Does your brand carry the right amount of inventory? (Think carefully before answering.)
Because when you have too little inventory, you run into stockouts and miss out on revenue. Too much, and you tie up cash flow, rack up holding costs, and wreck your profit margins. That leaves the sweet spot somewhere in the middle.
And if you’re like most direct-to-consumer (DTC) brands, you probably don’t know where exactly you sit between these 2 points. And you’re likely hurting your bottom line as a result.
That’s where your inventory velocity calculation can help.
Inventory velocity (also known as inventory turnover) measures the number of times a company sells and replaces its inventory in a given period (usually 1 year). Inventory velocity helps brands determine if they have too much or too little stock to meet demand.
Generally speaking, you want an inventory turnover rate between 2 and 4. Anything less than 2 means you have too much dead stock, and anything more than 4 indicates a stockout risk.
When retailers have a healthy inventory velocity, they achieve inventory optimization. They keep only enough inventory on hand to properly meet demand, which reduces operating costs, increases revenue, and improves the brand’s bottom line.
When you have a low inventory turnover ratio, it means you have excess inventory that’s been sitting around for too long. These units rack up warehouse fees that cut into your gross profit margins. But when you monitor your inventory velocity (and work toward optimizing it), you get rid of that inventory faster and minimize holding costs.
Generally speaking, the longer inventory sits, the less likely it will sell (and more likely it becomes dead stock). But when you maintain a high inventory velocity, you reduce the odds of obsolescence — by selling products quicker and getting rid of inventory faster.
A high turnover rate signifies strong sales and a quick inventory cycle. But if it keeps trending upwards, your inventory levels won’t be able to meet customer demand. This puts you at risk of frequent stockouts, which lead to lost sales and customer dissatisfaction.
Increasing your revenue is great, but if you don’t reduce costs, you end up operating against yourself. Meaning, you tie up too much capital in inventory and wreck your profit margins.
But when you proactively improve your inventory velocity, you optimize inventory to boost profits and increase the ROI on your initial investment.
Demand forecasts are the best way to improve your inventory velocity. And when you use these forecasts to inform your inventory planning, you avoid buying slow-moving SKUs and only purchase inventory that will actually sell.
Plus, you can calculate your inventory turnover rate for the last 365 days (versus waiting until the end of the quarter or the year) to see if you’re improving your inventory management. This way, you can see the ratio decrease or increase quickly. And you can take proactive action if so. For instance, you might discount aged inventory to eliminate holding costs or raise prices to avoid stockouts.
To calculate your inventory velocity, use the following inventory turnover formula:
inventory turnover rate = cost of goods sold / average inventory value
The formula for inventory velocity is simple. But there are 2 factors you need to consider while calculating inventory turnover: cost of goods sold (COGS) and average inventory value.
You can also use an alternative inventory velocity formula (but companies typically go with the first one):
number of units sold / average number of units on hand
For example, a DTC skincare brand decides to measure its inventory velocity. Their average inventory value is $10,000, and their COGS is $40,000. This puts their inventory turnover ratio at 4 (which is ideal).
inventory turnover rate = $40,000 in COGS / $10,0000 average inventory value = 4
However, say this ratio continues to trend upward. It might indicate that the brand isn’t charging enough for its skincare products. So, the team might want to raise its prices incrementally to slow demand or increase its purchase order size to meet the increasing demand.
Now, let’s look at a company with a not-so-ideal inventory velocity. Let’s say a decorative pillow brand noticed some slow-moving inventory. They measure their velocity to confirm this hunch. Their average inventory value is $9,000, and its COGS is $15,000. This puts their inventory turnover rate at around 1.66.
inventory turnover rate = $15,000 in COGS / $9,0000 average inventory value = 1.66
In this case, the pillow brand’s turnover rate is too low. The retailer can immediately increase its turnover rate by identifying which SKUs are slow-movers. Then, increase demand for those SKUs via product bundling, discounts, or giveaways.
But if the brand wants to fix its inventory velocity long-term, it must implement better demand forecasts. Why? Because more accurate predictions mean you only purchase inventory that’ll actually sell, improving your operational plans and reducing waste.
Inventory velocity does not operate in a vacuum. Instead, it’s impacted by several other key metrics, including cycle time, lead time, transit time, and demand variability.
Cycle time calculates the number of days it takes for inventory to turnover. Or, put simply, how quickly you can deliver all products from a PO to customers. For example, if you purchase 1,000 units and sell all those units within a month, your cycle time is 30 days.
Lead time is the amount of time between when a brand places a purchase order (PO) and receives that order from its supplier. These vendors require a down payment, which ties up capital in inventory you can’t sell until it arrives at your warehouse. So, the shorter your lead time, the better.
