The Causes and Consequences of Low Inventory Turnover
- Why do I have low inventory turnover?
- Why is inventory turnover important?
- Reasons for low inventory turnover
- Business problems caused by low inventory turnover
- How to overcome low inventory turnover
Why do I have low inventory turnover?
Most businesses that carry stock are striving to maintain a high inventory (or stock) turnover rate. Whilst inventory turnover will vary, industry to industry, many businesses will benchmark it against similar companies to ensure it remains comparatively high.
So, if you’ve recently calculated your inventory turnover ratio and noticed it’s low compared to your competitors, or you’ve seen your figures begin to fall – read this blog to help identify the cause.
Why is inventory turnover important?
Inventory turnover is important because it highlights how efficient a company is at converting inventory into final sales, and, therefore much needed cash. In addition, a business with a high inventory turnover is likely to better react to market demands and have lower carrying costs per item, making it more profitable than one with a low inventory turnover.
Reasons for low inventory turnover
Here’s six reasons why your business could be challenged with low inventory turnover:
So, let’s get the obvious reason out of the way! With a decision on Brexit currently pushed back until 2020, supply chain uncertainty for many businesses is not about to improve in the short term. If you’re stockpiling goods to reduce any risk of supply disruption, you’ll no doubt be noticing that your inventory turnover ratio has dropped. And the bad news is it’s unlikely to improve, until you start to use-up the excess goods sat in your warehouse.
The demand of many goods is dictated by seasonal patterns, such as the weather, festivals and traditions. For instance, a boiler supplier will often see demand peak during the winter months, due to the UK weather, whilst a distributor of fans will often see sales spike in the summer. Traditional festivals such as Diwali, Christmas or Halloween will also impact the sales of certain items at their respective times.
If inventory planners over-forecast for such fluctuations, they could be faced with excess inventory when demand plummets. As a consequence, stock will remain in the warehouse until the following year, negatively affecting inventory turnover ratios.
3. Product life cycle
When we look specifically at individual SKUs, inventory turns will change as an item moves through its product life cycle. At the introduction and growth stages, demand could be high, leading to high turnover rates. But as the item reaches the end of the maturity phase and hits decline, demand will obviously start to drop off and inventory turns will begin to slow down.
Business that fail to spot products reaching this phase could fall into the trap of over-ordering and be left with shelves of obsolete stock – and a poor stock turn rate.
4. Poor replenishment procedures
Low stock turnover ratios may be a result of poor inventory management policies and procedures. Inventory management teams without automated systems may struggle to improve efficiency and reduce their order cycle times, making it almost impossible to increase inventory turnover.
In addition, without stock control or inventory optimisation systems, teams may find it hard to keep track of what they have in stock, let alone what they should be ordering!
5. Carrying slow turning, high cost products
Stocking large numbers of slow-moving, high cost items will lower your inventory turnover ratio. In addition, you’ll be investing more working capital in inventory (at the expense of other areas of your business, such as marketing or IT) and possibly increasing your risk of stock obsolescence.
In some cases, it’s cheaper to rush through orders of high cost items from a supplier, compared to the cost and risk of keeping these items in stock.
6. Buying in bulk
It can sometimes be tempting for purchasers to buy in bulk from their suppliers in order to take advantage of discounts or economies of scale. However, it’s important to weigh up the extra carrying costs and opportunity costs against the savings to ensure you’re really getting a good deal.
Other businesses may find they have no choice in terms of the quantities in which they order from their suppliers, due to minimum order quantities, values or weights.
Business problems caused by low inventory turnover
There are three key business problems that arise when stock turnover is low.
Obsolete stock usually starts out as excess stock, and, if your inventory team doesn’t take the right actions, the excess stock gets older and less appealing to the marketplace until it becomes obsolete e.g has no demand.
Obsolete inventory has a negative effect on the balance sheet. Businesses will either need to sell off items at a lower margin, or write them off completely, damaging their bottom line.
Holding more stock than you need to meet demand will negatively affect your inventory turnover rate and result in excess inventory building up in your warehouse. Your business will therefore see more and more money tied up in stock and less being converted to sales and cash for other business opportunities.
High carrying costs:
A low inventory turnover will often mean you’re carrying too much stock, which will increase your holding costs, such as warehouse costs, utilities, insurance and opportunity costs.
How to overcome low inventory turnover
If you recognise any of the above causes or consequences of having a low stock turn, then it’s time to take action. Improving your inventory turnover ratio is easier than you think. But the answer is most definitely not to reduce the order quantities of all your SKUs! This approach could very quickly lead to stockouts and unhappy customers!
Instead the key is to optimise your inventory. This means prioritising the items you hold and order, based on their value to the business, forecasted demand, demand volatility and pick frequency (e.g identifying fast or slow-moving items). Armed with this information you can begin to replenish your stock in a much smarter and more strategic manner. These are the basic principles of EazyStock inventory optimisation software.
Read this post to find out more about how you can improve your inventory turnover without harming stock availability, or download our eBook below: