How to calculate inventory turnover?

Inventory turnover is an important financial ratio that helps measure the efficiency of inventory management in a company. It indicates how many times a company sells or uses its inventory during a specific period.

Formula for Inventory Turnover

To calculate inventory turnover, you need to use the following formula:

Inventory Turnover = Cost of Goods Sold / Average Inventory

Explanation

The formula for inventory turnover involves two key components: cost of goods sold (COGS) and average inventory. Cost of goods sold represents the direct costs related to the production of goods that were sold during a specific period. Average inventory is calculated by adding the beginning inventory and ending inventory for a period and dividing it by 2.

By dividing the cost of goods sold by the average inventory, you can determine how many times a company's inventory is being sold or used within a specific period. A higher inventory turnover ratio generally indicates that the company is efficiently managing its inventory and generating sales.

For example, if a company has a cost of goods sold of $100,000 and an average inventory of $20,000, the inventory turnover would be calculated as $100,000 / $20,000 = 5 times. This means that the company sells or uses its inventory 5 times during the given period.

Inventory turnover is a critical metric for businesses as it provides insights into the efficiency of their inventory management. Companies can use this ratio to identify areas for improvement, optimize inventory levels, and enhance overall operational performance.