In business, measuring and keeping a count of your inventory and how it sells is essential to responsible bookkeeping and success as a business. Inventory turnover is just such a concern. This is measured by the simple equation of the cost of goods sold divided by the average inventory. This reflects the number of times inventory is sold or used in a particular time period. Accurately measuring inventory is critical to understanding how a product is selling and appropriately managing your business’ supply, stocking, and virtually every other auxiliary cost involved in keeping the company running.
Turnover Rates
Inventory turnover rates depend largely on the type of business–some have very high turnovers; some have very low. Understanding the fluctuating balance is key. Obviously, no business wants to consistently have low turnovers, as that is seen as a failing model, but sometimes a low turnover rate is necessary and even good. When a business anticipates rising prices of a good or market shortages, having a high inventory and low turnover rate can be a good thing. Likewise, if the business is stocking up on product in anticipation of a major holiday sale or a perceived high demand, keeping turnover low for a time can be a smart marketing move to create the idea of scarcity and inflate demand.
In other instances, however, a constant low turnover rate could indicate a failing strategy. Overstocking, problems with the product or marketing, or just a general lack of demand for the product can all be causes of low turnover. This doesn’t mean, however, that very high turnover rates are ideal either. If the business is always out or low on product, customers can get frustrated and sales can go down. This may cause regular stock shortages as the business tries to maintain inventory to keep up with demand. Overall, the entire balancing act of inventory turnover is enough to make a business owner or manager go mad.
Cycling Inventory
Measuring inventory and sales is a constant process of adjustment. When looking at turnover ratios, it is helpful to take into account overall costs of sales and holding costs. The cost of sales is the basically the market value of the good or service provided by the company. Holding costs are the expenses a company has in stocking and maintaining product to be sold–things like rent, utilities, insurance, and employee pay factor in here. Through all of this, the inventory cycle reflects inventory turnover. Companies must coordinate much of their inventory stocking with marketing, annual sales figures, and overall operational costs to determine how to maintain the inventory cycle.
Transitions between seasons or low turnover rates may require adjusting product inventory, depending on the industry. Sometimes business will reduce the cost of products or initiate promotional marketing deals to boost sales and make a quick cycle through inventory. This is where reducing holding costs comes in as a strategy since the company wants to reduce overhead expenses in stocking product and free up space for the next wave of products. This is especially true in the retail business where items sell seasonally and customer’s expectations constantly change.
No matter the industry, proper inventory turnover is an integral part of the success of the business. On a basic level, the entire business model is based on holding an inventory and gradually selling it for a profit. The hard part is maintaining that oh so simple equation of costs of goods sold with average inventory. It is harder than it sounds.
Ben Vaughn has written on the importance of inventory turnover, warehouse management, and material handling. He recommends the website for Hoj engineering is a good resource to learn more about how companies manage their inventory.
Marty Huggins
