Your business invests lots of money in inventory. For hospitality businesses, it’s often the largest ongoing investment. That’s money not spent just to acquire inventory, but to store it for resale. How you manage that inventory directly impacts your cash flow, which in turn impacts how much money you can reinvest in your business. And how much and how quickly your business grows.
Here are two common ways businesses drop the ball on inventory management:
- They hold on to too much inventory, which ties up too much cash, and requires the ongoing cost of maintaining that inventory in a sales-ready condition. There is the added risk of inventory spoiling, too, for hospitality businesses.
- They don’t have enough inventory, run out of stock, miss current and future sales, and cause long-term damage to customer relationships. (Having enough safety stock and maintaining par level inventory helps avoid this.)
To find out if you’re effectively managing your inventory, look at your inventory turnover rate. Inventory turnover measures how often inventory is sold or used during a set time period. If your stock isn’t moving, your money isn’t moving, and your business is stagnating.
To find it, you’ll use this formula:
Inventory Turnover Rate = Cost of Goods Sold (COGS) / Average Inventory
Let’s walk through it step-by-step. And because they’re very similar, we’ll show you how you can calculate inventory usage along with your COGS.
Beginning Inventory Formula: How to Find Beginning Inventory
Beginning inventory is the total recorded inventory cost at the beginning of a set time period. Beginning inventory is also the ending inventory for the previous time period. It’s a necessary piece to determining average inventory.
To calculate beginning inventory, you can either look back in your records or you can use your COGS or inventory usage numbers. Here’s how to calculate beginning inventory with either COGS or inventory usage rate.
Beginning Inventory ($) = COGS + Ending Inventory ($) - Received Inventory ($)
Beginning Inventory (Units) = Inventory Usage + Ending Inventory (Units) - Received Inventory (Units)
Received Product Inventory
To determine your received product inventory, check your supplier or vendor invoices throughout the set time period. If you’re using beverage inventory software, those invoices are automatically factored into current inventory.
Ending Inventory Formula: How to Calculate Ending Inventory
Finding ending inventory is similar to finding beginning inventory. You can either take your inventory and manually count your ending inventory, or you can calculate your ending inventory. Like beginning inventory, ending inventory is needed to determine average inventory. Here’s how to calculate ending inventory:
Ending Inventory ($) = Beginning Inventory ($) + Received Inventory ($) - COGS
Ending Inventory (Units) = Beginning Inventory (Units) + Received Inventory (Units) - Inventory Usage
How to Calculate Average Inventory
Average inventory is the estimation of the value ($) or number (units) or a particular type of inventory at any given time during a set time period. Here’s how to calculate average inventory level:
(Beginning Inventory + Ending Inventory) / 2
If you want to find out your average inventory per month over a three-month period, you’d divide the sum of beginning and ending inventory by two.
How to Calculate Inventory Usage and Inventory Consumption
Inventory usage is similar to COGS, but it speaks to the number of units sold and not their monetary value. If you want to know how many bottles of vodka you used over the course of three months, you’ll have to determine vodka's inventory usage over time. That’s called the inventory usage rate.
Inventory usage and COGS use the same formula. The difference is that inventory usage measures units used (4 bottles, 10 kegs, etc.) and COGS measures the monetary value of the inventory used. Here’s the inventory usage formula:
Inventory Usage = Starting Inventory + Received Product Inventory – Ending Inventory
To find COGS, use the monetary value of each inventory, and not the number of units, in the formula.
How to Calculate Inventory Turnover
And, finally, once you get a hold of your COGS, here’s how to calculate inventory turnover:
Inventory Turnover Rate = COGS / Average Inventory
The higher the inventory turnover ratio, the better. Anywhere between 5 and 10 is considered good. Below 5, you’ve got some inventory management to do.
Let’s take a look at an end-to-end example and see how it all shakes out.
An Example of How to Calculate Inventory Turnover and Usage
As we know, to calculate inventory turnover rate, we need our COGS and our average inventory. Here’s the step-by-step process. We’ll calculate inventory turnover for bottles of vodka for one month—bottles of vodka that cost $15 from your supplier.
Step 1: Determine your starting inventory
Let’s start by counting the types of alcohol, number of units, and size of liquor bottles that you have in your storage areas. Let’s assume you currently have four 750ml bottles in the liquor room, two bottles in the back bar, and four more in the main bar. In this example, your starting inventory is 10 bottles of vodka.
Step 2: Find the received product inventory
Received product inventory is the number of products you ordered and received from your distributor during the time between your starting and ending inventory period. You check your invoices and see you ordered and received five bottles of vodka over a one-month period. Five bottles of vodka is your received inventory.
Step 3: Write down your ending inventory
Finally, you take the ending inventory for vodka bottles at the end of the inventory period. You make the rounds one more time and count up all the bottles of vodka in the same places you counted before: liquor room, back bar, and main bar. After counting, you’re left with three bottles of vodka. This is your ending inventory.
Step 4: Calculate COGS
Now that you have the three key numbers you need, plug them into the formula above to calculate your COGS for the last three months:
Starting inventory: 10 bottles or $150
Received inventory: 5 bottles or $75
Ending inventory: 3 bottles or $45
COGS = $150 + $75 - $45
COGS = $180
This number can also be expressed in units to calculate inventory usage rate.
Inventory Usage Rate = 10 + 5 + 3
Inventory Usage Rate = 12
This means that, over a period of one month, the cost you spent to acquire the bottles of vodka you sold was $180. And that equates to using 12 bottles of vodka.
Step 5: Calculate Inventory Turnover Rate
Inventory Turnover Rate = $180 / Average Inventory
Inventory Turnover Rate = $180 / [(Beginning Inventory - Ending Inventory) / 2]
Inventory Turnover Rate = $180 / [($150 - $45) / 2]
Inventory Turnover Rate = $180 / $52.50
Inventory Turnover Rate = 3.4
Your business sold and replaced its vodka stock 3.4 times over the inventory period. An inventory turnover rate below 5 isn’t very good. Most high-performing businesses maintain inventory turnover rates of between 5 and 10.
While this seems quite easy and simple to do, keep in mind that you must repeat the process of taking liquor inventory for every product in your bar by category, brand, item type, and sometimes even by the supplier. Even if you know the formula by heart and have all the numbers you need, calculating your inventory usage manually can still waste lots of time and be error-prone.
Here’s How to Make Inventory Easier
Liquor inventory software like BinWise Pro automates the process of taking and analyzing inventory. Using it saves time, saves money, and eliminates counting errors.
Book a demo to learn more about all the heavy lifting BinWise Pro does to keep bars and restaurants across the country running clean and profitable inventories. It calculates inventory usage rates, liquor variance levels, and par inventory levels, and can even help you place strategic and cost-effective alcohol orders.