Inventory Turnover

Inventory Turnover

Key takeaways

• Inventory turnover measures how many times a company sells and replaces its inventory over a period (usually a year).
• Formula: Inventory turnover = Cost of goods sold (COGS) / Average inventory.
• A high turnover generally indicates strong sales or efficient purchasing; a low turnover can signal overstocking or weak demand.
• Compare turnover ratios to industry peers and historical trends; seasonal and accounting differences can distort comparisons.

What the ratio shows

Inventory turnover gauges how efficiently a business converts inventory into sales. It helps identify:
* Sales strength or weakness
* Overstocking or obsolete items (dead stock)
* Operational efficiency in purchasing and merchandising

Interpreting the ratio requires context: industry norms, seasonality, and company strategy all matter. Very high turnover may also indicate insufficient stock and lost sales; very low turnover may point to excess carrying costs and obsolete goods.

Formula and how to calculate it

Inventory turnover = COGS / Average inventory

Where:
* COGS = cost of goods sold (preferred because inventory is recorded at cost)
* Average inventory = (Beginning inventory + Ending inventory) / 2

Notes:
* Some analysts use sales instead of COGS; that inflates the ratio and mixes cost and revenue measures.
* Use average inventory to reduce the effect of seasonal swings.

To convert turnover to days:
Days to sell inventory (DSI) = (Average inventory / COGS) × 365
Or equivalently: DSI = 365 / Inventory turnover

What it can tell you

• Low turnover: possible weak demand, poor merchandising, or excess stock — may lead to markdowns and higher carrying costs.
• High turnover: strong demand or tight inventory control — could also reflect insufficient stock, risking stockouts.
• Tracking trends and benchmarking against peers reveals whether changes stem from better operations, shifting demand, or accounting/cost effects.

Example use case: industries with perishable or seasonal products (groceries, fashion) rely heavily on turnover to minimize waste and maximize sales.

Dead stock and obsolete inventory

Products with persistently low turnover are candidates for classification as obsolete or dead stock. Because COGS is recognized only on sale, slow-selling SKUs show low COGS and low turnover; these should be reviewed for markdowns, liquidation, or discontinuation.

Related ratios

• Inventory-to-sales ratio: inventory ÷ net sales (inverse-style comparison using sales instead of COGS).
• Days Sales of Inventory (DSI): average days to convert inventory into sales (see formula above).
  These complements help assess inventory relative to sales pace and cash needs.

Limitations and caveats

• Industry differences: ideal turnover varies widely by sector and product type.
• Seasonality: peak seasons can skew annualized numbers.
• Cost volatility: changes in input costs, inflation, or FX rates can affect COGS and distort trend comparisons.
• Carrying costs and service levels: a high turnover ratio might hide costs from stockouts, rush shipping, or lost sales.
• Lead times: turnover does not reflect supplier lead times; a high turnover with long lead times can increase stockout risk.

How to improve inventory turnover

• Improve demand forecasting and replenish more accurately.
• Use inventory management systems and open-to-buy budgeting.
• Shorten lead times and localize supply where feasible.
• Adopt pull-based production (produce after orders) for appropriate products.
• Rationalize SKUs: remove slow movers or consolidate assortments.
• Run promotions or markdowns to clear slow stock.

Example calculation (illustrative)

If COGS = $490 billion, beginning inventory = $56.6 billion, ending inventory = $54.9 billion:

Average inventory = (56.6 + 54.9) / 2 = 55.75 billion
Inventory turnover = 490 / 55.75 ≈ 8.8 times per year
DSI = 365 / 8.8 ≈ 41 days

This means inventory turns roughly every 41 days on average.

Conclusion

Inventory turnover is a straightforward but powerful metric for assessing how effectively a company manages inventory relative to sales. Use it with industry benchmarks, complementary ratios (like DSI), and qualitative context (seasonality, lead times, pricing strategy) to diagnose inventory health and guide operational improvements.