Key Insights
Understanding your inventory turnover ratio is essential for maintaining healthy cash flow and maximizing profitability. In this guide, you'll learn how to calculate your inventory turnover ratio, interpret what the numbers mean for your business, and discover practical strategies to optimize your stock levels. Whether you're dealing with slow-moving products or trying to prevent stockouts, these insights will help you make smarter inventory decisions.
- Your inventory turnover ratio calculates how many times you sell and replace stock: Divide cost of goods sold by average value of the inventory to get a number showing how frequently inventory cycles through your business during a specific period.
- Calculate average inventory value by adding beginning and ending inventory values, then dividing by two: This provides the baseline number needed for accurate turnover calculations at both SKU and total stock levels.
- Low inventory turnover can signal overstocking or weak demand: Products sitting too long increase carrying costs for storage and maintenance while reducing cash flow and profitability.
- Consider price adjustments and marketing improvements to boost inventory turnover: Lower prices through sales, enhanced product visibility, and targeted promotions help move slow inventory faster.
If you run a retail store, you're going to be holding inventory. Depending on your business, that inventory might be final products like pottery or linens, or raw materials like lumber or wool. Either way, you don't receive revenue until you turn over or sell those goods. Your inventory turnover ratio can impact the amount of profit you have flowing through your business and determine whether you're able to meet the demand for your products.
Having strong visibility into inventory turnover is helpful for several reasons. Inventory turnover ratios can inform how you forecast sales for your business and reveal cracks in your inventory management processes. And once you get a handle on a few numbers, the ratio is easy to calculate.
What is inventory turnover ratio?
Inventory turnover is the rate at which inventory turns over, or the rate at which you can sell goods to customers. You might also hear this metric called stock turnover, inventory turns, or inventory turn rate. These terms all mean the same thing. It's typically represented as a number, not a percentage. A lower number means that a particular stock keeping unit, or SKU, is not selling quickly or is no longer in demand. A number that's too high means that you aren't stocking enough of an item and indicates you could be missing out on potential profits.
It's important to note that inventory turnover ratios are usually calculated at the SKU level but can also be aggregated to find the turnover rate for your entire stock.
Why is inventory turnover important for your store?
Similar to revenue growth, profit margin, and other business metrics, the inventory turnover ratio helps you measure performance and better understand how your products are selling. When you're choosing which units to sell each quarter or each year, it's important to know whether a product is flying off the shelves and should be stocked more regularly, or whether another product is idly gathering dust.
Carrying costs, or how much you spend to keep items in warehouses or keep them maintained while they await a sale, can add up. A low ratio can signal weak sales for an item, so it's helpful to reassess whether it's worth the associated carrying costs of storing and transporting it. Maybe it's time to stop stocking that product, or rethink your pricing strategy to prevent those SKUs from piling up.
How to calculate the inventory turnover ratio
To calculate your inventory turnover ratio, you look at two key pieces of data. These metrics should be easy to find in your business's income statement, profit and loss statement, or point-of-sale (POS) software. One important note: always use your cost of goods sold (COGS) in this formula, not your net sales or revenue. Using revenue instead of COGS is a common mistake that produces inaccurate results.
- Cost of goods sold (COGS): This figure measures the direct cost of the inventory that has been sold by your business. It's a major factor in your profitability and essentially equals what you spend to keep and maintain inventory. Don't make the mistake of assuming the cost of goods sold is just what you paid the supplier. This cost also includes what you may spend on storing those goods, packaging, and any additional labor involved in selling those products, all part of your order fulfillment process.
- Average inventory value: This number gives you insight into the mean value of your inventory during a certain period of time. A business uses this to accurately guess how much inventory it has available. To find your average inventory over a month-long period, add the cost of your beginning inventory and your ending inventory, then divide by 2. If you had inventory at the beginning of the month valued at $2,000 and at the end of the month valued at $4,000, then your average inventory for the month was $3,000.
