How do I calculate the inventory turnover ratio?

By Ryan C. Fuhrmann AAA
A:

Managing inventory levels is important for most businesses and this is especially true for retailers and any company that sells physical goods. The inventory turnover ratio is a key measure for evaluating just how efficient management is at managing company inventory and generating sales from it.

Inventory Turnover

Like a typical turnover ratio, inventory turnover details how much inventory is sold over a period of time. It is calculated as:

Cost of Goods Sold ÷ Average Inventory

Or

Sales ÷ Inventory

Usually, a higher inventory turnover ratio is preferred, as it indicates that more sales are being generated given a certain amount of inventory. Alternatively, for a given amount of sales, using less inventory to do so will improve the ratio.

Sometimes a very high inventory ratio could result in lost sales, as there is not enough inventory to meet demand. It is always important to compare the inventory turnover ratio to the industry benchmark to asses if a company is successfully managing its inventory. 

Days Sales of Inventory (DSI) or Days Inventory

The inventory turnover ratio on its own takes some time to put into perspective. Going a step further, days sales of inventory, also known as days inventory, is simply the inverse of the inventory turnover ratio multiplied by 365. This puts the figure into a daily context, as follows:

(Average Inventory ÷ Cost of Goods Sold) x 365   

DSI significantly changes between industries and it is important to compare it against peer companies. Businesses that sell perishable products like supermarkets or groceries stores have lower inventory days than business that sell furniture or appliances. 

Example

For the fiscal year ended Jan. 2014, Wal-Mart Stores Inc (WMT) reported annual sales of $476.3 billion, year-end inventory of $44.9 billion, and annual cost of goods sold (or cost of sales) of $358.1 billion. 

Its inventory turnover for the year equals:

$358.1 billion ÷ $44.9 billion = 8.0

Its days inventory equals:

(1 ÷ 8) x 365 = 46 days.

This indicates that Wal-Mart sells its entire inventory within a 46-day period, which is quite impressive for such a large, global retailer.

The Bottom Line

The inventory turnover ratio is one of the best indicators of how efficiently a company is turning its inventory into sales. Even better, the days inventory ratio puts it into a daily context.

At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

RELATED FAQS

  1. What is the difference between an income statement and a balance sheet?

    Find the current value of a business by reading the balance statement and determine whether operations are efficient by analyzing ...
  2. When should I use depreciation expense instead of accumulated depreciation?

    Distinguish differences between depreciation expense, which is reported on the income statement, and accumulated depreciation ...
  3. What are the differences between operating expenses and cost of goods sold (COGS)?

    Discover the differences between operating expenses and cost of goods sold, how each are calculated and why they are considered ...
  4. What are the differences between gross profit and gross margin?

    Learn how gross profit and gross margin are calculated and how each is used in fundamental analysis. Generally, these numbers ...
RELATED TERMS
  1. Overall Turnover

    A synonym for total revenues, commonly used in Europe and Asia. ...
  2. Working Capital Turnover

    A measurement comparing the depletion of working capital to the ...
  3. Inventory Turnover

    A ratio showing how many times a company's inventory is sold ...
  4. Turnover

    1. In accounting, the number of times an asset is replaced during ...
  5. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors ...
  6. Deferred Tax Asset

    A deferred tax asset is an asset on a company's balance sheet ...
comments powered by Disqus
Related Articles
  1. The Big Credit Card Companies Have Room ...
    Stock Analysis

    The Big Credit Card Companies Have Room ...

  2. Why Wall Street Is A Key Player In The ...
    Investing Basics

    Why Wall Street Is A Key Player In The ...

  3. Penny Stocks, Options and Trading on ...
    Options & Futures

    Penny Stocks, Options and Trading on ...

  4. Playing Penny Stock-Like ETFs
    Stock Analysis

    Playing Penny Stock-Like ETFs

  5. Study These Penny Stock Trading Trends
    Chart Advisor

    Study These Penny Stock Trading Trends

Trading Center