How to Calculate (and Optimize) Inventory Turnover Ratio for Your eCommerce Business

How do you know if your products are selling fast enough?

You might have a warehouse full of products, but they're just taking up space and tying up cash flow if they're not moving.

That's where inventory turnover ratios come in handy.

This metric can give you a clear picture of how well your products are selling and if you're stocking the right items. It can help you make smarter inventory decisions and avoid slow-moving stock.

In this guide, we're going to break down what the inventory turnover ratio is and how you can calculate it for your business. We'll also share some tips on what makes a good ratio and how you can improve yours to keep your business thriving.

Let's dive in.

What is inventory turnover ratio?

The inventory turnover ratio is a metric that tells you how many times your inventory is sold and replaced over a set period, usually a year. It's calculated by dividing the cost of goods sold (COGS) by the average inventory.

So, why should you care about this ratio?

Great question.

Working out your inventory turnover ratio helps you see how well your products are selling and whether you're stocking too much or too little of something.

A high inventory turnover ratio means your products are selling quickly - that's usually a good sign. You're likely managing your stock well and meeting customer demand.

A low ratio might mean you're carrying a lot of unsold stock. That can be bad news for your eCommerce store. It means your cash flow is tied up in excess inventory.

Understanding your inventory turnover ratio gives you insights into your sales performance and inventory management. You'll know when to push fast-moving products and when to wind down products that don't sell as quickly.

What are the benefits of calculating inventory turnover ratios?

There are plenty of reasons why you should bother calculating inventory turnover ratios. Let's dive into the benefits.

Better cash flow management

When you know how quickly your inventory is selling, you can plan your cash flow more effectively. If your products are moving fast, you can reinvest that money into new stock or marketing efforts. If some items are moving slowly, you'll know not to invest more cash in inventory.

Optimized inventory levels

Knowing your turnover ratio helps you avoid overstocking or understocking.

Overstocking is when you have too much inventory. Your capital is tied up in products that just sit there.

Understocking is when you don't have enough stock to meet market demand. You miss out on sales opportunities because you can't fulfill customer orders.

This can be a significant issue for eCommerce stores. A recent study found that 34% of businesses have unintentionally sold a product that was unavailable in their inventory:

Selling a product you don't have is a surefire way to annoy your customers.

Enhanced product range

Keeping tabs on your inventory turnover rates can give you insights into which products are your best sellers and which should be phased out. This can help you refine your product range and focus on the types of products that shoppers actually want to buy.

Business health indicators

A good inventory turnover ratio indicates that your business is doing well. It shows that you're managing inventory efficiently and generating plenty of sales.

If your ratio is low, it shows that something needs to change. You might need to revamp your marketing tactics, switch up your product selection, or sell off excess inventory. This is information that you need to know.

According to a recent study, 48% of small businesses miss out on these insights because they don't manage inventory or use manual processes. So it's no surprise that nearly 60% of retail companies fail to survive past 10 years.

What do you need to know before calculating your inventory turnover ratio?

Before we get to the calculations, you need to familiarize yourself with a few key terms. Understanding these terms is crucial because you'll use these metrics to calculate your inventory turnover ratio.

Cost of goods sold (Cogs)

COGS is the total cost of purchasing the products you've sold during a specific period. This is usually the amount you've paid to your suppliers. It also includes the value of your beginning inventory.

It does not include the cost of shipping products to your customers, utilities, and other business expenses.

Here's the formula:

COGS = Beginning Inventory + Purchases − Ending Inventory

For example, if your beginning inventory is $20,000, purchases are $140,000, and ending inventory is $25,000:

COGS = 20,000 + 140,000 −25,000 = 90,000

Your COGS would be $135,000.

Average inventory

This is the average value of your inventory over a certain period. It's calculated by adding the beginning inventory to the ending inventory and then dividing by two.

Your inventory levels can fluctuate throughout the year as you buy and sell stock. That's why it's important to use an average.

Here's how to calculate your average inventory:

Average Inventory = Beginning Inventory + Ending Inventory ÷ 2

20,000 + 25,000 ÷ 2 = 22,500

On average, you held $22,500 of inventory throughout the year.

First in, first out (FIFO)

FIFO is a valuation method that assumes that the first products you purchase are the first ones you sell. In simple terms, it means you sell your oldest stock first.

