Apply the Inventory Turnover Formula to Assess Your E-Commerce Business
Inventory Turnover Ratio (ITR) is one of the most crucial metrics for evaluating the effectiveness of your e-commerce business. The formula is simple:
INVENTORY TURNOVER = Cost of Goods Sold (COGS) / Average Inventory Value
For a given period, you divide your total cost of goods sold (COGS) by the average inventory value over that same period.
COGS are a time-based metric. It can be calculated for a period of time by adding your beginning inventory costs, adding the additional inventory costs (labor, parts, storage, etc.) and then subtracting your ending inventory value.
To find the corresponding average inventory value, total your beginning inventory and ending inventory value for the same period of time as your COGS calculation and divide that sum in half.
This ratio of the COGS and average inventory value for a period can tell you a lot about the efficiency of your e-commerce business while also generating key benchmarks for assessing your purchasing and sales performances.
Interpreting Your Inventory Turnover
Inventory turnover is a “sweet spot” type of metric – if it is too high or too low, you likely have an issue.
A low ITR is the most obvious problem. As your inventory turnover approaches zero, it indicates that your stock isn’t moving sufficiently to justify its cost. This could be due to any number of reasons: overstocking, dead stock, poor marketing, and/or a lack of a diversified marketplace strategy. A low ITR won’t pinpoint the problem for you, but it should act as the red warning light that it is time to diagnose the issue(s).
Conversely, a high ITR indicates that you are moving through inventory quickly. In most cases, this is a positive; but if your inventory turnover is too high, you may be missing out on sales opportunities due to low inventory levels and an inability to meet buyer demand. You never want to have to turn a potential customer away with an out-of-stock status message.
So where is the inventory turnover “sweet spot?” Most experts point to an ITR between 5 and 10 as the ideal. This is more of a guideline than a hard-and-fast rule. You should take into account your industry, customer profile, and specific business model to determine the best ITR for your e-commerce business’s performance.
For example, if you deal in perishables or high holding cost inventory, you want your turnover ratio to skew higher (since longer holding times equal higher costs). On the other hand, if you deal in luxury or niche products with lower holding costs, skewing lower may be best.
In general terms, as long as the product of your inventory turnover rate and gross profit margin percentage is less than 1, your average inventory value is not too high. Paying attention to the relationship between your ITR and overall profit-loss values should help you dial in your optimal inventory turnover conditions.
Other Inventory Value Metrics
Along with inventory turnover, there are other key data points you should be actively monitoring to maximize the efficiency of your e-commerce business.
Sellercloud’s Inventory Value Dashboard gives you access to a host of other graphs and data points about your inventory including:
- Inventory Value – This is your current total inventory value. This includes everything your company is currently holding – available and reserved, both sellable and unsellable. This provides a useful insight into the valuation of your stock, but more importantly, it provides a useful starting point for further analysis.
- Average Inventory Value – This is a mean inventory value for a selected date range. It is calculated by totaling the sum of the inventory values for each day and then dividing that sum by the number of days. In many cases, average inventory value (referred to as total value in Sellercloud’s Inventory Value Dashboard) is more useful than inventory value due to the fact that it can balance out steep, single-day drops or spikes that may occur. This is why average inventory value is typically used in calculating inventory turnover.
- Reserved Quantity Value – This shows the average value of your reserved inventory – merchandise and unshipped orders that are technically still on hand, but no longer available for sale. This is similar to On Order Value, which shows the actual value of items in an approved but unreceived purchase order (PO). These metrics allow you to isolate both inventory and revenue that has not yet been fully transacted.
- Top Products By Inventory Value – This surfaces your products with the highest costs. These products represent your largest inventory investments and thus their turnover has the most profound effect on your bottom line.
Sellercloud also features a number of inventory value reports that can be generated to drill even deeper into your inventory specifics:
- Inventory by Warehouse data allows you to isolate inventory value metrics based on their physical location. This can help you make adjustments to which inventory is stored where as well as identify potential logistics optimization opportunities.
- Inventory by Product data provides a hyper-focused look at particular SKUs and their performance. These metrics are the basis for calculations like COGS and inventory turnover at the product level. Staying tuned in to these figures (particularly for your highest cost products) can help you make decisions regarding details like stock reordering rates and product marketing. For example, paying attention to factors like Product Age and Unsold Inventory can make it easy to identify your high- and low-performing SKUs so that you can adjust accordingly.
Data-driven decision making is crucial to e-commerce success. The Sellercloud omni-channel e-commerce growth platform is designed to help you access and wield your inventory metrics to optimize your selling experiences and increase profits. Contact us directly for a free demo of the type of insights and logistical optimizations we can provide for your e-commerce business.