Then, to calculate the inventory turnover ratio, take the cost of goods sold and divide it by the average inventory. (This can be done for a specific SKU or your entire stock, depending on the insights you're seeking.) The number you get represents how many times your inventory was sold and restocked over a certain time period.
Imagine your cost of goods sold is $25,000 and your average inventory is worth $5,000. Your inventory turnover ratio is 5, which means you turned over your inventory and replaced it five times in the past month.
What is a good inventory turnover ratio?
Now that you have a number for your inventory turnover, how do you know whether it's good or bad? The answer depends on several factors unique to your business. Your industry plays a major role—a grocery store will naturally have much higher turnover than a furniture retailer. The durability and shelf life of your products matter too. Perishable goods or fast fashion need to move quickly, while durable items like appliances or seasonal decor can sit longer without losing value. Your storage capacity and costs also influence what's realistic for your operation. If you're working with limited space or high warehousing expenses, you may need higher turnover to stay profitable. While some e-commerce businesses aim for an annual ratio between 4 and 6, that's just a general benchmark, not a universal target. (Note that most published benchmarks refer to annual ratios, so if you're calculating monthly turnover, you'll need to adjust your expectations accordingly.) High-volume, low-margin businesses will typically see much higher ratios than low-volume, high-margin operations. The key is understanding what's normal for businesses similar to yours and what supports your specific profitability goals.
Five ways to improve your inventory turnover ratio
Let's say you don't like your inventory turnover ratio. Perhaps you think it should be higher, meaning that you're moving items too slowly, or you've decided that it should be lower, which means you're not keeping up with the demand for your products.
To increase an inventory turnover ratio:
- Revisit how you're pricing your products. Are the prices competitive enough when compared with similar products on the market? See if you can lower prices with a sale or discount, as long as the price still covers your costs. Find a way to charge a fair price in relation to the value of your product, even if that means exploring cheaper suppliers or manufacturers.
- Examine whether your prices might be too low and if that's impacting your profitability. There's also the possibility that your products can't stay on the shelves because they're priced less than your competitors'.
- Invest in stronger marketing or find ways to revitalize your excess inventory. You picked these products for a reason, whether it's the quality of materials or craftsmanship, so showcase those reasons. Your shoppers may just need greater awareness of those factors to be tempted to buy.
- Stock less of unpopular products. Simple but effective: Identify and phase out products with low sales, a key part of good catalog hygiene. Seasonal, occasional, and fashion-forward trends all impact inventory, so keep an eye on what's working and what's not and plan accordingly.
- Encourage customers to preorder. If you can get your customers to preorder and register for specific products, you'll have instant, confirmed sales to boost your turnover. Try crafting special marketing for preorder sales of your most popular items, and make sure the orders you take can be fulfilled from your inventory.
Keep in mind that you might want to actually lower inventory turnover that's too high. If a customer consistently sees that your products are out of stock, they will inevitably feel frustrated. To slow down inventory turnover, you can reevaluate the quantities of inventory you purchase at one time. That quantity might need to be increased to meet the demand for your product.
Frequently asked questions
Is inventory turnover expressed as a percentage?
No, inventory turnover is typically expressed as a number, not a percentage. For example, a turnover ratio of 5 means you sold and replaced your inventory five times during the period you measured. Think of it as a count of how many times your stock cycled through your store.
What does an inventory turnover ratio of 1.5 mean?
A ratio of 1.5 means you sold through your average inventory 1.5 times during the period you measured. For most retail businesses, this suggests inventory is moving slowly and may be tying up cash that could be used elsewhere. Consider reviewing your pricing, marketing, or product mix to see what might be holding sales back.
What is considered a bad inventory turnover ratio?
There's no universal "bad" number because it depends on your product category and business model. However, a ratio significantly below your industry average often signals overstocking or weak demand. If you're consistently below where similar retailers land, it's worth investigating which SKUs are dragging down your overall number.
The inventory turnover ratio can tell you at a glance how much you're selling and how quickly. So keep a close eye on it to keep the right amount of stock on the shelves and keep your shoppers happy. Ready to find products that move? Sign up to shop wholesale on Faire.
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