This can be useful if the price you pay for products increases over time. When calculating your COGS and average inventory using FIFO, your ending inventory is made up of the most recently purchased, higher-priced items.

Last in, first out (LIFO)

LIFO assumes that the products you purchased most recently are the first ones sold. So you sell your newest stock first.

Again, this can be useful if product costs are increasing over time. When calculating your COGS and average inventory using LIFO, your ending inventory consists of older, lower-priced items.

How do you calculate inventory turnover ratio?

Now we've covered the basics, it's time to calculate your inventory turnover ratio. While it might sound complicated at first, it's actually a very simple formula.

Inventory turnover formula

This is the most common way to calculate an inventory turnover ratio.

Inventory Turnover Ratio = COGS ÷ Average Inventory

Let's break it down with an example.

In the last year, we'll assume that your cost of goods sold was $135,000.

Your beginning inventory is $20,000, and your end-of-year inventory is $25,000. So, your average inventory value is $22,500.

Next, you need to plug that number into the formula:

Inventory Turnover Ratio = 135,000 ÷ 22,500 = 6

This means you've sold and replaced your inventory six times during the year.

FIFO (first in, first out) method

Next, we have the FIFO method. This assumes that the first products you bought are the first ones you sell.

The calculation is the same:

Inventory Turnover Ratio = COGS ÷ Average Inventory

Let's say your COGS calculated with FIFO is $140,000. With an average inventory cost of $22,500, your ratio would be:

Inventory Turnover Ratio = 140,000 ÷ 22,500 = 6.22

LIFO (last in, first out) method

Lastly, there's the LIFO method. LIFO assumes that the last items you bought are the first ones you sell.

Using LIFO, you still follow the same basic formula:

Inventory Turnover Ratio = COGS ÷ Average Inventory

If your COGS is $130,000, the calculation would look like this:

Inventory Turnover Ratio = 130,000 ÷ 22,500 = 5.77

Putting it all together

Using these formulas, you can calculate your inventory turnover ratio. Whether you use FIFO or LIFO, the key is to stay consistent with the method you choose. This will give you an accurate overview of your company's inventory performance.

You can apply the formula to individual products or your entire inventory.

Calculating the inventory turnover ratio for individual products can provide detailed insights into the performance of each item in your inventory. This will help you understand which products are selling quickly and which are slow movers.

Using the inventory turnover ratio for your entire inventory will give you an idea of how efficiently you manage your inventory as a whole.

What’s the ideal inventory turnover ratio?

So, you've calculated your inventory turnover ratio - that's great! But what does the number actually mean? Let's take a look at what makes a good inventory turnover ratio and the factors that can impact it.

What’s a good inventory turnover ratio?

Generally, a good inventory turnover ratio is between 6 and 12. This means you're selling and restocking your inventory every one to two months.

According to a report by CSIMarket, the retail industry has an average inventory turnover ratio of 12.08:

However, the ideal inventory turnover ratio can vary depending on your niche.

For example, if you sell food or perishable items, you can expect a high turnover as people purchase these items frequently. If you sell furniture, you can expect a lower inventory turnover rate as people don't buy a new wardrobe or sofa as often.

The key is to compare your ratio with industry benchmarks.

If your ratio is much higher than the industry average, it could mean you're doing great in sales. But it could also indicate that you're not keeping enough stock.

If your ratio is much lower than the average, it might indicate that your products are not selling as fast as they should.

What factors can impact your inventory turnover ratio?

There are a few key factors that can influence your inventory turnover ratio. Here's a breakdown of the most important:

Inventory management

This hardly comes as a surprise. How you manage your inventory has a huge impact on your inventory turnover ratio.

Ordering the right amounts at the right times can keep your turnover ratio healthy. You need solid inventory management systems in place to prevent overstocking and understocking.

Sales fluctuations

Sales are very rarely consistent. For example, if you invest in a ton of paid ads, you can expect your turnover ratio to spike as you make more sales.

Shifts in consumer behavior can also affect your inventory turnover ratio. If you sell smartphones, older inventory will naturally turn over more slowly when a new model is released - customers rush to buy the latest version.

Seasonal changes

If your eCommerce store sells seasonal products, you'll see significant changes in your inventory turnover ratio throughout the year. For example, sales for BBQ equipment will naturally slow down over the winter and peak in the summer. It's important to account for seasonal sales when analyzing your ratio.

