You may have heard that keeping a close eye on your inventory-to-sales ratio is key to a healthy eCommerce business, but what does that mean exactly? And how do you go about calculating it? In this post, we'll break it all down so you can get a better understanding of this important metric and make sure your business is on the right track.
What Is Inventory To Sales Ratio
Inventory to sales is an indicator of the efficiency used to calculate how quickly a company's stock is liquidated. Briefly said, the inventory to sales ratio compares how much inventory a firm has to how many sales it makes.
The I/S ratio shows how your inventory value and sales volume are related. Its goal is to keep track of how much money is spent on inventory relative to what is spent on sales in a given time. The lower the I/S ratio, the more effective a company's capital allocation to inventories is.
When a business's I/S ratio is 1.0, it signifies that it spent the same amount of money in inventories as it did in total sales during the period under consideration. However, there is more to comprehend to acquire the complete picture. The I/S ratio compares inventory value, which depends on the cost of your items, to sales value, based on the price of goods sold. A lower inventory-to-sale ratio is beneficial for your company, although most indicators are advantageous when their discounts are significant. Because it means you're selling more per item in your inventory, that's a good sign.
Knowing the inventory turnover formula can help understand this notion again, as a greater turnover rate suggests more inventory transformation to sales. Because the stock to sales ratio is the opposite of inventory turnover, a lower inventory as a percentage of sales value implies industry standards.
Why Does It Matter?
Inventory is among the most critical aspects of any business, but it's one of the most costly. Maintaining your present merchandise is a delicate balancing act that may quickly go awry if you don't make enough sales or keep enough inventory on hand. You're losing money every time you have merchandise languishing on your shelf or in your storage area. As a result, you should constantly be worried that the overall number of sales is as nearly equal as feasible to the overall number of inventory items.
Inventory To Sales Ratio Formula
The company's net sales are computed by subtracting any sales it refunds from its gross sales. The average inventory is calculated by adding the starting and ending stocks and dividing the result by two to account for periodicity.
The income statement and balance sheet of the company contain all of the information needed to compute net sales and average inventory.
A low inventory to sales ratio shows that sales are strong and inventory is low, indicating that the firm is performing well. In simple words, a low inventory to sales ratio indicates that the company can swiftly sell off its goods. This demonstrates the company's operational efficiency, resulting in a high likelihood of profit. A strong inventory to sales ratio indicates that the company's inventory is rapidly increasing in comparison to the rate at which it is being sold. This might also mean that the commodities on hand were not matched with clients' tastes and preferences, resulting in diminishing sales for the company. When inventory levels are excessive, the company may be forced to spend warehousing and operating costs, which affects the profitability.
Inventory To Sales Ratio Analysis
Since the crucial variables are not present immediately on a normal financial statement, calculating the inventory to sales ratio is not always as easy and clear as it appears in the formula. Because many businesses' sales are cyclical, the requirement for an average of inventories over the entire year is justified.
This ratio is critical when it comes to making informed inventory managerial decisions in a business. When plotted on a long term trend over a period of 3 to 5 years, it becomes more informative. The inventory to sales ratio for a single year cannot be utilized to evaluate if a company's performance is improving or deteriorating.
It is thus recommended that you examine multi-year numbers before making a final judgment on the company's performance to see whether there has been any progress. Depending on the circumstances, both an elevated / low inventory to sales ratio may have different meanings. Some businesses may have a mindset of constantly keeping bigger inventory, irrespective of the sale; as a result, their ratio will always be higher. Likewise, a low ratio might be the consequence of significant reductions in both sales and inventory, but the ratio remains the same.
As a result, analysts must utilize this ratio to carefully examine inventories and sales separately to guarantee that the organization is on the correct track
Which Inventory-To-Sales Ratio Is The Right Choice?
According to several experts, a decent inventory to sales ratio is between 16 and 14. It may assist in determining the formula for inventory turnover that is the opposite of the inventory to sales ratio, to comprehend why a desirable inventory to sales ratio should lie inside this range:
Inventory turnover = net sales/average inventory
When sales surpass the inventory costs, a company's revenue is positive. As a result, a good inventory turnover rate should be more than one, and a good inventory to sales ratio should be less than one, as the inventory turnover rate is the reverse of the inventory to sales ratio. It's preferable if you can go as near to 0 as possible.
You have a good inventory to sales ratio, your company should be able to better compete in the market. Remember that it's not just about what you buy and how much but when. Make sure that any items on your shelves are bought at accurate rates so you can maintain profitability from each sale while keeping an eye on replenishment cycles for important products.
Conveyr is a 3PL service provider that helps you manage your inventory efficiently. We build the tools 3PLs use to not only compete but to win new business. If you're looking for help with inventory management, we'd love to talk with you about how our services can benefit your company's goals and needs. Contact us today!