Track your inventory control ratio.
Question: I own a small retail business and do not know if I am doing what I should to manage my inventory. Is there a tool I can use to optimize inventory control?
Answer: You are on the right track. Many small retail businesses do not focus enough attention on inventory control. The inventory turnover ratio can be a very useful tool.
For a glimpse of how important this ratio can be, consider this comparison: One store has an average inventory of $50,000 and sales of $200,000 per year; another store has an average inventory of $100,000 and the same sales figure. Which makes more profit? Obviously, the first retailer has a higher profit because his inventory costs are lower, assuming all other expenses are equal.
However, the financial picture of every business is very complex and profitability is affected by many factors. The inventory turnover ratio lets you look through the data fog to focus on how inventory affects profitability. In the example above, the first retailer has a turnover ratio of 4 ($200,000 divided by $50,000) and the second has a turnover ratio of 2 ($100,000 divided by $50,000). A higher turnover rate shows a stronger contribution of your inventory management to profit.
While higher turnover ratios are better for profitability, types of businesses vary in the ratio they can sustain. Businesses with higher gross margins can survive on lower turnover rates and vice versa. A resource for determining the turnover ratio appropriate for your specific business is the Almanac of Business and Industrial Financial Ratios, which you can find at the Eugene Public Library.
The usual formula for the inventory turnover ratio is cost of goods sold during the year divided by the average inventory investment during the year. Alternatively, you can use your revenue from sales divided by the retail value of inventory, which may be easier. The turnover ratio can be used to examine other periods and to examine particular product lines to identify slow sellers.
A low ratio may indicate a need to take action to move slow-selling merchandise. Mark downs may be one option, but special displays, coupons, product linkages and incentives for sales people may workinstead. Alternatively, increasing the frequency and reducing the size of your restocking orders may improve your turnover ratio.
There are many merchandising techniques you can use when your turnover ratio tells you there is a problem. You should consider tapping the experience of the counselors at SCORE or at the Lane Community College Business Development Center for help with the specific inventory management concerns of your business.