Supply chain management, Inventory Management

How to optimise inventory turnover: 9 tips

BY Crystal Gilliam 7 Jul, "15

In this guest post Heather Smith covers the importance of efficient inventory turnover to your business operations.  She discusses why inventory turnover is such an essential part of operations, and nine strategies for optimisation.

To ensure your business is efficiently and effectively managing inventory, optimising business cash flow, meeting customers’ needs and maximising profits, you should aim to achieve your optimal Inventory Turnover ratio.

Inventory Turnover is a measure of the number of times inventory is sold and replaced in a time period. The time period is typically a year, but can be shorter. Across business industries and across the world, Inventory Turnover may be called slightly different names, and may be calculated in different ways. For example, two calculation methods are as follows:

Inventory Turnover Ratio Calculation

Inventory Turnover Ratio Calculation

  1. Sales divided by Inventory
  2. Cost of Goods Sold divided by Average Inventory

You may prefer one or the other, depending on your respective business model. Whichever one you choose, however, it’s vital that the same calculation method is applied consistently, so trend analysis is meaningful.

The first method is generally used from an outside comparative analysis perspective. It may be distorted by fluctuating sales value, which actually had real no implications on the inventory’s actual movement.The second calculation method is considered more reasonable, because it uses the real cost of the goods and also levels out potential seasonal fluctuations.

Ideally, a business should compare their Inventory Turnover ratios against industry averages, and seek to better them. However, for unique small to medium enterprises, ascertaining comparable industry standards can be difficult, and so the business needs to look internally to their own trends, while recognising potential seasonal fluctuations and the type of inventory group under the microscope.

A business selling fast-moving consumer goods (FMCGs) such as perishable foods would have a considerably higher Inventory Turnover ratio to a business selling slow-moving consumer goods (SMCGs), such as household appliances. Taking this a step further, a lower than desirable Inventory Turnover indicates low sales in relation to carrying high inventory, indicating cash is tied up in inventory, representing a lost opportunity that could be used elsewhere to grow the business. Furthermore, if selling prices fell, the business could find itself with overvalued stock in relation to what the market is prepared to pay.

Businesses can implement a number of strategies to improve their Inventory Turnover ratio:

1. Increase demand for inventory through a targeted, well-designed and cost-appropriate marketing campaign. This should result in an increase in sales, and movement of inventory. The return on investment (ROI) of the marketing campaign should also be monitored alongside the Inventory Turnover ratio.

2. Review the businesses pricing strategy and analyse what will lead to an overall increase in sales value. Pricing psychology is a complex science; simply reducing prices may not lead to an increase in sales volume. It may, in fact, teach your consumers to only buy from you during sales. Instead, you could explore a number of pricing strategies: premium, bargain, seasonal, rush delivery, providing different pricing levels to different customers, cost plus pricing, including bonuses or value-add with purchases, and the ever-popular playing around with the cents (such as 99 cents versus 50 cents).

I’ve seen the positive impact of this [pricing strategy] within the cycle industry, where shops have stocked an exclusive brand with a high price tag. While the stock turnover was low, customers travelled distances to purchase … [and] once in the shop there was the ability to sell more.

-Jonathan Gaunt, Managing Director, FD-WORKS (http://www.fd-works.co.uk/)

3. Regularly review purchase prices with suppliers and ask for discounts when requesting a quote or placing orders. Explore any options available to minimise prices, such as a bulk-purchase discount, pre-paid freight, extended credit options, and associated freebies. Some suppliers have been known to offer a catered corporate box or lodge if purchase levels are achieved. While this type of bonus won’t help improve your inventory turnover ratio, holistically it’s likely to boost employee morale if they have the opportunity to partake in the perk.

Inventory Turnover Ratio Calculation

4. Define inventory groups in a manner that will be useful to your business so you’re better placed to analyse, understand and react to inventory that theoretically should behave in a similar manner. Most wine merchants would define their stock as red and white, but one may take it a step further and define them as shiraz, merlot, cabernet sauvignon and so on. From another perspective, the wine merchant may use the country of origin (France, Spain, Argentina and so on), the age of the wine, or maybe even the volume of the wine. Factors such as political unrest, weather, currency fluctuations, and even cultural events (such as a Spanish Film Festival in the local area) may explain price, availability and sales behaviour of different groups, and help the wine merchant oversee inventory management.

5. Stock inventory that sells. Use grouping and detailed up-to-date inventory reports to understand what is selling well and generating a profit.

Focus on optimizing your optimal re-ordering quantity.

-Ryan Lazanis, Xen Master, Xen Accounting (http://www.xenaccounting.com/)

6. Optimise the supply chain by buying smaller quantities more frequently.

The cost of storing, warehousing and tracking excess inventory directly impacts your bottom line and it could be tying up extra cash that could be used to grow the business. How do you manage this? Buy inventory to meet one months’ worth of your sales forecast plus a small safety stock, and reorder on a regular basis. (The exception is if you get significant pricing discounts for bulk orders, and would be able to obtain those with an order of several months’ worth of sales, but no more.)

-Dan Schmidt, founder and CEO, The Emerging Business CFO (http://www.ebcfo.com/)

7. Improve forecasting accuracy by grouping inventory, monitoring trends, staying aware of the macroeconomic climate, engaging knowledgeable staff and using timely and accurate data.

8. Encourage clients to pre-order inventory, because this assists the business in planning inventory purchases, moves inventory through the business fast, and enhances cash flow.

9. Review and eliminate stagnant inventory to avoid it simply deteriorating or occupying valuable warehouse space.

At Mishy Moo Pets, I periodically review slow-selling inventory, and then do a number of things: first, see why they aren't selling by referring to my small network of experts (that is, contacting previous customers of MMP to see if the products are items they would look at buying and, if not, why not). I also regularly review and compare my prices to other online and retail stores to ensure I remain competitive on those items. Most importantly, I would review my SEO on these products to see if it is still relevant and, if needed, adjust to keep it so.

-Laurena Reisman, founder, Mishy Moo Pets (www.mishymoopets.com.au)

Utilising an integrated business platform that provides real-time inventory data, and setting and monitoring a realistic inventory turnover goal ensures efficient and effective inventory management, optimal use of cash, maximises profits, and keeps customers happy.

See also:

What accountants aren't (and should be) asking small business clients about their inventory management procedures

Xero inventory management versus TradeGecko inventory software

Using Cloud Computing to break inventory management bad habits

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