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Inventory Turnover Rate: "Cruise Control" for Your Inventory Levels

by Patricia M. Johnson and Richard F. Outcalt  

These days, few retailers can afford to have excess inventory.  Storage costs, insurance, pilferage, damage, obsolescence, taxes and interest on loans add up to 30 percent annually to the cost of the goods you carry. Because those costs continue to rise, tight inventory control is still one of the best investments you can make—especially during the buying season.

If your store is like many other independent retailers, it’s probably overstocked much of the time. This excess inventory is like excess fat: It looks bad, consumes energy the inventory “muscle” needs, and threatens the financial health of your business.

If you’d like to time your inventory flow so you always have fresh merchandise and a healthy turnover rate, consider the following shape-up plan. It will help trim away excess inventory without cutting into the muscle of your stock.

Achieve the Ideal

Inventory turnover is the theoretical measure of how often, at the current rate of sales, you sell your entire inventory in one year. It is a measure of the velocity at which merchandise comes into and out of your store. 

To calculate inventory turnover, divide total annual sales by your average monthly inventory at retail; or, annual cost of goods sold divided by average inventory at cost.

An inventory turnover rate doesn’t just happen—or at least it shouldn’t. You can choose, within reason, the turnover rate you want to achieve. 

Remember, low turnover ties up your capital and lessens your gross profit.

To get the most out of your inventory, settle on a turnover rate that balances your customers’ needs for selection and service with your need to maintain a solid return on investment.

To get an idea of your store’s optimum turnover rate, track it over a period of time. Is your merchandise turning faster or slower than it was this time last year? 

Another way to assess your turnover rate is to compare it to other stores in the your particular retail niche.  (Click here to find your industry segment's benchmark numbers.)

Get MORE about inventory control

The essence of an inventory control program is to plan your stock levels more stringently by using weeks-of-supply inventory maxims. The goal: No excess inventory.

We’ve already discussed how to identify your targeted turnover rate

Once you find the rate you want to maintain, you can convert it to "weeks of supply" (see the steps in “Excess Inventory?” sidebar). For instance, if you find you should have two turns per year, you need to have a six-month—or 26-week—supply of inventory on hand at all times. But no more than that! 

How do you know how much inventory you’ll need for one selling period? 

By projecting your sales (Step 3).  Remember, close counts; your sales forecast is a “best guess-timate”.  

To project sales, analyze last year’s results, recent receipts, trends in your community (as well as the entire industry) and your total merchandising plan. Due to holidays and other factors, projected sales will vary month to month throughout the year. Be sure to take into account the uncertain economic climate and remember to allow for recessionary factors.

By the time you reach Step 4, you should have a good rule-of-thumb figure for your store’s ideal level of inventory. 

If your current level of inventory is more than you need for one selling period, get rid of the excess! 

• Streamline your assortments. 
• Return all substitutions and unauthorized shipments. 
• Investigate controls to ensure that no orders are accepted after their cancellation dates. 
• If necessary, mark down old merchandise.

Set Turnover Goals

Here’s a way to visualize the process.

Assume you project a total sales volume of $900,000 for next year. What inventory level should you maintain to keep in line with your sales and inventory targets?

Suppose you set three turns as your goal for the year. Dividing 52 weeks by 3, you find you should "sell out" your inventory approximately every 17 weeks. That equals "one turn's worth".

Further assume you expect sales to be $250,000 for the first 17 weeks of the year. That means you should have $250,000 worth of inventory at retail on hand at the first of January.

By contrast, let’s say you’re planning inventory levels for the last 17 weeks of the year. Because that period includes the holidays, you anticipate $450,000 worth of sales during those weeks. You should enter that period with $450,000 worth of inventory at retail on hand. During that time, you will gradually sell down from $450,000 to $250,000, always maintaining the inventory level equal to your sales projections for the next 17 weeks.

The key to this whole process is projecting your sales week by week. Then, at any point in the year, you can look at your sales projections for the next turnover period (in this example, 17 weeks) to determine how your actual inventory compares with your optimum inventory.  The more you compare these figures, the smaller the variations will be and the easier they will be to adjust. 

In all these examples, we’ve treated your store’s inventory as a whole. However, you can and should apply these steps to each department or inventory classification within your store. 

You can’t realistically expect to turn all items in your store at the same rate, so set turnover goals for each category. Combine those results to come up with the desired turnover rate for the entire store.

Maintain the Balance

Retailing is a delicate balance between merchandise and cash. Retailers must take one of two risks: 

• commit themselves to large quantities of inventory and possibly end up with an excess
• commit to less and later find goods unavailable. 

Given the current economic situation, it’s probably better to go with the second risk.

If you hold inventory in proportion to your projected sales for the weeks of supply, you will have a greater share of fresh merchandise. In addition, timing the inflow of merchandise as closely as possible to the start of the selling season will, in most cases, be more profitable than taking goods far in advance, even if vendors grant dating or other price concessions.

The other costs of carrying inventory will almost always wipe out whatever savings you realize by taking goods early

Inventory control requires disciplined effort.

It takes work to maintain a steady flow of fresh merchandise while keeping stock quantities proportionate to your ideal turnover rate. But if you do shape up your inventory turnover rate, it will improve your income statement, balance sheet, and, your bottom line!

And that’s a program worth doing!

©Copyright, The Retail Owners Institute^® and Outcalt & Johnson: Retail Strategists, LLC.

How Much Inventory Should You Have?

Step #1: What is the targeted annual inventory turnover rate for your store(s)?  

(Oops. Not sure what that should be? For free guidance, find your retail segment under the BENCHMARKS tab at The ROI.) Every retailer must know their targeted turnover rate.

Step #2: Next, convert that turnover rate into "months of supply".

For example, 4 turns divided into 12 months in a year equals 3 "months of supply of inventory", what we call "one-turn's worth".

Step #3: Add up "one-turn's-worth" of sales.

For example, on April 30, at 4 turns, you would add up your expected sales for the upcoming 3 months, May + June + July. That is the "one-turn's-worth" of inventory @retail you need to have on hand on April 30. 

Step  #4: Then, roll it forward.

At 4 turns, the targeted Ending Inventory @Retail for May 31 would be the expected sales for June + July + August. And so on.

Notice how the total for the targeted Ending Inventory goes up, as you get closer to those months with a higher sales volume? Then it comes down as sales drop off. 

Managing to "one-turn's-worth" is like having "cruise control:" inventory levels rise and fall in advance of sales peaks and valleys.

Here's The ROI's "rule of thumb:"
At any point in time, you should have enough inventory on hand (@retail) for the next "one-turn's worth" of sales. 

Learn more here: TOPICAL TUESDAYS Seminar on Using Turnover to Drive Inventory Control

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