Managing inventory is mandatory in any hospitality business. But it’s much more important in the restaurant, and generally in the foodservice industry. If the inventory isn’t neatly managed, the restaurant is probably losing money because of it.
There are a few methods that can be utilized to calculate the inventory turnover ratio, which can involve different variables. This article will teach you how inventory turnover ratio can be calculated by using the cost of goods sold and average inventory.
But first, let’s explore what inventory turnover ratio really means for your business.
In layman’s terms, inventory turnover ratio is the number of times your restaurant has sold and replaced a particular item/ingredient and has now become a part of your internal inventory during a specified time period.
Getting an inventory turnover ratio of 1 means that your restaurant has only sold its average inventory once. This is usually bad, but it is extremely bad for restaurants since restaurants work with fresh produce and are more prone to food waste.
A low turnover ratio can indicate that the restaurant has either low sales or very bad inventory management - excess in stock.
But a high turnover ratio doesn’t necessarily mean the restaurant is booming with sales. It can also be an indication of poor inventory management, like a shortage of little in stock, whereas a high inventory turnover ratio can also indicate strong sales, and that means you have a healthy business.
With this method, we use two metrics - COGS and average inventory - to determine the restaurant’s inventory turnover ratio.
The first thing you need to do is specify a timeframe - consisting of either monthly, annually, semi-annually, or any other established time period.
Next, you’ll need to determine these three variables to calculate the inventory turnover ratio.
- Cost of Goods Sold (COGS)
- Beginning Inventory (in currency)
- Ending Inventory (in currency)
Sum up the beginning inventory and the ending inventory and divide that by 2 to get the average inventory.
(Beginning Inventory + Ending Inventory) ÷ 2 = Average Inventory
Calculate Inventory Turnover Ratio
Here’s the equation for calculating the inventory turnover ratio.
Inventory Turnover Ratio = COGS ÷ Average Inventory
For example, let’s say that a small restaurant named Kenny’s Pizza isn’t racking in high profits. Kenny, the owner, thinks it’s because he’s in a small town and there aren’t many people in that community that often eat out.
Since this is a restaurant, inventory needs to be very neatly managed, or else they’ll have lots of waste and a huge loss in profit.
As was said before, the first step to calculating the inventory turnover ratio is to decide the time period we’re calculating for. Since this is a restaurant, let's analyze Kenny’s inventory for a period of three months.
Now we need to find the cost of goods sold. We do that by summing up all the costs that make a product. These can include pizza dough, tomato sauce, cheese, etc.
If the restaurant is making 20 pizzas per day, then the means it’s selling is 1,800 pizzas per three months. If the cost of goods for a pizza is $5, then we get a COGS of $9,000.
The next number we need to calculate is average inventory, and after adding the beginning inventory to the ending inventory, we get an average inventory of $2,700.
The final calculation we need to complete is our inventory turnover ratio - COGS ÷ Average Inventory utilizing Kenny’s Pizza’s numbers.
9,000 ÷ 14,500 = 3.33
This number indicates that Kenny’s Pizza hasn’t sold its inventory only three times during the three-month period. This is extremely bad, and calls for better inventory management, as the average inventory turnover ratio for restaurants is approximately 19.
No matter how good or bad your inventory turnover ratio is, it’s always worth it to search for ways of attaining the best inventory turnover ratio.
Here are three ways to achieve a better turnover ratio.
1. Predict Sales and Inventory
Predicting sales and inventory can help you greatly improve your turnover ratio. You can do this by diving into monthly sales reports for the past year and determine the optimal amount of product you should be ordering.
If you’re using inventory management software, this task will be much easier as the reports will be automatically generated for you.
2. Ensure Your Inventory is Always Fresh
When it comes to restaurants, most of them operate using the FIFO (first-in, first-out) method. This makes sure your produce never expires.
Organize your inventory in a way that makes the most recent items easily accessible, so that you minimize or even fully remove expired products from your worries.
3. Negotiate the Cost of Products with Available Distributors
Distributors are usually open to negotiations, even more so when it comes to wholesale. If you have some items that have a “best-by” date, try to lock in a lower price for them - and maybe even buy a bigger lot than usual.
Talking to multiple distributors would also be helpful as you’ll be able to get multiple prices and then choose the best one.
Optimize Your Inventory Turnover Ratio
Inventory turnover ratio is crucial, especially in the restaurant industry. Having a bad inventory turnover ratio can mean you’re wasting produce and losing a lot of money because of that.
If you’re worried about wasted expenses, calculate your inventory turnover ratio. You can also schedule a regular inventory turnover ratio calculation by month, per three months, or semi-annually.
Ensure your employees are using the best practices such as FIFO to make sure your produce never expires.