Inventory turnover is one of the most crucial metrics for your business. It helps business owners estimate their sales by giving me an idea about the stocks sold in a fixed duration. This metric is directly linked with order and warehouse management. Apart from that, it has other significant points as well. Before we head towards the importance of this metric, we need to know what it is and how to calculate it.
What is Inventory Turnover?
Inventory turnover is the rate at which the stocks in a warehouse are sold or replaced in a fixed time. It gives you an idea of how many stocks you have sold in a month or any other duration. The typical time frame used for inventory turnover is one year.
How to Calculate It?
Calculating the inventory turnover ratio is not rocket science. You just need a simple formula to estimate this crucial metric. Divide the cost of goods you sold with the average inventory. It can be represented as:
Inventory Turnover = Cost of Goods Sold (COGS) ÷ Average Inventory
Here COGS is the total cost of items you sold and the average inventory is the mean value of the stocks you have in your inventory in a year. It helps a lot in managing inventory and orders. A high ratio means that you have strong sales and vice versa.
Significance of Inventory Turnover
The inventory turnover ratio is a crucial metric because it helps you manage several other things in your company. The main points that reflect the significance of this metric are:
Optimized Warehouse Management
Managing the warehouse is one of the most crucial things to keep your business growing. From storing products to delivering orders, warehouse management plays a major role in countless business operations. By knowing the inventory turnover ratio, you can optimize your warehouse management.
Firstly, it will provide you with useful information about stocks. Secondly, if the ratio is high, you will focus on contacting dealers and stocking enough products to meet customers’ demands. Similarly, if the ratio is low, you will try to stock a limited number of products that your company is able to sell in a fixed duration.
Reduced Holding Cost
To stock your products, you need to bear several extra expenses. Insurance fees, management costs, storage bills, and risks of obsolescence are associated with stocking different products. These holding costs keep rising when you have to stock them for a long time. However, when you know the inventory turnover ratio you can reduce the holding cost.
When the ratio is high, it means you are selling most of your stocks and only have a few products to store in the inventory. It will automatically reduce holding costs. On the other hand, if the ratio is low, you can estimate the stocks that are extra and can replace them with in-demand products. It also reduces the holding cost.
Enhanced Order Management
Managing orders is one of the primary tasks you have to do if you want to scale up your business. Without proper order management, you may not be able to satisfy your potential clients and make them return customers. Inventory turnover can modify the order management system.
If you observe the ratio is high, it means the sales department is doing good and you are selling most of the stocks. You can stick with your current strategies and make changes to them for extra efficiency. On the other hand, if the ratio is low, it means you are not managing orders appropriately. You need some advanced strategies to boost sales and manage orders efficiently.
Improved Order Fulfillment
To enhance order management, you need to fulfill customers’ demands efficiently. Inventory turnover helps in managing warehouses that are directly linked with order fulfillment. In an optimized inventory, order fulfillment will be more efficient.
A higher inventory turnover ratio means that you need to keep more stocks to meet customers’ demands efficiently. So, inventory turned over prompt order fulfillment as well.
Final Words
Inventory turnover is one of the major KPIs for your business. It helps in managing the warehouse and orders which automatically boosts the order fulfillment rate. In short, you need to maintain a higher inventory turnover ratio to grow your business at a rapid pace.
