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Retail Management: Inventory Turnover

Monday, July 14, 2014

Retail Management: Inventory Turnover

by Kelly Weaver, Small Business Development Center Regional Director

 

Managing inventory has to be one of the biggest challenges for retailers, and it is certainly a key to running a profitable retail business.  There are some measurements that can help you manage the inventory and make decisions about how to get the most out of what you stock in the store. 

 

Gross Margin (in dollars or percent of sales) is a foundational number to track.  It is defined as the dollars remaining from a sale once you pay for your product.  Assume you buy an item for $5 and sell it for $15.   Your gross margin would be $10 (revenue less cost) or 67% (margin divided by revenue).  To make more money, you can increase your gross margin by raising your price or lowering your costs.  Not a bad strategy, but not the only one either.

 

Managing Inventory Turnover is another way to boost profits.  Inventory turnover is a measure of how often inventory would theoretically sell out (or turn over) in a year.   If the inventory turnover was 2.0 that means the inventory would be sold through twice a year; it also means that you have 6 months of inventory on hand!  Unless your product is seasonal or your lead time from suppliers is long, this may be too much. 

 

So how does inventory turnover affect profits?  With new stock rotating through the store more often, there is less need for markdowns and a fresh flow of merchandise can raise sales.  You will also have less money invested in inventory (and less room needed to store it) to sell the same amount of product. 

 

Using our example above, assume you sell 10,000 units per year at $15 per unit for total sales of $150,000.  The table below shows your return on inventory at a turnover rate of 2 turns and 2.5 turns per year.   

 

Units Sold/Yr

Inventory Turnover

Inventory Units On Hand

$ Invested in Inventory at $5/unit

Gross Margin (GM) at $10/unit

Gross Margin ROI (GM $ /Inventory)

GM Return on  $1 of inventory

10,000

2

5,000

$25,000

$100,000

400%

$4.00

10,000

2.5

4,000

$20,000

$100,000

500%

$5.00

 

 

 

 

 

 

 

While your return in dollars and your gross profit margin % are both the same, you are getting a higher return on your inventory investment, freeing up money for other uses and potentially saving costs in the financing, storage, handling, and obsolescence of your inventory stock.  This measurement is also useful in evaluating inventory for a specific department or product line.

 

Investing money in inventory is easy and can easily get out of hand.  Use these tools to fine tune your operation and increase your return.

           

Kelly Weaver is the Regional Director of the Small Business Development Center in Aberdeen which offers free, confidential business consulting to start up and existing businesses.  She can be reached at (605) 626-2565 or kweaver@midco.net.  The Center is hosted by GROW South Dakota (also known as Northeast South Dakota Community Action Program).

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