Inventory turnover is an important metric for businesses to track. It tells you how often your inventory is sold and replaced. This number can help you determine whether you need to order more inventory, or whether you are selling your products too quickly. In this blog post, we will teach you how to calculate inventory turnover using two different methods. We will also discuss the benefits of tracking this metric and give some examples of businesses that could benefit from improving their inventory turnover.
What is inventory turnover in a restaurant?
One of the most important indicators you must learn in your restaurant business is the inventory turnover rate. A restaurant's inventory turnover rate (or ITR) is the number of times you sell inventory over a period. Understanding how to handle inventory in your restaurant is critical to your success and calculating your inventory turnover rate is a big part of it. This will help you make better purchasing decisions, reduce food waste, and increase revenue.
Understanding Inventory Turnover
There are a variety of factors that influence whether you have a high or low turnover rate in your business. In general, a high ITR suggests that inventory is being sold efficiently and that sales are stable. A low ITR might indicate an excess of inventory and low sales.
Assessing what your ITR is trying to tell you about your business may take time. When assessing your turnover rate, it's critical to consider the overall aspects.
Why is inventory turnover important?
The efficacy and operational efficiency with which a company's raw materials are utilized may have a significant impact on its business success. So keeping track of how your company generates sales isn't enough. You also must consider evaluating your entire inventory on how often these resources are replenished. Because the food in your restaurant has a shelf life, it's important to measure turnover. Your restaurant's ITR can help you to determine the overall operational productivity. This insight will definitely help track, optimize inventory management, the inventory cost incurred, and bottom line. Understanding this primary measure is the key to permanently improving resources as well as the company's efficiency and making better business decisions in the long run.
Increase profitability
Evaluating your inventory turnover is a certain technique to achieve strong profits. Higher inventory turnover promotes revenue, therefore this key performance indicator (KPI) is one of the most essential retail growth metrics. Other businesses with high inventory turnover save money on storage and can respond more quickly to changing client needs. It's a win scenario.
Make better decisions
Monitoring your company's inventory turnover will assist you in making better, and more informed business decisions. The following are some of the most important factors for inventory turnover in your company.
- You’ll have a clear idea of what needs to be ordered or reordered.
- You'll be able to see which items are underperforming and implement measures to remedy the situation, such as revising their prices, offering discounts, and so on.
- You’ll be able to forecast order demand, allowing you to make manufacturing and production decisions ahead of time.
What Is the Inventory Turnover Ratio?
The inventory turnover ratio measures how frequently a company's inventory is changed over a period of time. This might be done once a month, quarterly, or once a year. It is also used to determine how long it will take to sell the inventory on hand. The turnover ratio is determined by dividing the cost of products sold by the average inventory during the same time period. A higher ratio is better than a low ratio since a high turnover ratio indicates strong revenue.
Monitoring how efficiently the restaurant goes through its raw materials might provide a lot of information. Effective inventory control, also known as stock control, gives a clear insight into what is on hand, is required to determine the turnover ratio. Some areas influenced by inventory turnover include everything from packaging and shipping to purchasing and ordering.
Good Inventory Turnover Ratio
While no two businesses or scenarios are alike, the ideal inventory turnover ratio for retailers lies between two and six. If your inventory turnover ratio is in this range, your restocking and sales rates are balanced. You'll have just enough inventory to fulfill market demand and there's no such thing as too much or too little.
Bad Inventory Turnover Ratio
Any inventory turnover ratio below two might suggest weak sales and decreasing product demand. This might lead to an overabundance of inventory on warehouse shelves, as well as a waste of both space and resources.
An inventory turnover ratio of more than six, on the other hand, indicates that market demand is exceeding supply. That implies your inventory purchase levels might be too low, resulting in lost sales opportunities or poor customer experiences as a result of late delivery.
What is COGS and why is it important for inventory turnover?
The COGS is a measure of a company's production costs. COGS only includes direct costs, such as the inventory cost of raw materials, and excludes indirect costs, such as those associated with selling or marketing the product.
The average value represents the average cash worth of the company's in-stock inventory in a certain period of time. An inventory turnover ratio can assist business owners to measure out how many times all the inventory was turned, or sold out and replenishing new inventory.
How to Calculate the Cost of Goods Sold (COGS)
To determine the COGs sold in a given period of time, add the value of the inventory you had at the beginning of the period to any purchases you made to acquire more inventory. Then subtract the value of the inventory at the end of that period from the total. The COGS formula is shown below:
COGS = Beginning Inventory + Purchases - Ending Inventory
How to Calculate the Average Inventory Value
Average inventory is frequently used to balance general increases and dips produced by outlier changes over a short period of time, such as a day or month. As a result, average inventory becomes a more consistent and reliable indicator.
