Managing the ins and outs of inventory for an ecommerce business is fundamental to survival — and success. However, for many small and medium-sized business owners, mastering inventory turnover can be like trying to solve a Rubik’s Cube – challenging, sometimes frustrating, but rewarding when you’ve cracked it.  

In this article, we’ll demystify the complexities of the product lifecycle and help you learn how to calculate inventory turnover accurately, once and for all. 

Ready to wave goodbye to guesswork and say hello to more informed decision-making? Let’s dive in.

What is inventory turnover?

Inventory turnover is the straight-talking rockstar of financial metrics, indicating the number of times your inventory is sold and replaced in a specific time period. Aside from being a reliable indicator of overall organizational health, your inventory turnover rate can also help you assess efficiency. 

Inventory turnover rate can help you assess — and address — efficiencies such as:

• Cash flow 
• Supply chain operations
• Asset utilization

Financial agility is your all-expenses paid (literally!) ticket to business success, so using a no-nonsense metric like inventory turnover as a guiding compass is one of the best ways to fine-tune operations. Plus, by keeping your capital constantly reinvested where it’s needed most, you can avoid the treadmill of excess inventory costs.

What are the basics of calculating inventory turnover? 

To crack the code and discover how to calculate inventory turnover, all you need is a couple of simple formulas:

• Cost of Goods Sold (COGS) / Average Inventory Value = Inventory turnover ratio

In addition to using financial metrics, you can also calculate inventory turnover ratios by looking at SKU units using the following formula:

• Number of units sold / Average number of units on hand = Inventory turnover rate

How to calculate inventory turnover: A step-by-step guide

Unsurprisingly, nailing how to calculate inventory turnover begins with meticulously gathering the right data sets so you have accurate figures to plug into the formulas above. Let’s take a more in-depth look at calculating COGS, stock levels, and how to pick the best inventory turnover timeframe.

Step 1: Know your cost of goods sold

Grab your detective hat and magnifying glass (or just your regular glasses, that works too) because it’s time to dig into your financial records to identify and gather your COGS data. 

Accurate COGS data is the cornerstone of calculating inventory turnover, so the secret is to leave no stone unturned when analyzing your balance sheets. Start by peeling back the layers of your financial statements. Identify and gather every component contributing to the creation or acquisition of your goods. This includes:

• The raw materials that go into your products
• The labor invested in their production
• The overhead costs that keep your operation humming 

Step 2: Track your inventory levels

Now, let’s shift our focus to your inventory. The goal is to have a clear and up-to-date picture of the quantity and value of goods on hand. So, the key to success is establishing a system that consistently monitors your inventory levels.

Whether you implement a sleek, all-in-one inventory management system like Linnworks or utilize your existing software is up to you. But, whichever route you go, real-time tracking is your Jedi power if you’re to avoid stale data and run accurate calculations. Even a tiny misjudgment of stock levels can throw off your groove, making it harder to anticipate trends, make informed decisions, and keep up with your competition.

Step 3: Determine the time frame

The final step is to decide the period over which you want to measure turnover – typically monthly, quarterly, biannually, or annually, depending on the nature of your business and industry. There’s no one-size-fits-all solution, as different industries have varying norms for turnover measurement periods. 

For example:

• Shorter timeframes are most suitable for businesses selling perishable goods like flowers, groceries, health foods, and supplements. 
• Medium timeframes are better suited to industries influenced by seasonal trends. Prominent examples include fashion retail, home furnishings, and agricultural supplies. 
• Longer timeframes work well in industrial settings like the automotive sector – or any other industry characterized by prolonged procurement processes and slower turnover rates for high-value items.

Whatever tempo you choose for your inventory turnover dance, remember that consistency is vital if you’re to determine meaningful comparisons over time and detect patterns that will help you navigate the seas of inventory turnover with precision. 

A practical example of inventory turnover 

Let’s look at how to calculate inventory turnover ratios and rates using a real-world example. 

We’ll begin by calculating the inventory turnover ratio. Imagine your financial figures are as follows:

• COGS: $500,000
• Starting inventory: $120,000
• Ending inventory: 80,000

This would make your average inventory $100,000. So:

500,000/ 100,000 = an inventory turnover ratio of 5.

Now, let’s calculate the inventory turnover rate. During whatever timeframe you’re using for measurement, imagine you sell 2,000 units and have an average of 500 on hand in your warehouses at any given time. In this instance, your inventory turnover rate would be 4.

How to calculate average inventory if starting and ending inventories vary

Looking to learn more about how to calculate inventory turnover averages to smooth out fluctuations? This is often the trickiest part of the calculation because inventory levels are rarely static throughout a given timeframe. But fear not. We’ve got you covered. 

In the example above, we kept it simple by adding starting and ending inventory together and dividing by two. However, there are some more advanced moves you can play:

• Adding from multiple periods – Add inventory from multiple periods, then divide by the total number of periods measured.
• The weighted average cost method – Inventory is valued using the cost of goods sold (COGS) and the value of the ending inventory by averaging the costs of all units in stock.
• The moving average price method – The average price of the product is calculated after every goods acquisition.

How to analyze inventory turnover results

Alas, the work doesn’t stop once the number crunching is done. You also need to analyze and evaluate your inventory turnover results to decipher what it means for your business. Here’s a quick guide to interpreting the language of turnover and leveraging benchmarking to turn your revelations into actionable insights.

High inventory turnover

A high turnover rate suggests that your SKUs are swiftly transitioning from shelves to customers, signaling efficiency, responsiveness, customer demand alignment, and optimum supply chain visibility. A fast and furious turnover rate often correlates to healthy profit margins, with products being efficiently converted into revenue. It also means your capital is continuously reinvested, thus minimizing the financial strain of excess inventory carrying costs. This liquidity is crucial for meeting day-to-day operational expenses, investing in growth initiatives, and adapting swiftly to market shifts. 

