Inventory Turnover

Asset management ratios Print Email

Definition

Inventory turnover is a measure of the number of times inventory is sold or used in a given time period such as one year. It is a good indicator of inventory quality (whether the inventory is obsolete or not), efficient buying practices, and inventory management. This ratio is important because gross profit is earned each time inventory is turned over. Also called stock turnover.

Calculation (formula)

Inventory turnover is calculated by dividing the cost of goods sold by the average inventory level ((beginning inventory + ending inventory)/2):

Inventory turnover = Cost of goods sold / Average Inventory

In the income statement (statement of comprehensive income, IFRS) cost of goods sold (COGS) is named "Cost of sales".

Another approach is to divide sales (revenue) by average inventory:

Inventory turnover = Sales / Average Inventory

The number of days in the period can then be divided by the inventory turnover formula to calculate the number of days it takes to sell the inventory on hand or "inventory turnover days":

Days inventory outstanding = 365 / Inventory turnover

Norms and Limits

There is no general norm for the inventory turnover ratio; it should be compared against industry averages. A relatively low inventory turnover may be the result of ineffective inventory management (that is, carrying too large an inventory) and poor sales or carrying out-of-date inventory to avoid writing off inventory losses against income. Normally a high number indicates a greater sales efficiency and a lower risk of loss through un-saleable stock. However, too high an inventory turnover that is out of proportion to industry norms may suggest losses due to shortages, and poor customer-service.

A high value for inventory turnover usually accompanies a low gross profit figure. This means that a company needs to sell a lot of items to maintain an adequate return on the capital invested in the company.

Exact Formula in the ReadyRatios Analytic Software

Days Inventory Outstanding = ((F1[b][Inventories]+F1[e][Inventories])/2)/( F2[CostOfSales]/NUM_DAYS)

Inventory turnover = 365 / Days Inventory Outstanding

F2 – Statement of comprehensive income (IFRS).

F1[b], F1[e] - Statement of financial position (at the [b]eginning and at the [e]nd of the analizing period).

NUM_DAYS – Number of days in the the analizing period.

365 – Days in year.
Quote Guest, 1 May, 2013
Yeah at the beginning you put cost of goods sold/average inventory was a bit confused at first
Quote Guest, 27 May, 2013
why do we devide by 2 after adding begining inventory and ending inventory?
Quote Vit. A., 27 May, 2013
Quote
Guest wrote:
why do we devide by 2 after adding begining inventory and ending inventory?
In order to calculate its average value.
Quote Guest, 2 September, 2013
Lets assume that for the entire year we have the inventory distribution moth wise.

In that case will it be better to calculate the Average Inventory = (Jan + Feb + March...+ Dec)/ 12 ???

This will provide more closer average value. Your thoughts please.
Quote Guest, 10 November, 2013
what is opening balance for the inventory is 0? how do i calculate it.
Quote Vit. A., 21 July, 2015
Quote
Guest wrote:
Lets assume that for the entire year we have the inventory distribution moth wise.

In that case will it be better to calculate the Average Inventory = (Jan + Feb + March...+ Dec)/ 12 ???
In this case you should sum 13 values (inventory at 31 Dec 2013, 31 Jan 2014, 31 Feb 2014 ... 31 Dec 2014) and dived by 13.
Quote Guest, 6 October, 2016
what if I sell all nothing remains on January since its 31 days the turn over will be 31
Quote Guest, 26 October, 2016
The easy way is to express the level of Days outstanding by simply divide the inventory by the average sales per day, i.e : DIO: Inventory end of year/(Sales/365). By using this formula it's (normally) easier to compare with other piers. The same formula could be used to calculate DPO (Days Payables outstanding) and of course DSO (Days sales outstanding, It you add DSO+DIO-DPO you get C2C (cash to cash) as an expression og the working capital level. I have found it particullary usefull when comparing and making KPI.

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