The inventory to sales ratio, sometimes known as the inventories to sales ratio or inventory as a percentage of sales, compares the value of the items you keep in stock with the value of all sales your business makes. This metric, which is closely related to your inventory turnover rate, is invaluable in knowing when you must sell your inventory more quickly. However, planning to sell more inventory and successfully doing so are two different things.
Why is the inventory to sales ratio important?
The inventory to sales ratio helps to indicate how much inventory you are converting to sales. The inventory sales ratio is crucial to your small business operations since your inventory is at once vital to your sales and among your largest expenses. Maintaining a balance between a well-stocked inventory and selling enough to afford to stock your inventory means that, if you aren’t selling enough to move your inventory from storage into your customers’ hands, your business will lose money.
Seven crucial questions for understanding the inventory to sales ratio
To further understand what the inventory to sales ratio means for your business, you should know the answers to these seven questions:
1. What do you need to calculate the inventory to sales ratio?
You must calculate two vital metrics before calculating your inventory to sales ratio: average inventory and net sales. Once you tally your average inventory and net sales for the period in question, you can calculate your inventory to sales ratio.
2. What is the inventory to sales ratio formula?
The inventory to sales ratio formula is:
Inventory to sales ratio = average inventory/net sales
While the formula is simple and can be executed using a step-by-step inventory to sales calculator, interpreting what its value means for your business can be more complicated.
3. Why do inventory turns matter?
Inventory turns matter. This figure, which indicates the number of times per year that you sell all your small business’s inventory, reflects how much cash your small business has available to cover expenses. If your business has low inventory turnover, it may mean that your sales are lacking, and with lower revenue comes less ability to pay your employees, suppliers, and lenders.
4. What is the best inventory to sales ratio?
Many experts say that a good inventory to sales ratio is in the range of ⅙ to ¼. To understand why a good inventory to sales ratio should fall within this range, it may help to know the formula for inventory turnover, which is the inverse of the inventory to sales ratio:
Inventory turnover = net sales/average inventory
A business’s revenue is positive when its sales exceed the cost of its inventory. A good inventory turnover rate should thus be greater than one, and since the inventory to sales ratio is the inverse of the inventory turnover rate, a good inventory to sales ratio should be less than one. The closer to zero, the better.
5. What should be done to combat a bad inventory to sales ratio?
If your inventory as a percentage of sales indicates that your business is not converting enough inventory to sales, experts suggest striving to sell more of your inventory before moving to decrease your inventory. Begin by offering promotions and pre-orders on your current inventory to drive sales.
Should these efforts fail to increase sales, change your inventory purchasing habits to buy less stock more often instead of buying more stock less often. If you make this shift, you will spend less money while holding onto fewer items you ultimately can’t sell, and you can also open storage space for better-selling items.
6. Why is a smaller inventory to sales ratio better?
Whereas most metrics are better when their values are higher, a small inventory to sales ratio is better for your business. That’s because it indicates that you are making more sales per item in your inventory. Understanding the inventory turnover formula may again help to clarify this concept, as a higher inventory turnover rate symbolizes more conversion of inventory to sales, and since the inventory to sales ratio is the inverse of inventory turnover, a lower inventory as a percentage of sales value indicates good business practices.
7. Can the inventory to sales ratio ever be too high?
Since the recommended range for the inventory to sales ratio is ⅙ to ¼, it is possible for the inventory sales ratio to be too low or too high. A value greater than this range indicates poor sales, whereas a value below this range may indicate that you are selling your stock too quickly to keep up with customer demand.
What is the 80/20 rule for the inventory sales ratio?
According to the 80/20 rule for the inventories to sales ratio, you should assume that 80 percent of the sales that your small business makes comes from 20 percent of your inventory. This assumption can be crucial for managing your inventory to maximize your sales. When buying new stock, prioritize the 20 percent of inventory that drives sales before restocking the remaining 80 percent of your items.
If your lower-selling inventory begins to run out, then most of the time, you should indeed move to restock it, but if sales are too low to justify doing so, you can stop offering the product.
Inventory management is key to a good inventory to sales ratio
To achieve a good inventory to sales ratio, you need to properly manage your inventory. Good inventory management involves knowing which items to restock, when to restock them, and what price you should expect to pay for them. Follow the 80/20 rule, make sure the prices you pay for your inventory allow you to make revenue on sales, and adjust your purchasing habits as needed to achieve a good inventory to sales ratio. Don’t forget about promotions and pre-orders if the need arises.
The Best Option for Funding
Need funding to rebuild your business? Don’t waste time going from bank-to-bank filling out multiple applications. SmartBiz helps you find the best financing for your unique needs whether that’s an SBA loan, Bank Term loan, or other financing. About 90% of qualified applications we refer to banks are funded and our financial professionals are on hand to answer your questions. Discover if you’re pre-qualified here without impacting your credit scores and read the SmartBiz 5-star customer service reviews on TrustPilot.
