In this article, we explore what inventory velocity is along with a simple formula to calculate this metric. We also provide a simple 6-step framework for improving your inventory velocity ratio, with real-world examples. Read on to learn more.
Inventory velocity refers to the speed at which inventory moves through a supply chain or is sold in a given time period. It measures how quickly a business can convert its stock into sales or finished goods, highlighting the efficiency of its inventory management and sales processes.
Example: Tech World sells 5,000 units of a particular gadget in a month, indicating a high inventory velocity for that product.
Inventory velocity acts as a pivotal metric for businesses aiming to optimize their stock levels. Here are some key reasons why:
Efficiency: Monitoring velocity helps businesses maintain an efficient inventory, reducing holding costs.
Cash Flow: A faster inventory turnover means quicker returns on investments, improving cash flow.
Consumer Demand: Understanding velocity can aid in aligning stock with actual consumer demand, preventing stock-outs.
Storage Costs: Faster inventory movement means reduced storage costs and warehouse space requirements.
Product Freshness: For perishable goods, higher velocity ensures products remain fresh when sold.
Profitability: Efficient inventory turnover can lead to higher profitability and better resource allocation.
Inventory velocity presents several challenges. We explain some of the most common problems below:
Factors like economic shifts or changing consumer tastes can alter sales patterns. Predicting steady demand and then facing downturns can lead to stagnant inventory, affecting both the velocity ratio and risking obsolescence for certain items.
Companies might overstock to prepare for demand spikes or benefit from bulk discounts. However, if expected demand doesn't arise, they face higher holding costs and potential profitability impacts due to potential obsolescence or discounting needs.
Timely restocking is essential for inventory velocity. Unforeseen supplier delays, whether from logistical hiccups or raw material shortages, can disrupt stock flow, leading to missed sales and potential harm to the company's reliability reputation.
The inventory velocity ratio offers insights into how effectively a company is managing its inventory in relation to its sales.
The most common formula to calculate this metric is:
Inventory Velocity Ratio = Cost of Goods Sold / Average Inventory
Example: Let's consider the case of "FashFits," a clothing brand. If "FashFits" had a Cost of Goods Sold (COGS) of $200,000 during a specific period and their Average Inventory during that same period was $50,000, the calculation would be:
Inventory Velocity Ratio = $200,000 / $50,000
Inventory Velocity Ratio = 4
This result means that "FashFits" sold its entire inventory four times over that period. It indicates that the value of the goods they sold was four times the average value of the inventory they had in stock.
Higher Inventory Velocity Ratio generally indicates that the company manages its inventory well, selling products without holding onto stock for an extended time. This leads to lower holding costs and fresher stock. It can also indicate robust sales performance.
On the other hand, a low Inventory Velocity Ratio might suggest overstocking, which can result in increased holding costs and potential obsolescence or spoilage, especially for perishable items.
In the case of "FashFits," having a ratio of 4 suggests they are doing a good job at managing and selling their inventory, as they are turning over their entire stock approximately every three months (12 months in a year divided by the ratio of 4).
To boost your inventory velocity ratio, follow our simple 6-step process:
Focus on strategies that expedite the sale of inventory items.
Example: Gadget Grove identifies slow-moving items and bundles them with best-sellers at a slight discount, promoting faster sales and increasing the velocity ratio.
Recognize products in declining stages and manage their stocks accordingly.
Example: Trend Trove notices a certain fashion accessory's waning popularity, so they limit its restocking and promote it for clearance.
Ensure stocks are replenished only as they're needed, minimizing held inventory.
Example: Brew Bistro uses JIT for their perishable ingredients, ordering just enough to meet short-term demand, thereby increasing the velocity at which these items are used.
Use more accurate methods to predict exactly how much stock will be needed.
Example: Tech Titan uses machine learning models to forecast sales of their products, ensuring they stock just enough to meet anticipated demand.
Reduce procurement and delivery times by nurturing strong relationships with primary suppliers.
Example: FurniFab collaborates closely with their timber supplier, ensuring faster and consistent material deliveries, leading to faster production and sales.
Identify and promote items that have historically shown high inventory velocity, ensuring they're always available and prominently displayed.
Example: Sports Star promotes its top-selling running shoes, keeping them in stock and front-and-center in stores, ensuring they're sold quickly and restocked promptly.
Urban Threads is a trendy urban clothing retailer that has recently seen a dip in their inventory velocity ratio. Eager to optimize this ratio for better efficiency and profitability, they followed our simple 6-step framework for optimizing inventory velocity:
After a thorough review, they identify 2,000 units of slow-moving denim jeans. They bundle these jeans with their best-selling graphic tees at a 15% discount, which not only moves the jeans faster but also boosts sales of the tees.
Their inventory analysis highlights that their retro collection, totaling 3,000 units, is losing steam. They promptly limit future orders for this collection and set up a "Flashback Sale" to clear out the existing stock.
Urban Threads decides to adopt JIT for their seasonal collections. By doing this, they order only 5,000 units of winter wear, knowing they can restock quickly if demand spikes, rather than the 8,000 units they previously would have ordered.
They incorporate an AI-powered tool that predicts they'll sell 10,000 units of their new summer collection based on various data points. This is lower than their initial estimate of 12,000 units, so they adjust their order accordingly, preventing potential overstock.
They negotiate with their primary fabric supplier for faster delivery times, cutting down procurement time from 30 days to 20 days, ensuring that they can produce and stock new designs more rapidly.
Urban Threads' sneakers have always been a hit, with 7,000 units sold in the last quarter. They decide to give them prime real estate in both their physical and online stores, ensuring visibility and quick sales.
We hope you now have a better understanding of what inventory velocity means and how to optimize it.
If you enjoyed this article, you might also like our article on inventory maintenance or our article on inventory issues.
