Customers used to walk into a store to buy goods or services. The company or entrepreneur had to interact with the customers from when they walked into the store building to when they purchased an item or service. Ecommerce platforms and digital transformation come together to make online purchasing and selling easy for both sides without requiring them to communicate with one another. Entrepreneurs and businesses do hundreds of online transactions from the time they receive the raw materials to when they sell the items. As a result, companies require inventory velocity to boost their business inventory.
Today, we focus on inventory velocity and its importance to entrepreneurs or eCommerce companies. We will also learn how companies can calculate and improve their inventory velocity. Besides, we will go over all the frequently asked questions to help you understand inventory velocity and how it affects your company.
What Is Inventory Velocity in Ecommerce?
Inventory velocity in eCommerce is the financial ratio showing the number of times a company has replaced its inventory and the sales over a specific period, like a month or year. In simple terms, inventory velocity is the speed at which a company can acquire a product at wholesale or raw material when they sell the finished goods over a given period.
Suppose you are new to eCommerce and the entrepreneurship department. In that case, inventory is the number of goods or raw materials a company purchases, and the finished product is available for a company to sell.
After understanding the inventory and its velocity, your company should aim to keep inventory velocity high. Why? High velocity shows a company having high sales and a low inventory count. In comparison, low inventory velocity shows that a company is experiencing low sales with excess inventory.
For example, supermarkets and retailers are low-margin industries producing the highest inventory velocity.
Inventory processes are conducted under standardized steps. For instance, an inventory process map will notify you of orders out of stock while you decide on the specific way to deal with the issue. Options range from placing backorders to client refunds. The process is conducted as follows:
- Product delivery to the business premises – list the goods in your inventory;
- Product inspection, sorting, and storage strategies include dropshipping, cross-docking, and specified storage spaces;
- Monitoring inventory levels – conducted manually, using an inventory cycle count software;
- Clientele order placement – customers order online or in-person;
- Clientele order approval- often conducted through automated POS systems or by suppliers in dropshipping;
- Product picking – Items are retrieved from the stock, packed, and shipped accordingly;
- Inventory update – Manually record sales or have automated stock level changing programs. It helps in reordering to meet strong sales demand.
Inventory analysis will come in handy after or before the above process to help one identify what amount of stock is enough to meet supply demand and save on inventory storage and spending.
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The Importance of Inventory Velocity
Keeping records and performing consistent inventory velocity calculations will help a company make strategic decisions. Some of these strategic decisions include:
- Marketing Strategies
When the inventory velocity is low, a company will know whether the current marketing strategies are working or not. They will also need to know which department they should focus on, sales or marketing.
The inventory velocity will indicate which goods a company should increase manufacturing. Besides, the company will also know which stocks they should stop manufacturing and replace with other items.
- Purchasing New Inventory
Similar to manufacturing, the inventory velocity will tell a company whether they should purchase a new inventory. A company can buy new inventory if its current goods have a slow inventory velocity.
- Perishable Goods or Obsolescence Inventory
Inventory velocity will indicate and keep track of seasonal and perishable goods. They will show which goods slowly become absolute and have an expiration date. These goods include vegetables, fashion trends, seasonal clothes, and vehicles.
High inventory velocity indicates there is a low risk of inventory becoming obsolete. For instance, there will be high inventory velocity for sweaters and winter boots during the cold or winter season. Towards the end of the season, having a high stock of sweaters and winter boots indicates a loss of profits. We refer to these unsold inventories as “absolute inventories” or “dead stock.”
- Automated Systems
Some companies purchase automated systems to help them with their inventory control. You can include an inventory section in the automated systems. That will help companies know how the inventory is performing, how much inventory they need to purchase, and which inventory incurs a loss.
Integrating the automated software into the company’s inventory and financial processes will also help estimate the company’s future sales. Automated software can work for some industries more than others. For example, automated software will not work in fast-selling sectors like fast food companies. However, it will perform better with a fashion company selling seasonal clothes.
For a company to conduct auditing, they will need consistent and organized data like the ones we use in inventory velocity. Therefore, auditors, especially external auditors, will find it easy to carry out their tasks.
- Inventory Day Sales
The inventory velocity helps to keep track of the day’s sales inventory. These two are different in that inventory velocity is the number of times a company sells inventory in a year. On the other hand, day sales inventory is a company’s time to turn the inventory into sales.
- Keeping Track of Holding Costs
Inventory velocity will help a company track the holding costs and other expenses incurred from purchasing raw materials to selling the goods.
People spend more money storing the inventory by paying for the warehouses, insurance, shelving, staff, security, tracking arrangements, and fridge space or electricity for perishable goods. Therefore, inventory velocity will let you know which goods are moving. For example, a high inventory indicates low holding costs, which increases the profit margin.
How to Calculate Inventory Velocity?
We also refer to the inventory velocity as the inventory turnover. The ratio shows you how quickly it takes for a company to turn its inventory into sales.
Therefore, to calculate Inventory turnover, a company will need to divide the Cost of Goods sold by the average inventory for a given period. Thus, the inventory turnover formula will look like this:
Inventory Turnover rates = Cost of Goods Sold\ Average Inventory
To also get the average inventory value, You will use this formula:
Average inventory = Total inventory (Final inventory + Beginning Inventory)/ 2
The other option for calculating inventory velocity is dividing the sale by the average inventory.
The formula should look like this:
Inventory Velocity= Sales/ Average Inventory
Typically, many companies use the Cost of Goods Sold, the first formula, instead of the sales to get the most accurate results. It would not be advised to use the sales in calculating the inventory velocity because the sales include the mark over cost figures, which causes inflation in the final results.
