Inventory velocity definition
/What is Inventory Velocity?
Inventory velocity is the time period from the receipt of raw materials to the sale of the resulting finished goods. Thus, it is the period over which a business has ownership of inventory. It is very much in the interest of a company to keep inventory velocity as high as possible, for the reasons noted below:
Improved cash flow. A high inventory velocity ensures that a business quickly converts inventory into sales, reducing the amount of cash tied up in unsold goods. When inventory moves quickly, the company can reinvest the proceeds into new stock, operations, or growth opportunities. This minimizes the need for excessive working capital and reduces the risk of cash shortages. Businesses with slow inventory turnover often struggle with liquidity issues, making it harder to cover operational expenses.
Lower holding costs. The longer inventory sits in storage, the higher the costs associated with warehousing, insurance, and potential obsolescence. A high inventory velocity helps reduce these carrying costs by ensuring that products move through the supply chain efficiently. This is especially important for perishable goods, seasonal products, or technology items that can quickly lose value over time. By reducing the time inventory remains in stock, businesses can free up space and resources for newer, more profitable products.
Reduced risk of obsolescence. Industries such as fashion, electronics, and consumer goods face rapid changes in market demand, making it crucial to maintain a fast-moving inventory. When inventory turnover is slow, products risk becoming outdated or unsellable, leading to markdowns, write-offs, or financial losses. A high inventory velocity ensures that businesses consistently sell newer stock, keeping their offerings fresh and aligned with current consumer trends. This also enhances brand reputation, as customers perceive the business as up-to-date and responsive to market needs.
Increased profitability. A faster inventory turnover rate leads to more frequent sales cycles, allowing a company to generate higher revenue over time. By continuously moving inventory, businesses can take advantage of volume discounts from suppliers, negotiate better terms, and reduce capital tied up in unsold products. Additionally, fast-moving inventory often means fewer markdowns and discounts, preserving profit margins. A high inventory velocity also enables businesses to respond more flexibly to market trends, adjusting pricing and stock levels to maximize profitability.
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How to Calculate Inventory Velocity
To measure inventory velocity, divide the cost of goods sold by the average inventory for the measurement period. You can determine the average inventory level by adding together the beginning and ending inventory figures for the reporting period and then dividing by two. The formula is as follows:
Cost of goods sold ÷ Average inventory = Inventory velocity
However, this metric only applies to the inventory in general, and not to more specific inventory items. To gain more insight into the measurement, track inventory velocity for specific items, especially those most subject to obsolescence.
Problems with Inventory Velocity
It is possible to focus too much on a high inventory velocity level. If a company keeps little stock on hand, it may find that it cannot fill unexpected customer demand, and so must forego these sales. This is a particular concern when serving a market niche in which customers expect fast fulfillment times. Thus, it may be necessary to maintain a certain minimum investment in inventory that places an upper cap on inventory velocity.
Terms Similar to Inventory Velocity
Inventory velocity is also known as inventory turnover.