We’re rounding out this series on SKU management and debt strategy with some information about two important metrics: ROII and inventory turns. These two data points are part of a formula that will help you make decisions about your business’s ability to scale and take on debt. Tyler explains more in the video below.
Return on Inventory Investment, or ROII, is a SKU-level metric that reveals how your profit margin relates to your COGS. In the simplest terms, you can think of a product’s ROII as an investment multiplier: for every $1 you put into the product, how much are you getting out?
To calculate a product’s ROII, use this formula:
PAG % / COGS % = ROII
For example, if you calculate the ROII of Product A at 107%, that means that every time you invest $1 in Product A, you get that dollar plus $1.07 back. In contrast, if Product B has a margin of 68%, every time you invest $1 in Product B, you get that dollar plus $0.68 back. When looking at ROII alone, it seems as though Product A is more profitable, but there is one other metric to consider.
Inventory turns are a measurement of how quickly a particular product moves. Generally this figure is calculated annually, and it discloses how often a business can reinvest its capital into a certain product.
Higher inventory turns mean that a business can spend the same amount of money on product multiple times in a year. This means that even if a product has lower margins than other SKUs, it can still be profitable if it turns over multiple times a year.
To calculate a product’s annual ROI, use this formula:
ROII x Inventory Turns per Year = Annual ROI per product
Continuing with the example above, if Product A has a ROII of 107%, but it only turns over less than two times a year, you have less opportunity to reinvest in your profitable product than if it sold more quickly. Product B, while it does have a lower ROII, moves faster than Product A and ultimately provides a higher annual ROI overall. Even though it delivers smaller margins on its own, Product B has the potential to bring in greater revenue because you can sell more of it annually than Product A.
For a SKU to be considered healthy and profitable, e-commerce sellers should aim for an inventory turns number of 3-4. Between 4-5 is considered an excellent turnover rate, and anything less than three is a slow-moving product.
Understanding performance at the SKU level is great for recognizing profitable products, but what does it tell you about when you should raise capital?
After calculating your annual ROI on your products, it’s important to consider your debt strategy and what kinds of lenders you may be working with.
Any sort of lending partner that charges a high interest rate over the course of a year will absolutely annihilate any poor performing product. While your product may scrape by on its own with a 50% annual ROI, that number is useless when you include a 40% interest rate paid on your loan. Ultimately, the combination of the high interest rate and low product ROI makes it impossible to scale your business with this product.
When faced with a low-margin product that you don’t want to dump just yet, it’s better to avoid taking on debt and allow yourself to grow slowly than to take on debt that you’ll never be able to outsell. And while it can be hard to let go of a product, the best option may be to cut the product from your store altogether.
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