Unfortunately, companies cannot use these formulas to calculate inventory velocity for specific items. We only use the formula in the final inventory.
However, you can calculate inventory velocities for each type of product you are looking to analyze.
Cost of Goods Sold entails all expenses directly linked to the production of the good. It is exclusive of overhead and marketing expenses. To calculate the sold Cost of goods, use the following formula:
Starting inventory + purchases – ending inventory= Cost of goods sold.
It is helpful to a business person in determining their gross profits and margin.
> Find the most profitable products in your offer using the Product Assortment Optimization Framework!
How to Improve Inventory Velocity?
For eCommerce businesses and every other business to survive, they need to stay in the game by changing their business models. These business models must adapt to these innovations to compete with other competitors.
As we have mentioned before, low inventory velocity indicates slow performance for a company. The company, at this point, is losing profits because they are mismanaging their products. That is why companies aim to have high invoice velocity by improving inventory planning and reducing the time spent in storage.
Typically, to improve inventory velocities, companies should focus on increasing sales and forecasting by:
1. Regularly Reviewing Stock Models
Retailers should constantly review their stock models to reduce wastage and increase inventory velocity. The two models that companies can use to replenish and monitor their inventory velocity are:
Companies can use this model to improve their inventory velocity by monitoring their inventory for a given period. The company can set a time limit like a month, three months, or yearly to monitor and replace the stock. The method is effective, but the following factors make it difficult for some companies to implement:
- The set period can limit the company’s time for stock review and order, resulting in a weak inventory.
- The company could face an understock or overstock situation because they are not focusing on consumer demand but on their set timeline.
- Companies will need to order more inventory that will sustain them during the timeline, which means they will need more capital.
A low-inventory company can use this model to review the inventory using the inventory management system constantly. The system or application will alert the management of the current amount of product and time to restore the product. Besides, the system alerts you weekly, daily, or whatever time you set.
The advantage of this model is that it is flexible enough to accommodate customer needs and fluctuating demand. However, the disadvantage is that companies will have to hold security stock to satisfy the many customers’ demands, which will cause a shortage of stock. The problem with the stock is that the company will never know how much to hold or if they will even use it.
The company will need to do more analysis and forecasting to solve this problem. They will also have to stock frequently and hold fewer goods. So, what else will work to reduce overstocking and understocking? The next point.
2. Creating Demand Forecasting Models
Consumers have fluctuating demands where companies can use demand forecasting to reduce the risk of overstocking and understocking. Similarly, demand forecasting will also improve inventory velocity. But what is demand forecasting? It is an art and science that companies use strategies to forecast and find the balance of demand and satisfaction. Demand forecasting uses quantitative and qualitative methods of collecting consumer data for analysis.
Inventory forecasting is essential for the above process to be effective since it helps predict how the inventory levels will behave for a certain period in the future. It improves sales tracking and supply-demand, thus managing purchased orders as a management solution.
To maximize the accuracy of demand forecasting and analysis, companies use technologies like artificial intelligence. The advanced technology collects, stores, processes, and makes it easier to retrieve data.
3. Centralizing Each Technology Used For Management
Companies with separate management systems for external and internal software can collect the wrong data. To improve inventory velocity, companies can integrate or sync the systems to have one central management to improve inventory velocity.
One major management company can combine devices using the internet of things. Companies can also improve transparency and promote communication through blockchains. Lastly, companies should also automate processes to speed up conversion rates.
4. Discarding Safety Stocks
Remember, consumer demands fluctuate, which can cost a company a lot of money, especially if there is more stock in storage. The key is to optimize forecasting for companies to stop storing safety stock.
5. Decentralizing Inventory
Decentralizing inventory is where companies distribute their warehouses to different locations, making shipping more straightforward and faster. For instance, international companies can set up warehouses in other countries to serve people in that area instead of shipping from one country. As a result, consumers will receive their product fast, encouraging them to order frequently and eventually increasing a company’s inventory velocity.
Nowadays, small businesses and entrepreneurs are adopting drop shipping to serve customers in different locations.
Integrating inventory velocity methods can be challenging, especially if you lack experienced personnel. What’s the worst-case scenario? It can take time for a company to master the art of ensuring they have a constant high inventory velocity.
Frequently asked questions about inventory velocity
What Is a “Good” Inventory Turnover?
5 to 10 inventory turnover is high because companies don’t need to restock frequently or understock. This turnover ensures that a company can restock the inventory after a month or two.
What Is a Good Inventory Velocity?
Every company needs to have between 5 and 10 items of inventory velocity for them to stock every month or two. That means they will not run out of stock or have to restock frequently to meet customer demand.
What Is a Good Inventory Turnover Ratio for Ecommerce?
A good inventory turnover ratio is between 5 and 10 per year. This inventory turnover ratio ensures that companies restock their products every month or two to avoid overstock or understock. However, the inventory turnover should be higher for companies that sell perishable or seasonal goods like flowers or the fashion industry.
How Is Inventory Velocity Calculated?
A company can find the inventory velocity by dividing the cost of goods they sell by the average inventory in a given period. They will also need to add the beginning and final inventory at a given time, then divide by two to find the average inventory.
What Is Meant by The Term Inventory Velocity?
Inventory velocity is the speed it takes to recycle its inventory over a specified period. A good inventory velocity rating ranges between 5 and 10, showing that the firm will sell and restock its inventory in a one or two months period. Industries dealing with highly perishable products should aim for a higher rating to confirm that they do not incur losses for spoiled goods.