Doing cash flow projections are absolutely critical to ensure your business is healthy. Most businesses that have been around long enough have run into similar problems. You estimate that it will take you 3 months to sell that inventory and you can sell it for twice as much as you purchase it for so in 3 months you double your money- not bad!
Without further examination everything looks dandy, but in reality, you are going to have serious cash flow problems! Fine, that sounds fair. However, each year my company still either misses out on thousands of dollars worth of sales from under- ordering or we get thousands of dollars tied up in slow moving inventory from over- ordering. Have you had purchasing wins or fails?
Have you imported way too much of a product and been stuck with it sitting in your garage for months on end? Have you nervously made a large order and have it sell as well as you anticipated? If your business has seasonal peaks, using your average inventory can account for the fluctuation at certain times in the year, according to Investopedia.
For example, retailers might have higher inventory numbers leading up to the fourth quarter and lower levels after the holidays. Calculate average inventory by adding inventory numbers from the beginning of the year and the end of the year, dividing the sum by two. Most companies consider a desirable turnover ratio to fall between 6 and 12, according to Investopedia , but this can vary greatly. Fashion retailers average between 4 and 6, grocery stores are often around 14 and a business that sells high-priced items, such as a car dealership, is often as low as 2 to 3, reported TradeGecko.
Another formula that will help you understand how often you cycle through products is the Days Sales of Inventory DSI. Simply take the number of days in the year and divide it by your inventory turnover rate.
While a lower DSI is ideal, your industry can impact this number just like it does your inventory turnover ratio. To put numbers into context, consider this example from Target. This means Target replenishes its inventory 5. Knowing your inventory turnover ratio can help you see how well you turn inventory into sales. Maybe you need to invest in sales training for employees for good measure. Having to discount your prices will result in a lower inventory turnover ratio.
And a higher inventory ratio could indicate that you frequently sell your full-priced items and need to add more products. Keep in mind that your inventory turnover ratio and DSI are averages and not every product on your shelf will sell. The reality is that some items sell quickly while others take a while. Consider industry averages as a way to compare your inventory sales to your competitors. You can usually find these averages on market research sites like CSI Market.
This is the practice of forecasting how much your customers will buy from you over a certain period of time. Again, there are plenty of events that can throw off your demand planning.
But starting with a basic understanding of how regularly you sell out of a product can help establish a baseline of how much stock you need to keep on hand.
Turnover varies for different products—for example, ice cream has a lower days inventory than freezers. There are two lead times you need to know to keep your inventory levels in balance. These are internal lead time and supplier lead time. Internal lead time is how long it takes your business to receive a delivery and get the products ready for the customer to buy.
There are several factors that play into the amount of lead time you need internally, including:. Supplier lead time refers to the time between when you place an order with a supplier and when they deliver the order to your store or warehouse.
If they tell you they can deliver your inventory in two weeks but consistently take four weeks to complete the delivery, you need to build a two-week cushion into your ordering cycle. Ultimately, these lead times can help you understand how soon you need to reorder inventory and expect to have it ready for customers. The first is the inventory turnover ratio , which tells you how quickly you sell out of stock. This calculation is your sales or cost of goods sold divided by average inventory.
If your inventory turnover ratio is low, you may have excess inventory. The next calculation is days sales of inventory DSI. This is the number of days it takes your inventory to sell. To get your DSI, divide inventory by cost of sales and multiply by CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation. Once you have a better idea of what it costs to keep inventory, you can implement a few smart practices to ensure you purchase the correct amount of stock.
Using inventory management software , like QuickBooks or SYSPRO , you can see which products are most popular, which items sell slowly, and whether certain times of the year are more profitable than others. Consider implementing a daily or weekly spot-checking practice, wherein you count one high-selling product to check that your online records match the physical number in your warehouse.
Doing this can help you discover trends, identify quantity patterns for bulk ordering, and ultimately make more accurate sales forecasts. To calculate your inventory turnover ratio, divide the costs of goods sold COGS — which is the amount of money it takes to produce, process, and carry your products — by the average cost of inventory you have on hand.
In this case, your inventory turnover rate would be 7. According to CSI Market, for example, the average inventory turnover ratio for the retail apparel industry is 8. First, you need to have a firm grasp on supplier lead time, which is how long it takes your suppliers to deliver inventory after you place an order.
Does it take two weeks or 30 days? Does the estimated lead time always align with the actual lead time? You should also factor in internal lead time, which is the amount of time it takes your team to process items, conduct quality control inspections, complete production, package, and ship everything to customers.
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