While market fluctuations, increasing order volumes, and supply chain disruptions are making it harder for brands to manage their inventory in a way that prevents stockouts but also prevents holding on to too much excess inventory. However, striking the correct balance here is critical for any growing ecommerce brand.
The inventory management KPI brands need to track to determine this balance is the inventory to sales ratio, and we’ll break down how to calculate that ratio, how to interpret inventory sales ratios, and how to improve them.
What is the inventory to sales ratio?
The inventory to sales ratio, also known as stock to sales ratio, compares the average inventory value to the average sales value and is one measure of a company’s inventory level health. This KPI helps retailers determine how quickly they’re liquidating stock, and how much capital they have invested in inventory.
Lower inventory to sales ratios are generally better because it means that a brand is selling through its inventory quickly. However, the most important thing is that a brand determines an inventory to sales ratio that works for its unique business and meets consumer demand—rather than just striving for the lowest ratio possible.
Why is the inventory to sales ratio important for businesses?
Because the inventory or stock to sales ratio shows how quickly brands sell through their inventory, it’s a good indicator of the leanness of a brand’s supply chain. It’s critically important that brands aren’t paying excess storage fees for products that are just sitting on shelves.
However, maintaining inventory levels can be a tricky balance. While brands don’t want to pay for excess storage, brands also don’t want face insufficient inventory and miss out on sales. Brands also may face obsolete inventory, which poses another challenge. The inventory to sales ratio is best tracked over a long period of time (ideally, several years), which allows brands to gain insights and optimize stock levels, adjust sales models, and achieve sales growth.
If a brand determines its inventory to sales ratio is too low, that generally means stockouts and poor sales performance. On the other hand, an inventory to sales ratio that is too high generally means a brand is holding on to too much total inventory, facing overflow storage, and incurring excess storage fees.
How to calculate inventory to sales ratio
In order to calculate a brand’s inventory to sales ratio, a brand needs to have a couple of other figures on hand. All of these figures can generally be found in the company’s income statement, balance sheet, and other financial statements.
The first part of calculating the inventory to sales ratio is to calculate the average stock value. Brands need to add their beginning inventory value and ending inventory value together, and then divide that sum by 2.
Average stock value = (Beginning inventory + Ending inventory) / 2
The second step is to calculate net sales, brands should calculate their gross sales valuation (total sales before discounts and returns) and subtract from it the value of all returned sales.
Net sales = Gross sales – Sales returns
The inventory to sales ratio can be calculated by dividing a brand’s average inventory value for a certain period of time by the net sales from that same period of time.
Inventory to sales ratio = Average stock value / Net sales value
How the inventory to sales ratio works
Inventory to sales ratio is best tracked over a long period of time to account for seasonal variations and to identify patterns. There are several factors that influence a brand’s inventory to sales ratio.
Factors affecting the inventory turnover ratio (sales volume, inventory levels, COGS)
The formula for calculating the inventory to sales ratio includes both a sales metric and an inventory metric. That means that if either of those change—in small or large ways—the inventory to sales ratio will also change. That’s why it’s important to track the metric over a longer period of time. The cost of goods sold will also influence the inventory to sales ratio because as COGS change, so will net sales.
How to interpret the inventory to sales ratio
As mentioned earlier, the inventory to sales ratio is best calculated over a longer period of time, three to five years. If the inventory to sales ratio is only tracked for one year, the seasonal variations will make the metric less than ideal for forecasting and analysis.
The ideal inventory to sales ratio is not the same across brands or industries, so it’s important for every brand to benchmark against themselves to identify the ideal inventory to sales ratio for their unique business.
How to manage your inventory sales ratio
Achieving and maintaining the right inventory to sales ratio can be challenging, especially in a fast-paced, ever-changing global market, where sales and shipping times are constantly changing.
A solid inventory management strategy, as well as the technology to back it, is critical to maintaining the right inventory to sales ratio. The many factors that influence a brand’s inventory to sales ratio — sales volume, inventory levels, COGS — need to be tracked in real-time to give brands the best information possible to analyze and optimize.
Optimize your inventory management with Flowspace
Every growing ecommerce brand needs to be tracking inventory management KPIs, like inventory to sales ratio, inventory turnover, and inventory days on hand. A fulfillment partner can serve as an invaluable partner in tracking and optimizing supply chain KPIs to grow business.
Flowspace partners with ecommerce brands to optimize product inventory management, including ordering, processing, picking, packing, loading, shipping, and more. Flowspace’s OmniFlow Visibility Suite gives brands real-time visibility and ability to track inventory management KPIs like inventory to sales ratio. But Flowspace’s platform goes beyond just tracking KPIs; Flowspace’s platform gives retailers actionable insights in order to improve and optimize their inventory KPIs.
The OmniFlow suite of tools provides visibility from fulfillment through delivery with platform-level transparency so brands can stay ahead of low inventory. The platform’s real-time insights and predictive analytics allows brands to forecast future inventory needs so they’re never caught with out-of-stock products. Ensuring optimal inventory levels can improve customer satisfaction, build customer retention, and, ultimately, boost a brand’s bottom line.
Flowspace’s forecasting and inventory planning software gives brands real-time insights and recommendations for inventory optimization. Actionable inventory data can help brands make informed safety stock decisions to avoid out-of-stock products. Investing in inventory software makes facility management and inventory tracking much easier while ensuring customer service level expectations are met.
Get in touch with Flowspace today to learn more about inventory management solutions.