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 It is a good indicator of inventory quality (whether the inventory is obsolete or not), efficient buying practices, and inventory management.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.
Inventory 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be the result of ineffective inventory management (that is, carrying too large an inventory) and poor sales or carrying out-of-date inventory to avoid writing off inventory losses against income.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.
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