Inventory Turnover Rates
Inventory turnover is an important measure showing how much inventory a business has replaced and sold throughout a given period. A business may then multiply the number of days in the current period by the inventory turnover ratio formula to arrive at the number of days it actually takes to replace the inventory in stock. Jan 10, 2021 is the earliest date that can be used in this calculation. If the turnover is much higher than expected, it may be due to a number of reasons. This article discusses some of them.
One reason for higher inventory turnover is bad marketing or a product mix that has not been properly tested or that has not sold well. Another reason could be too much focus on one single product and not testing other similar products. For example, if a company manufactures children's toys, it is likely that it will produce the toys in large quantities, keep the prices low, and sell them quickly.
To calculate ideal inventory turnover, a company must identify the average number of days to replenish stock with new merchandise. It must then calculate the average number of days it takes to replace existing inventory. This is known as the inventory turnover ratio or ITR. The ITR can also be calculated by dividing the total number of days to replenish stock by the average time it takes to replace inventory.
To calculate the ITR, companies have to be aware of their own industry averages and their overall merchandise turnover. One way to determine industry averages is to look at sales figures from each of the last three years for each of the industry averages. These industry averages can then be multiplied by 30 days to arrive at the industry average inventory turnover rate. A useful tool to use in calculating industry averages is the average inventory turnover ratio, which compares the industry average inventory turnover rate against the industry standard.
Another way to calculate inventory turnover is to determine the level of open-to-buy inventory that a company should carry on hand. By measuring the length of time it takes for goods to be "thrown out" or returned to stock inventory, companies can determine if they are meeting their inventory turnover targets. Ideally, a company should maintain a one percent open-to-buy inventory turnover. To calculate this ideal inventory turnover, subtract the total number of days the company sells goods to customers from the number of days the company keeps goods in inventory and multiply the result by a ratio, such as two percent.
The inventory turnover ratio, while important to management, is only one part of the equation in determining a firm's inventory turnover rates. The other factors that affect the turnover rate are the type of goods sold, the cost of those goods, and the profitability of the firm. If a firm's goods sell for less than its costs, it will have a higher inventory turnover than a firm that charges higher prices for its goods. Likewise, if its products sell for more than its costs, its inventory turnover rate will be lower than a firm that sells goods at lower prices. In addition, a firm with high levels of customer loyalty will tend to have low inventory turnover rates, while a firm that sells only for profits has high levels of customer turnover.
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