How to Calculate the Inventory Turnover Ratio and Why Its Important

That prioritization could affect your spending on active and planned marketing campaigns, while your customer service team receives fewer complaints when high-turnover products are readily available. Inventory turnover is a simple equation that takes the COGS and divides it by the average inventory value. This ratio tells you a lot about the company’s efficiency and how it manages its inventory.

The inventory turnover ratio measures the efficiency of the business in managing and selling its inventory in a timely manner. This ratio gauges the liquidity of the firm’s inventory and also helps the business owners determine how they can increase sales through inventory control. Knowing your inventory turnover ratio additionally allows for a better understanding of cash-flow management, through inventory optimization, and decisions dealing with pricing and purchasing.

• Cost of goods sold is an expense incurred from directly creating a product, including the raw materials and labor costs applied to it.
• Many or all of the products featured here are from our partners who compensate us.
• Cost of sales yields a more realistic turnover ratio, but it is often necessary to use sales for purposes of comparative analysis.
• Measuring at the SKU (stock-keeping unit) or segment level has several benefits.

Selling accounts receivables, which are, after all, a current asset, can be considered a way to receive short-term financing. Now that you know the COGS formula, you will need to calculate your average inventory. The good news is that you don’t need an elaborate system or a specialized inventory turnover calculator to determine inventory turns. You can apply a few simple formulas to your existing data, especially once you understand the best practices for turnover analysis. These limitations emphasize the need for a holistic approach to inventory management, integrating factors beyond turnover rate alone. Planning ahead helps prevent overstocking and stockouts, improving overall operational efficiency.

How to Calculate Inventory Turnover Ratio?

You can use whatever timeframe you prefer, but it’s common to use yearly, quarterly, or monthly data. You can use the following formula to calculate inventory turns for a given period of time. For example, if you have an e-commerce store selling consumer goods, you’ll likely have a higher inventory turnover ratio than a luxury car dealership.

To calculate the inventory turnover ratio, divide your business’s cost of goods sold by its average inventory. Since the inventory turnover ratio represents the number of times that a company clears out its entire inventory balance across a defined period, higher turnover ratios are preferred. Another ratio inverse to inventory turnover is days sales of inventory (DSI), marking the average number of days it takes to turn inventory into sales. DSI is calculated as average value of inventory divided by cost of sales or COGS, and multiplied by 365.

Disregards Variations in Product Profitability

With this data, you can make smarter decisions about inventory management. Calculating inventory turnover ratio helps you make business decisions about pricing, purchasing, marketing, and more. Ultimately, business owners should understand why their company’s inventory turnover ratio is high or low and take action where needed. Companies with a high inventory turnover must be very diligent about reordering to prevent stockouts. If the company’s turnover ratio is too high, it means it sells out too fast and might be missing out on sales because it can’t keep items in stock. This could reveal an opportunity for a price increase due to high demand.

Calculate Inventory Days

In other words, it measures how many times a company sold its total average inventory dollar amount during the year. A company with $1,000 of average inventory and sales of $10,000 effectively sold its 10 times over. The inventory turnover rate takes the inventory turnover ratio and divides that number into the number of days in the period. This calculation tells you how many days it takes to sell the inventory on hand.

Advertising and marketing efforts are another great way to boost your inventory turnover ratio. Consider promoting products that have been sitting around for a while to consumers outside your established customer base. You could also use email marketing and social media marketing to highlight specific products to existing and prospective customers. The inventory turnover ratio is closely tied to the days inventory outstanding (DIO) metric, which measures the number of days needed by a company to sell off its inventory in its entirety. For companies with low turnover ratios, the duration between when the inventory is purchased, produced/manufactured into a finished good, and then sold is more prolonged (i.e. requires more time). That said, low turnover ratios suggest lackluster demand from customers and the build-up of excess inventory.

Inventory Turnover Formula and Calculation

Identify which products are likely to be “impulse buys” for your customers and move them to high-traffic areas of your store. As you test out different placements, pay attention to your inventory turnover ratio before and after each change to help you determine what’s working and what isn’t. Simply put, the inventory turnover ratio measures the efficiency at which a company can convert its inventory purchases into revenue. As you can see, you can make specific business decisions to move the products more efficiently. You can put them on sale, order more contemporary products and lower the inventory you carry so that you aren’t waiting on sales and have your cash flow hampered.

These barcodes track the details of the inventory, including price and manufacturer.

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The longer an item is held, the higher its holding cost will be, and so companies that move inventory relatively quickly tend to be the best performers in an industry. Monitoring the ITR is pivotal for businesses to ensure they are neither understocking nor overstocking items. It quantifies how often a business can sell its entire inventory in a given period, often annually. Sales have to match inventory purchases otherwise the inventory will not turn effectively. That’s why the purchasing and sales departments must be in tune with each other. Although Coca-Cola’s ITR was lower, you might find other metrics that show that it was still stronger than the other averages for its industry.

Method to Calculate Inventory Turnover

The inventory turnover ratio is a financial indicator that shows how frequently a company uses and replaces inventory within a set time period. One industry in which accounts receivable turnover is extremely important is in financial services. For instance, CIT Group Inc. (CIT) helps extend credit to businesses and operates a unit that specializes in factoring, which is helping other companies collect today is the tax deadline their outstanding accounts receivables. One is that it causes dead stocks to fill up your inventory, leading to too many unsold inventories tying down your cash flow. To calculate inventory turnover, divide the total cost of goods sold (COGS) for a given period by the average inventory value. Inventory turnover is an important inventory management metric you need to keep an eye on at all times.