Reviewed by Oct 05, 2020| Updated on
Inventory turnover is a ratio that states the number of times a company has sold and replaced its inventory during a period of time. The number of days in the specified period is then divided by the inventory turnover formula to know the number of days it takes to sell the current inventory. The ratio helps businesses make better decisions on manufacturing, marketing, pricing, and purchasing new inventory.
Inventory Turnover = Sales / Average Inventory
Where, Average Inventory = (Beginning Inventory + Ending Inventory) / 2
Companies also use the cost of goods sold (COGS) as a parameter instead of sales. Analysts use this method of dividing COGS by average inventory instead of sales; this method gives greater accuracy in the inventory turnover calculation because sales include a markup over cost. The average inventory factor removes seasonality effects on the result.
Inventory turnover measures the speed of the company’s sales inventory. The speed can be seen as a measure of business performance. Retailers with fast inventory movement tend to outperform. The longer inventory is held, the higher the holding cost will be. Consumers may not visit the retailer again in this case.
Overstocking implies low turnover with weak sales and excessive inventory. The cause of such a situation can be the goods offered or poor marketing.
When the ratio is high, it implies strong sales or insufficient inventory. The latter may lead to a loss in business.
When dealing with perishable and time-sensitive goods, such as milk, eggs, trending/seasonal clothes, and periodicals, the businesses must be careful about inventory movement. The longer these goods stay in inventory, the more the business loses.