Higher inventory turnover ratios can mean lower inventory levels overall, meaning the business incurs fewer inventory costs, freeing up cash for more productive uses. Depending on the type of inventory, spoilage or shrinkage (theft) can also be a problem, which increases inventory costs. First, the company may own or rent a warehouse to store its goods. Holding inventory brings associated costs. Investors also care about inventory turnover because it can show the efficiency of a business's supply chain. Two retailers of different sizes will have vastly different sales numbers, but their turnover ratios can show how many sales they make relative to the inventory they carry. Higher inventory ratios usually correspond to higher sales numbers, so looking at the inventory turnover ratio gives investors an easy way to compare businesses in the same sector in a way that looking at raw sales numbers can't. The more products that a retailer sells, the higher its revenues tend to be. Investors care about inventory turnover because it is an easy indicator of the strength of a business.Ĭompanies that carry inventory make a lot of their money by selling that inventory.

Similarly, they may have a lower turnover in the months leading up to the holidays as they stock up on additional inventory to prepare for the rush. A store specializing in holiday decorations might have a higher turnover near Christmas, Halloween, or the Fourth of July because of increased sales. Seasonal businesses will need to look at the inventory turnover with an eye toward seasonality. However, low inventory turnover can be a good thing if prices are expected to rise or if a shortage is expected because it may indicate that a retailer has sufficient inventory to capitalize on rising prices. Low inventory ratios usually indicate a company that is failing to sell its goods or with too much inventory. On the other hand, a company that doesn't carry sufficient stock might have a high turnover ratio while leaving money on the table in the form of lost sales. High turnover ratios can indicate strong sales numbers or a company that manages its inventory efficiently. Typically, a high inventory ratio is a good thing for companies. The higher the turnover ratio, the less time it takes for the company sells through its inventory. If the figure is high, it will generally be an indicator of the fact that the company is encountering problems selling its inventory.Inventory turnover measures a company's ability to sell through all of its inventory. Companies are aiming to keep their days in inventory figures low. What is Days in Inventory?ĭays in inventory is a measure of how many days, on average, a company takes to convert inventory to sales, which gives a good indication of company financial performance. Inventory Turnover (IT) = COGS / ĮI represents the ending inventory. The following formula is used to calculate inventory turnover: Should a company be cyclical, the best way of assessing its operations is to calculate the average on a monthly or quarterly basis. We calculate the average inventory by adding our starting and finishing inventories together and dividing by two. We calculate inventory turnover by dividing the value of sold goods by the average inventory. The ratio can show us the number of times and inventory has been sold over a particular period, e.g., 12 months. Inventory turnover is a very useful way of seeing how efficient a firm is at converting its inventory into sales.

Lifo inventory turnover formula