Understanding what your ratio means

Once you know your inventory turnover ratio and understand the factors that affect it, you can start making smarter decisions. The goal is to find a balance that works for your eCommerce business.

A high turnover ratio indicates strong sales and good inventory management. However, if the ratio is too high, it suggests you're not keeping enough inventory and could be missing out on sales.

A low turnover ratio indicates slow sales or overstocking. You might be tying up too much capital in unsold stock. If that's the case, review your marketing tactics and think about ways to improve your sales forecasting.

What mistakes should you avoid when calculating your inventory turnover ratio?

The inventory turnover ratio is a super helpful metric for eCommerce. However, there are a few common mistakes people make when calculating and interpreting this ratio.

Inconsistent calculation methods

One of the biggest mistakes is not following a consistent method when calculating your inventory turnover ratio. Whether you use FIFO or LIFO, pick one and stick with it. Switching between methods will give you misleading information about your inventory.

Ignoring industry benchmarks

Understanding how you compare to the rest of your industry is important. If you're significantly above or below the industry average, it's worth investigating why. Is something causing you to turn over stock too slowly or too fast?

Not regularly monitoring your ratio

Your inventory turnover ratio isn't something you calculate once and forget about. It's a metric that can change based on sales and stock purchases, so you need to keep an eye on how it changes over time. Regular checks will help you spot trends and keep on top of inventory levels.

Misinterpreting high and low ratios

Generally, a high inventory turnover ratio is good, and a low inventory turnover ratio is bad. But you don't want to rush any decisions based solely on this number.

For example, you might currently have a low ratio, but that could be that you're just well stocked for an upcoming peak sales season. You need to account for the factors that influence your eCommerce business.

Neglecting the impact of discounts and promotions

Promotions can be a great way to boost sales and get stock moving. However, you need to account for these temporary sales increases when analyzing your data. A promotional period can distort your ratio and give a misleading view of your inventory management.

Not adjusting for inventory write-offs

If you have to write off any inventory, make sure you account for the impact on your ratio. For example, if your warehouse floods and you need to replace a lot of stock, that's going to distort your turnover ratio. Adjust your numbers to reflect the real inventory levels.

How can you improve your inventory turnover ratio?

Now that you know how to calculate your inventory turnover ratio and why this metric is so important, how do you improve it?

That's what we're going to reveal in this section. Here are some practical tips to help you boost your ratio.

Accurate demand forecasting

The number one cause of a poor inventory turnover ratio is excess stock. That's why demand forecasting is so important. This means predicting how much of each product you will likely sell over a certain period.

You can use historical sales data and market research to make more accurate predictions. The more accurate your forecasts, the better you'll be at ordering the right amount of stock.

Streamline your inventory management

There are plenty of inventory management software tools that can help you monitor stock levels and stay organized. You need to make sure you're keeping a close eye on your stock levels, reordering fast-moving items at the right time, and reviewing your inventory for slow movers.

Optimize your product listings

Make sure your product listings are doing a good job of converting traffic into sales. According to a recent study, product images and descriptions are the most influential on-page elements for mobile shoppers in the U.S.: 

High-quality photos and detailed descriptions can make a big difference in how quickly your products sell. You can use the resources below to discover more ways to boost conversion rates for your online store.

Enhance your marketing efforts

Marketing always has a big impact on sales. That means it can also significantly affect your inventory turnover ratio.

There are tons of ways you can reach the right people and promote your products. Check out the resources below for expert tips on how to drive more eCommerce sales.

Improve supplier relationships

Having a better relationship with your suppliers can help with inventory management. You have more control over your inventory levels when you work with reliable suppliers that deliver orders quickly. It can help you avoid overstocking and understocking issues.

If you're looking for new suppliers for your eCommerce business, make sure you check out the resources below.

Grow your eCommerce store with effective inventory management

Keeping a close eye on inventory turnover ratios is essential for the success of any business. After reading this guide, you should be more confident about calculating and using this metric to optimize your stock levels.

If you're looking to find reliable suppliers for your online store, SaleHoo can help. Head over to the SaleHoo Directory to discover millions of products from over 8,500 vetted wholesalers, manufacturers, and distributors. It's the most affordable and most up-to-date supplier directory in the world.

Find reliable suppliers now!

If you have any questions or need tips on anything related to eCommerce, don't hesitate to contact our expert customer support team.