There’s no shortage of KPIs that can be tracked when it comes to ecommerce, but inventory turnover is one that most retailers pay close attention to. So what is inventory turnover? How do you calculate inventory turnover, and what other factors—like the type of goods you sell or your return solution—affect your rate?
Here, we’ll take a closer look at what inventory turnover is, how to calculate inventory turnover ratio, examples, and how to interpret your results in the context of your unique business.
Simply put, inventory turnover is a measurement of how frequently a company sells and replaces its inventory within a given period. Also called ‘inventory turns,’ inventory turnover is typically measured as a rate or ratio that gives a business insight into import, manufacturing, purchasing, and pricing decisions.
Although inventory turnover can be measured by dividing the market value of a company’s sales by its ending inventory figure, supply chain professionals generally prefer to calculate inventory turnover as follows:
Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory
Measuring COGS instead of market value takes the potential impact of market fluctuations on pricing out of the equation, while using average inventory instead of ending inventory can better account for seasonal variation in purchase patterns.
Here’s an example to see how to calculate inventory turnover ratio values in practice. Imagine that you want to calculate your retail business’s inventory turnover last year. First, you’ll look at last year’s income statement to find your total COGS—let’s say they totalled $200,000. Then, you’ll use your balance sheet to find the average value of your inventory account over the past year—imagine that’s $40,000.
Dividing your COGS ($200,000) by your average inventory ($40,000) produces an inventory turnover ratio of 5:
COGS ($200,000) / Average Inventory ($40,000) = 5
In essence, you sold through and replaced your inventory five times over the past year.
Industry benchmarks for inventory turnover vary, but most suggest that a ratio of 4-10 is healthy for ecommerce businesses. ReadyRatios is a good source of benchmarks by industry, though the site expresses inventory turns in days, rather than ratios.
To convert your inventory turnover ratio to inventory turnover days, divide 365 by your ratio. Continuing with the earlier example, an inventory turnover ratio of 5 becomes 73 inventory turnover days (365 / 5 = 73). Expressed this way, inventory turns over every 73 days, or five times total in a year.
That said, even as you look at industry benchmark figures, what’s more important is understanding how inventory turnover factors into the bigger picture of your business’s finances.
Broadly speaking, a higher inventory turnover ratio is almost always better—especially for retailers of perishable goods, such as grocery stores, convenience stores, and florists. Retailers of low-margin goods also typically need to maintain high inventory turnover rates to remain profitable.
When inventory turnover is high, storage and warehousing costs are reduced, as companies don’t have to pay to store slow-moving products. However, inventory turnover ratios can also be driven artificially high by unsustainable sales or ineffective buying. If these factors result in inventory shortages, lower sales can potentially follow in the future.
Conversely, low inventory turnover ratios may be cause for concern in some scenarios. Low inventory turnover generally results from items sitting in inventory for longer than is expected or desirable. Not only do these items incur storage costs, they also tie up business funds in the form of unsold inventory and risk degrading in quality or falling out of favor with consumers.
But low inventory turnover isn’t always a negative sign. Take the example of a vintage auto seller or a luxury jewelry store. Because individual purchases may be fewer and farther between, these high-ticket purchases will naturally drive lower inventory turnover ratios, even though the businesses themselves may still be highly profitable.
Beyond the question of high inventory turnover versus low turns, there are a number of other ways to delve more deeply into how your inventory is moving.
Imagine that your company sells three different product lines and has an overall inventory turnover rate of 5. According to industry benchmarks, that might be an acceptable ratio for you. But what if breaking inventory turns down by product line revealed that:
Even though you’re hitting your inventory turns benchmark, it may still be worth taking a closer look at whether continuing to sell product line A makes sense for your business.
Similarly, turnover can be assessed on a per-outlet basis. If you have multiple physical stores, inventory turns can be compared between stores—--or you can evaluate the inventory turnover of established stores versus newer outlets.
Measuring your inventory turnover by location can help support strategic decision-making on where your company is underperforming or where you may want to position your next outlet.
Finally, it’s a good idea to consider your inventory turnover rate relative to the number of items that are returned to you.
The inventory turnover calculation indirectly takes returns into account, in that any returns you process would affect both your COGS and average inventory values. But comparing the two separately can prove insightful; if your inventory turnover rate is high, but your return rate is also high, you risk overestimating the health of your sales program.
Clearer marketing messages and more specific product detail pages (PDPs) may help bring your return rate down, but it’s also important to make sure you have the right technology partners onboard. Narvar’s returns solution can help you recapture revenue through seamless exchanges, while also giving customers a more positive experience when returns are truly unavoidable.
If you liked this article, you might also like, “The Customer Returns and RMA Process Defined,” or "What is an RMA: Meaning, Use Cases, and Best Practices."