To calculate your average inventory (AI) value, add the beginning inventory to the ending inventory and divide by two. The formula is shown below:
Average Inventory Value = (Beginning Inventory Value + Ending Inventory Value)/2
How Inventory Turnover Ratio Works
Inventory turnover ratios are used to strengthen inventory management, pricing strategies, supply chain performance, and sales and marketing, among other components that contribute to a restaurant's success.
Here are three of the most common applications:
Turnover trends
Inventory turnover ratios are a good approach for identifying market demand-driven patterns as well as outdated or slow-moving inventory. That way, you'll have a jumpstart on deciding whether to scale up or reduce any product line or brand. You'll have much better inventory control and strong sales as a possible outcome of this.
SKUs and segments
For stricter controls on particular stock levels, inventory turnover is generally tracked at the SKU (stock-keeping unit) or segment level. Inventory segmentation is the process of categorizing or segmenting SKUs based on metrics that make sense for your company. Grocery stores, for example, may arrange product categories to assess how they compare to others in their portfolio.
Inventory turnover can also be applied at an aggregated level, when assorted goods are grouped together, for example, by retail outlet location.
Rule of 80/20
In the case of inventory, it indicates that 80% of your company's sales are likely generated by 20% of the SKUs you carry.
A loss leader is a pricing strategy in which a product is sold for less than its market value in order to encourage sales of more profitable items or services. It will always be valuable in driving customers into virtual and physical stores, where they may be tempted to buy more, or more profitable products, for example. It's critical to understand what stock segment you're dealing with so you can maintain sufficient goods on hand.
How do you calculate inventory turnover?
Inventory turnover which is also known as inventory turns, stock turn, and stock turnover measures the number of times inventory is sold or consumed in a given time period. The inventory turnover ratio formula can be calculated using a simple formula.
From your annual income statement, calculate the total cost of goods sold (COGs).
COGS = BEGINNING INVENTORY + ENDING INVENTORY
Divide the total beginning inventory and ending inventory balances for a particular month by two to determine the cost of average inventory.
AVERAGE INVENTORY VALUE = (BEGINNING INVENTORY + ENDING INVENTORY)/2
Finally, you can determine the Inventory Turnover Rate by dividing the average inventory by the cost of goods sold (COGs).
INVENTORY TURNOVER RATE = COGS/AVERAGE INVENTORY
Note that when evaluating Inventory Turnover Ratios, checking your company's balance sheet and your annual statement may save you a lot of time. The cost of goods sold is often recorded on the annual statement, whereas inventory balances are recorded on the balance sheet.
Example of an Inventory Turnover Calculation
Yakult's (beverage company) annual income statement reported that the COGs were $18.426 million. Its average inventory value between 2016 and 2017 was $3.182 million. Now, you can use these figures to calculate the ratio:
- ITR = COGs/average inventory
- ITR - $18.426 million/3.182 million
- ITR = 5.791
Therefore, Yakult's ITR for that year was 5.791. To determine how well Yakult is performing, you can compare it to other beverages and snack food companies. For instance, let's say that you found out that a competitor's ITR was 8.1. This indicates that the competitor is selling products more quickly than Yakult.
There are a number of reasons why one company's ITR is lower than another. It does not necessarily imply that one company is better than the other. To gain a complete view, study a company's financial statements as well as any notes.
How Do You Calculate Inventory Turnover Ratio (ITR) for restaurants?
Inventory turnover ratio (ITR) may be calculated in a variety of methods, each requiring various inputs. The inventory turnover rate of your restaurant may be calculated in two ways. Whether you utilize total yearly sales or total cost of goods sold is the difference between the two.
Method #1 Inventory Turnover Formula(TTM) Using COGS:
The most common and recommended method of calculating ITR is to use the Cost of Goods Sold (COGS). On your restaurant's income statement, the Cost of Goods Sold is also known as the Cost of Sales or the Cost of Revenue.
To begin, use the following formulas to compute your COGS and average inventory during the same time period:
Cost of Goods Sold = Beginning Inventory + Purchases – Ending Inventory
Average Inventory = (Beginning Inventory + Ending Inventory)/2
Then, using this method, you may start calculating your ITR:
ITR = COGS / Average Inventory
Method #2 Inventory Turnover Formula using (TTM) Sales:
The second method is to divide how much your company sells in a year (your yearly sales) by your average inventory to get your ITR.
Inventory Turnover Rate = Total Annual Sales / Average Inventory
Why is it preferable to use the COGS method?
The COGS technique is preferred by restaurateurs because it is more accurate and does not contain markups, as the sales formula does. Inflating your ITR by dividing yearly sales by average inventory might make you think you're turning inventory quicker than you are. Using the sales strategy might result in you buying more products than you need and losing money.
