tightening up your product descriptions and return processes can help lower returns while boosting sales. Having the right tech partners on board, like Narvar’s returns solution, can make returns seamless for customers and help you retain revenue through exchanges.

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