Loading the player...
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.

For more, check out "What does a high inventory turnover tell investors about a company?"

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 does inventory turnover tell an investor about a company?

    Find out more about the inventory turnover ratio, what the ratio measures and what the inventory turnover ratio indicates ... Read Answer >>
  2. How does an investor evaluate an inventory turnover ratio for a retail company?

    Understand more about inventory turnover and what it measures. Learn how an investor should evaluate an inventory turnover ... Read Answer >>
  3. What is the formula for calculating inventory turnover?

    Learn about the inventory turnover ratio, how it is calculated and what this efficiency metric tells businesses about their ... Read Answer >>
  4. What does a high inventory turnover tell investors about a company?

    Inventory turnover is an important metric for evaluating how efficiently a firm turns its inventory into sales. Read Answer >>
  5. Why is it sometimes better to use an average inventory figure when calculating the ...

    For a couple of key reasons, average inventory can be a better and more accurate measure when calculating the inventory turnover ... Read Answer >>
  6. Why should investors care about the Days Sales of Inventory (DSI)?

    Learn about days sales of inventory and what it measures; understand why an investor would want to know a company's days ... Read Answer >>
Related Articles
  1. Investing

    Days Sales of Inventory

    Days Sales of Inventory, also called Days Inventory Outstanding, is a key financial measurement of a company's performance pertaining to inventory management. In simple terms, it tells how many ...
  2. Investing Basics

    How to Analyze a Company's Inventory

    Discover how to analyze a company's inventory by understanding different types of inventory and doing a quantitative and qualitative assessment of inventory.
  3. Economics

    What is Involved in Inventory Management?

    Inventory management refers to the theories, functions and management skills involved in controlling an inventory.
  4. Personal Finance

    AR & Inventory Turnover Is Key For These Sectors

    Accounts receivable and inventory turnover are two important ratios in the current asset category. We will also discuss the key industries that benefit from a thorough understanding of these ...
  5. Fundamental Analysis

    Inventory Valuation For Investors: FIFO And LIFO

    We go over these methods of calculating this component of the balance sheet, and how the choice affects the bottom line.
  6. Fundamental Analysis

    Understanding Periodic Vs. Perpetual Inventory

    An overview of the two primary inventory accounting systems.
  7. Fundamental Analysis

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  8. Professionals

    Understanding Operations Management

    Operations management is concerned with converting materials and labor into goods and services as efficiently as possible to maximize profits.
  9. Investing

    Understanding Turnover

    Turnover has a number of different, but related, meanings depending on the context in which it is used. Generally, it means the number of times an item is replaced with a new or similar version ...
  10. Options & Futures

    Financial Statements: Working Capital

    By David Harper (Contact David)A recurring theme in this series is the importance of investors shaping their analytical focus according to companies' business models. Especially when time is ...
RELATED TERMS
  1. Days Sales Of Inventory - DSI

    A financial measure of a company's performance that gives investors ...
  2. Inventory Reserve

    An accounting entry that represents a deduction from earnings ...
  3. Perpetual Inventory

    A method of accounting for inventory that records the sale or ...
  4. Obsolete Inventory

    Term that refers to inventory that is at the end of its product ...
  5. Highest In, First Out - HIFO

    In accounting, an inventory distribution method in which the ...
  6. Inventory Financing

    A line of credit or short-term loan made to a company so it can ...
COMPANIES IN THIS ARTICLE
Trading Center