When comparing your rate to others, you must state whether it is COGS or Total Sales, regardless of the ratio you choose.
How do you calculate the inventory turnover period?
Inventory turnover indicates how many times a company's inventory has been sold and replaced in any time periods. Once you have the turn rate, you can calculate the number of days it takes to clear your inventory. Since there are 365 days in a year, simply divide 365 by your turnover ratio. The formula is shown below:
INVENTORY TURNOVER PERIOD = 365/ITR
The result is the average number of days it takes to sell through inventory.
Days Sales of Inventory or Days Inventory
Days Sales in Inventory (DSI), often known as inventory days or days in inventory, is a metric that measures the average number of days or time it takes for a company to turn its inventory into sales. In addition, for inventory purposes, products that are designated "work in progress" (WIP) are included.
To calculate the DSI value, divide the inventory balance (including work-in-progress) by the amount of cost of goods sold. After that, multiply the result by the number of days in a year, quarter, or month.
DAYS SALES OF INVENTORY = (ENDING INVENTORY / COGS) * 365
How do you compute inventory turnover in Excel?
Inventory Turnover in days: Excel calculation
Determining the turnover inventory formula in Excel is very simple. Simply divide the average stock per product by the sales, then multiple by the number of days in the period (for example, we use values over 1 year).
Inventory Turnover ratio (cycle): Excel calculation
To calculate the frequency at which the stock turns over during the accounting period, just simply divide the how much your company sells by the stock (without using the accounting period in the calculation).
What Is the Best Inventory Turnover Ratio?
An inventory turnover ratio of four to six is even better for most sectors, showing that you're replenishing your goods every two months on average.
However, there is no such thing as a one-size-fits-all inventory turnover ratio, and your ideal inventory turnover ratio will be determined by a variety of criteria, including your business, the type of items you sell, and the markets you serve.
For optimal efficiency, low-margin industries tend to deal with fast-moving commodities like groceries must disperse their stocks as rapidly as possible. Industries with high holding costs (such as automobiles and major electronics) would target a high turnover rate to save expenses and maximize profit. However, and this is where things get interesting, high-margin industries such as luxury sectors like watches and jewelry have a relatively low inventory turnover rate. However, in this case, it isn't necessarily the wrong thing. Instead of making money through rapid turnovers, these big-ticket items have a very high-profit margin built-in.
What Should I Do About a Low Inventory Turnover Ratio?
You most likely have an inventory problem if your ITR is too low.
As a result, you're probably not selling enough to cover the inventory you're carrying. Over-ordering goods increases your risk of wasting food or stockpiling resources.
You need to keep an eye on inventory levels. Are you placing your order against a set of numbers? Are you making use of technology? Do you know how much you should order each week on average? Keep an eye on your inventory levels and make sure you know how much and when to order.
Why Is a Higher Inventory Turnover Ratio Better?
A higher inventory turnover ratio is usually preferable because it indicates that more sales are generated from a certain amount of inventory.
When there is insufficient inventory to match market demand, a high inventory ratio could result in lost sales.
Can Inventory Turnover Ever Be Too High?
A high turnover rate indicates that you're buying stocks just when it's needed and have less money invested in current assets. Is it possible to have the highest inventory turnover? The answer is yes.
When your ITR is too high, you could be running out of essential ingredients leading you to have 86’d menu items because of weak inventory management. Ineffective buying will lead to too low inventory and a loss in sales.
According to CSIMarket, the average turnover rate for restaurants in Q2 of 2018 was: 17.82 (calculated using COGS) 40.32 (calculated using total sales)
Despite the fact that the average ITR for restaurants was 17.82, rates will vary depending on the concept or concepts you own. A fast-food restaurant like McDonald's will have a substantially different ITR than a single-unit BBQ establishment, for example.
What's An Optimal ITR?
You'll want to make sure your turnover rate is high to reduce food loss and spoiling. A high ITR typically means you have strong sales and you're doing well and you're making good use of your inventory.
A low ITR might suggest either that you have too much inventory on hand or that sales are low. A low turnover rate may not automatically indicate a restaurant's problems. It's critical to consider the big picture such as:
- What's the state of your finances? Are they capable?
- What percentage of inventory is held in current assets?
- Do you have products on hand for fewer than 12-15 days? (There is less chance of spoiling or hoarding)
Restaurant inventory management software, such as Wisk are often used by concepts that are able to clear inventory faster to keep track of what has been ordered, ensuring that there is never too much or too little of an ingredient on hand. Calculating your inventory turnover rate is a simple technique to address inventory issues and see how your business compares to others in your area.
Efficient inventory turnover can have a profound impact on your business's success. By applying these methods, you'll see your ROI mirror the benefits of streamlined inventory practices.
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