Shop Talk: Practical answers for tough business questions
Question: After two years of looking for a location, we finally found it and are now finalizing our financial plan to open this fall. One thing I am confused about is what inventory-turn target we should shoot for. Is there an industry average? How do I figure this out?
Answer: Inventory turnover, or inventory turns, measures the number of times the dollars you have invested in inventory sells during a specific time period, usually a year. It is a way to measure how quickly your inventory is turned into sales and therefore profit. You can find your inventory turn rate in a couple of ways. You can take your total retail sales and divide it by your average inventory for the year at retail price. Or, the method I prefer is to take your cost of goods sold for the year and divide it by your average yearly inventory at cost. If you don’t have a point-of-sale program that tells you your average inventory, add your inventory value at the beginning of the year with the inventory value at year end and divide by 2 to get your average.
My best answer is to shoot for an inventory turn of between 3.5 and 4. When your inventory turns under 2 times, it indicates you have too much inventory or too much that just doesn’t sell. And turns of more than 5 or 6 can be good, but more is not always better. When inventory turns that quickly, it may mean you run out of bestsellers, and if customers repeatedly find you are sold out of their favorites, they may start to shop somewhere else. It is a balancing act to order just in time, so you are never out but not overstocked either.
First published in Vol. 27 No. 5 of Retailing Insight. © 2013 Continuity Publishing Inc. All rights reserved.