Low inventory turnover

Low turnover rates are bad news from a financial standpoint as they tie up capital, leading to increased carrying costs. They typically indicate sluggish sales, overstocked shelves, or mismatched products, pointing to potential operational bottlenecks or market misjudgments. So, if you experience lower-than-expected inventory turnover, it’s worth re-examining your pricing strategies, market positioning, and product relevance so you can adapt your product mix and marketing tactics accordingly to better meet customer demand. 

How to benchmark your turnover rate against industry standards

The ideal inventory turnover rate in most industries is between 5 and 10, meaning you’ll sell and restock inventory roughly every four to eight weeks, or around 6-8 times per year. That said, some industries will naturally have higher or lower turnover rates than others, so it’s essential to consider the context when benchmarking. 

Industry associations, market research reports, and trade publications can often provide valuable insights into the right norm for your operation. Once armed with the right benchmarking criteria, you can compare your turnover rate. If yours is significantly higher than others, it may suggest aggressive sales strategies or potential stockouts. If it’s lower, it could signal overstocking or less effective inventory management. 

Whatever the results, you should regularly revisit and reevaluate your benchmarking processes to ensure your business stays aligned with current trends.

How to improve inventory turnover

Enhancing inventory turnover isn’t just a numerical goal. It’s a strategic dance that requires finesse and proactive decision-making. Here’s a few top tips to up your game:

• Embrace Just-in-Time (JIT) inventory management – If you can hit the sweet spot of ordering and receiving goods just in time for production to meet customer demand, you’ll minimize holding costs, reduce the risk of overstocking, and enhance responsiveness to market changes.
• Improve your demand forecasting strategies – By leveraging data and analytics to predict future demand more accurately, you can anticipate fluctuations in customer demand, optimize inventory levels, and ensure your shelves are stocked with products aligned with market preferences.
• Implement inventory automation systems – Using the right tools to decode your business’s operational rhythm is essential. By automating key processes and streamlining tracking, you’ll reduce manual errors, improve efficiency, and gain a comprehensive view of inventory levels with more real-time insights.
• Streamline supplier management processes – Cultivating strong relationships with suppliers ensures timely deliveries with minimal disruptions – often with the perk of being able to negotiate favorable terms for early payments and extended payment windows that can optimize your cash flow. 
• Introduce flexible pricing strategies to clear out stock – Incentivize the quick sale of slow-moving or obsolete stock by offering discounts, promotions, bundle offers, or flash sales. Alternatively, you can implement dynamic pricing based on demand, seasonality, and inventory levels.
• Reconsider your product mix — Analyze sales data to identify top-performing products and adjust your inventory mix accordingly, focusing on high-demand products that reduce the risk of overstocking for slow-moving items.
• Diversify your product offering – By introducing new products or variations that appeal to a broader customer base, you can reduce reliance on specific products and maintain a fresh and varied inventory that aligns with the changing preferences of your target audience.

Understanding — and avoiding — common mistakes in calculating inventory turnover

Mastering how to calculate inventory turnover like a pro requires a vigilant eye for detail. An accurate calculation hinges on determining a precise COGS value. Here’s a list of common missteps and pitfalls, and a few pointers on how to avoid them.

Overlooking costs 

Neglecting to incorporate every cost associated with production or acquisition, such as raw materials, labor, and overhead expenses, leads to an artificially inflated turnover rate. The most commonly missed figures are typically ‘hidden costs’ that don’t necessarily pop out of a spreadsheet when you’re combing through your financial records. A few examples include:

• Customs duties
• Packaging expenses
• Technology and software costs
• Regulatory compliance fees
• Insurance premiums
• Quality assurance costs

Misinterpreting inventory levels

Some ebb and flow is to be expected. However, misinterpreting fluctuations can result in misguided decisions. Common mistakes include:

• Ignoring the influence of seasonal variations.
• Overlooking the impact of new product launches.
• Disregarding changes in the market landscape due to competitor actions.
• Forgetting to include parameters for lead time variances between suppliers. 
• Ignoring interruptions in the production process due to factors like machinery breakdowns, labor strikes, or supply chain disruptions. 

Avoiding mistakes for a more accurate analysis

Follow these steps to stay on top of your inventory turnover for data that’s always on point: 

1. Conduct a comprehensive and meticulous review of all components within your COGS framework, leaving no cost unaccounted for.
2. Implement normalized adjustments to account for seasonal fluctuations.
3. Factor in the potential impact of product launches on inventory turnover.
4. Regularly reassess data inputs, especially in the face of significant business changes.

Tools and software for inventory management

The marriage of technology with inventory management is no longer regarded as a leap into the future. Rather, it’s a strategic necessity for businesses aspiring to thrive in today’s competitive landscape. 

Utilizing cutting-edge tools and software solutions helps to ensure your data inputs remain reflective of current business dynamics. With a solid foundation of actionable reports and insights based on historical performance, market trends, and other critical parameters, you can avoid the perpetuation of errors over time and make more strategic decisions.

Technology like Linnworks offers a whole host of inventory management advantages, transforming the way your business operates and enhancing overall efficiency by guaranteeing:

• Real-time visibility
• Automated COGS calculation
• Efficient order processing
• Multi-channel integration
• Optimized reorder management
• Enhanced stock forecasting accuracy

Need help with how to calculate inventory turnover, manage your inventory processes, or master warehouse management? With platforms built and tailored toward the needs of ecommerce sellers, the Linnworks team is here to guide you and provide all the support you need. Book a demo today to discuss your pain points and find the right solution for your business.