Laurena Reisman, founder of Mishy Moo Pets, periodically takes a close look into items that aren’t selling well on her online pet store. When that happens, she says in an article for iQuoteExpress, she pings previous buyers to get their opinion on the slow-sellers; compares her pricing to competitors; and, most importantly, makes sure that her search engine optimization (or SEO) is still relevant. Prospective customers may be desperately searching for a particular dog collar Reisman carries — but the search engines might not realize she has it in stock.
The reasons inventory isn’t turning over can be complex, critical and illuminating in their metrics – determining how many times a company has sold and replaced its inventory over a particular period, such as a year.
Doing the math
The specific calculation is the cost of goods sold divided by the average inventory. The web site Accounting Explained shows how to calculate inventory turnover ratio using the theoretical example of ABC Company. In this example, ABC has opening inventories of $25,000; closing inventories of $30,000; and a cost of goods manufacturing of $245,000.
The math works like this:
Cost of goods sold = $25,000 + $245,000 – $30,000 = $240,000 Average inventories = ($25,000 + $30,000) ÷ 2 = $27,500 Inventory turnover ratio = $240,000 ÷ $27,500 = 8.73
Check your competitors
You might wonder whether an inventory turnover ratio of 8.73 is a cause for concern or celebration. That depends on the industry. For example, supermarkets, which sell perishable goods, will inherently have a higher turnover ratio than a company with a pricier, slow-moving product, like an automobile dealership.
For that reason, as Accounting Explain points out, Wal-Mart needs to evaluate its inventory by comparing its ratio against direct competitors like Costco; knowing the inventory turnover of a manufacturer like John Deere doesn’t tell Wal-Mart if it’s managing inventory efficiently, or if sales have slowed and goods are overstocked,
By benchmarking your ratio to competitors, you may discover many insights, like whether your sales and procurement departments are working in sync. The ratio may also alert you that you might be a little too stingy when it comes to inventory. “Sometimes a very high inventory ratio could result in lost sales, as there is not enough inventory to meet demand,” explains Investopedia.
Maintaining your inventory turnover ratio at the right level can keep your business running profitably and well — and let you know changes you might address that may otherwise escape your attention.