You need inventory to fill orders, so having plenty of everything on hand might seem smart. There would never be a stockout and closing sales would be as easy as sending someone to the warehouse. But maintaining too much inventory may undermine your business.
Holding considerable inventory can force you to hold more product than is necessary. What you might consider, instead, is only stocking the amount of merchandise you need, and the inventory turns ratio (ITR) can help you find the inventory levels for your business.
Availability is good, but has a cost
High availability means buying, carrying, and storing a lot of product. Inventory costs money, so you end up using capital that could otherwise help grow and sustain the company. Too much money in inventory can also affect your need to finance and how much you might need.
And there are other problems: Inventory ages, not only on the books, but on the shelves. You may have products fall out of support, become discontinued, get damaged, or otherwise lose value. Then there’s the cost of storage space and increased headcount to manage the additional product.
This all adds up to money your business will have to spend on maintaining a constantly full inventory level.
Increasing inventory turns
Instead of more inventory, consider replenishing stock more frequently. So long as there are enough products on the shelf to satisfy orders that will come in until the next delivery, you can keep customers happy and reduce costs.
This is why you need to look at the ITR. ITR shows how frequently you replace stock over a given period – such as each month, each quarter or each year.
Calculate inventory turns by dividing the cost of goods for the sales you make in a period by the value of your average inventory over the same period.
The idea is to push inventory turns as high as you can to make better use of that inventory.
Setting the right turns level
Finding the right ITR can be a challenge. If you drive turns too high, you may miss filling orders in a timely basis because you don’t have the products you need. Too low, and it means cash is locked up.
Balance inventory turns with sales, vendor stock availability, supplier reliability, and minimum order sizes. Sales fluctuations like seasonality or outsized importance of certain products can also make it tougher to monitor and control ITR. Arrival of new stock in a timely manner becomes more critical.
There is no magic way to know what ITR will be right for your company, but understanding how ITRs work may help you test stock levels and optimize for your operations.