Loading the player...

What is 'Inventory Turnover'

Inventory turnover is a ratio showing how many times a company's inventory is sold and replaced over a period of time. The days in the period can then be divided by the inventory turnover formula to calculate the days it takes to sell the inventory on hand. It is calculated as sales divided by average inventory.

BREAKING DOWN 'Inventory Turnover'

Inventory turnover measures how fast a company is selling inventory and is generally compared against industry averages. A low turnover implies weak sales and, therefore, excess inventory. A high ratio implies either strong sales and/or large discounts.

The speed with which a company can sell inventory is a critical measure of business performance. It is also one component of the calculation for return on assets (ROA); the other component is profitability. The return a company makes on its assets is a function of how fast it sells inventory at a profit. As such, high turnover means nothing unless the company is making a profit on each sale.

Inventory Turnover Example

Inventory turnover is calculated as sales divided by average inventory. Average inventory is calculated as: (beginning inventory + ending inventory)/2. Using average inventory accounts for any seasonality effects on the ratio. Inventory turnover is also calculated using the cost of goods sold (COGS), which is the total cost of inventory. Analysts divide COGS by average inventory instead of sales for greater accuracy in the calculation of inventory turnover. This is because sales include a markup over cost. Dividing sales by average inventory inflates inventory turnover.

Approach 1: Sales Divided By Average Inventory

As an example, assume company A has $1 million in sales. The COGS is only $250,000. The average inventory is $25,000. Using the first equation, the company has inventory turnover of $1 million divided by $25,000, or 40. Translate this into days by dividing 365 by inventory days. The answer is 9.125 days. This means under the first approach, inventory turns 40 times a year, and is on hand approximately nine days.

Approach 2: COGS Divided By Average Inventory

Using the second approach, inventory turnover is calculated as the cost of goods sold divided by average inventory, which in this example is $250,000 divided by $25,000, or 10. The number of inventory days is calculated by dividing 365 by 10, which is 36.5. Using the second approach, inventory turns over 10 times a year and is on hand for approximately 36 days.

The second approach gives a more accurate measure, as it does not include a markup. Only compare inventory turnover that uses the same approach for an apples-to-apples comparison.

For more details, check out "How do I calculate the inventory turnover ratio?"

RELATED TERMS
  1. Turnover

    Turnover is an accounting term that calculates how quickly a ...
  2. Average Inventory

    A calculation comparing the value or number of a particular good ...
  3. Average Age Of Inventory

    The average number of days it takes for a firm to sell to consumers ...
  4. Perpetual Inventory

    A method of accounting for inventory that records the sale or ...
  5. Carrying Cost Of Inventory

    This is the cost a business incurs over a certain period of time, ...
  6. Inventory Reserve

    An inventory reserve is a contra asset account on a company's ...
Related Articles
  1. Investing

    Measuring Company Efficiency

    Three useful indicators for measuring a retail company's efficiency are its inventory turnaround times, its receivables and its collection period.
  2. Investing

    Key Financial Ratios for Retail Companies

    Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
  3. Investing

    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.
  4. Investing

    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.
  5. Investing

    Tesla's 3 Key Financial Ratios (TSLA)

    Learn about Tesla Motors, Inc. and the company's key financial ratios, such as gross margin, operating margin and inventory turnover ratio.
  6. Investing

    Fund Transactional Activity

    Portfolio turnover is one of the simplest measures of mutual fund quality quality. Find out how to measure it.
  7. Investing

    Key Financial Ratios to Analyze The Automotive Industry

    Learn about the most critically important financial ratios investors and market analysts utilize to evaluate companies in the automotive industry.
RELATED FAQS
  1. 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 >>
  2. How Do I Calculate The Inventory Turnover Ratio?

    The inventory turnover ratio is a key measure for evaluating how effective a company's management is at managing inventory ... Read Answer >>
  3. Which industries tend to have the most inventory turnover?

    Understand what inventory turnover measures and why it is good to have high inventory turnover. Learn what industries tend ... Read Answer >>
  4. How do you analyze inventory on the balance sheet?

    Learn how to analyze inventory using financial statements and footnotes by doing ratio analysis and performing qualitative ... Read Answer >>
Hot Definitions
  1. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  2. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  3. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  4. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  5. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  6. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
Trading Center