To calculate your lead time, use the following formula:
lead time = PO processing time + production time + PO fulfillment time + supply chain delays
Transit time is how long it takes for a shipment from your supplier to arrive as inventory. For example, it might take an offshore supplier 30 days in transit (because it has so far to go) and a domestic supplier only 3 days in transit time. But before you jump ship, remember that domestic suppliers are typically more expensive. So while switching to a local supplier might improve inventory turnover, you should also consider the financial impact that decision will make.
Demand variability measures the variance in customer demand, which might be impacted by seasonality or DTC trends. It’s the difference between what sales you think will happen and what sales actually occur. For instance, a high-demand unit might require regular replenishment. In contrast, low-demand units can be ordered on an as-needed basis.
Here’s how to proactively improve your inventory velocity ratio when it’s too low or too high:
Brands should regularly and routinely review their stock models to eliminate waste and improve inventory turnover. This can be done using a periodic review model — where brands manually monitor real-time inventory at regular intervals (like every week). Then, they decide how many units are necessary for replenishment.
Or, you can use a continuous review model by relying on an inventory management system or ops optimization tool like Cogsy to track inventory levels in real-time. (Cogsy will even send replenish alerts when inventory levels drop below the optimal levels.)
This eliminates human error and makes it easier to restock with smaller orders quickly. That way, you incur less holding costs and are less likely to end up with dead stock or excess inventory.
Reducing lead times means replenishing your inventory faster and more often. And in most cases, this means placing smaller orders more frequently to eliminate overstocking inventory and optimize your stock levels.
But brands can also do the following to reduce lead times:
Cogsy’s actionable dashboard stores all your real-time and historical data in one place, giving you the clarity needed to improve your operational plans. And with better plans, your lead times shorten (and become more reliable).
Similar to purchase order lead time, brands can shorten transit and supplier lead times (how long it takes vendors to fulfill new orders). That way, they get inventory faster and hopefully increase inventory turns.
This strategy has gained attention recently as fuel costs rise and supply-chain disruptions pop up.
The most effective way to shorten these gaps is to choose the right supply chain partners and foster those relationships.
For example, if transit time is a factor, consider switching from an international supplier to a domestic supplier.
But if supplier lead time is the challenge, be more transparent about your production planning (you might even want to share forecasts for the next 12 months or so). This way, your supply chain partners can prepare accordingly and fulfill your production orders faster.
Forecasting customer demand is the most effective strategy for improving your inventory velocity. Because when you better predict how much supply you need to meet demand, you only purchase the inventory that will actually sell (leaving you with less waste).
And with Cogsy, you don’t even have to do this work manually with spreadsheets (which is time-consuming and prone to human mistakes, BTW). Instead, Cogsy uses predictive sales and inventory intelligence to automate your demand planning processes. That way, you always know what to expect and can prepare accordingly.
If your inventory turnover rate is too low, what you call “safety stock” might actually be excess stock. Meaning, the extra units aren’t protecting you from stockouts; they’re putting you at risk of dead stock.
Luckily, Cogsy’s forecasting feature can eliminate this temptation to overstock. How? By providing a clear and accurate prediction of how much inventory you’ll need (based on your real-time inventory levels and historical sales trends).
Increasing product demand can quickly improve your inventory velocity (AKA turnover). For instance, you can get rid of slow-moving SKUs by:
Typically, this is a reactive, short-term fix. And without an accurate demand forecast, this step could ultimately lead to costly stockouts.
Thankfully, Cogsy incorporates all your marketing events into your demand forecasts and operational plans. That way, you don’t have to worry about having enough inventory on hand to meet the generated demand.
Automating purchase orders generally means relying on a centralized inventory replenishment system. This gives you better inventory control, eliminates costly mistakes, and ensures you only reorder what actually sells (reducing excess inventory that turns into deadstock).
Cogsy simplifies the purchase order process by drafting POs that meet your immediate inventory needs (so you don’t have to). All you have to do is check the documents and hit “submit.”
Inventory velocity and inventory turnover are synonymous terms. Both measure how often a company sells through and replaces its inventory in a given time frame (typically 1 year).
For most ecommerce businesses, the ideal inventory velocity ratio sits between 2 and 4. Anything less than 2 suggests that the brand is collecting dead stock. Meanwhile, anything above 4 indicates that the brand is at risk of stockouts.
Inventory velocity indicates how well a brand manages its inventory. A low inventory turnover ratio, for instance, tells you that the brand is not selling its goods fast enough. Meanwhile, a high inventory turnover ratio tells you the brand is not ordering enough inventory.