Knowing how to calculate inventory turnover is one of those business metrics that can seem straightforward once you get the hang of it. But what exactly is it, and why does it matter for your business?
The inventory turnover ratio measures how often your inventory is sold and replaced over a period. That’s a pretty simple concept, but it has a significant impact on profitability and operational efficiency.
So, how do you calculate it? You divide the Cost of Goods Sold (COGS) by the average inventory value. That’s the formula in a nutshell. But what’s behind that formula? This inventory turnover calculation helps businesses understand how efficiently they are converting inventory into sales.
The COGS is the total direct cost of producing the goods sold by your company. That includes raw materials, direct labor—but excludes indirect expenses. You can find COGS in your income statement, making it accessible for businesses to calculate.
To determine COGS, you use the formula:
That gives you a clear view of the actual production cost of sold goods.
Average inventory is calculated by adding the beginning and ending inventory balances and dividing by two. That helps smooth out seasonal variations in inventory levels.
Let's say your beginning inventory is $20,000 and your ending inventory is $30,000. Your average inventory would be: $25,000
Now, to perform the inventory turnover ratio calculation, you divide COGS by average inventory value. That determines the number of times inventory is sold and replaced over a specific period.
For instance, if your COGS is $100,000 and your average inventory is $25,000, the inventory turnover ratio would be: 4
Industry benchmarks for inventory turnover can give you insights into your business's operational efficiency and competitiveness. What's ideal for a grocery store might not be suitable for a luxury car dealership.
Cherry Woods Furniture, for example, reported a COGS of $47,000 and an average inventory of $16,000, resulting in an inventory turnover ratio of 3. That's a pretty good indicator of how efficiently they're selling and replacing their inventory.
By understanding and calculating your inventory turnover ratio, you can minimize inventory on hand, reduce holding costs and increase responsiveness to customer demand. That's the power of inventory turnover.
Inventory turnover ratios can be all over the map—and that's exactly what makes context so important when interpreting the results. What those numbers mean for your business is what really matters.
You see high inventory turnover as a sign of strong sales performance and efficient inventory management. But it can also indicate you're selling through stock so quickly that you might not have enough on hand to meet demand. That can lead to stockouts and lost sales opportunities.
A low inventory turnover ratio, on the other hand, can signal weak sales—or that you’re stuck with too much inventory. That ties up cash and reduces profitability. When you compare your turnover ratio to industry benchmarks, you get meaningful insights into your inventory management practices.
What constitutes an ideal inventory turnover ratio varies by industry and product type. Grocery stores, for example, have a high turnover ratio—around 14. Retail averages about 10.86. Fast-fashion retailers turn over inventory quickly due to their business model.
A good turnover ratio usually falls between 2 and 6 for many types of retailers. If your ratio is lower than 2, you may have issues with sales or inventory management. Higher ratios suggest you’re doing inventory management right. That ideal turnover ratio is a benchmark for assessing performance.
Low turnover often means weak sales—or too much inventory. That can result from overstocking, inefficient sales processes or economic downturns. Excessive inventory can lead to increased holding costs and hinder potential sales opportunities. Maintaining too much inventory increases carrying costs and ties up capital that could be put to better use elsewhere in the business.
To address low turnover, you need to evaluate your marketing strategies, sales performance and supply chain efficiency to find areas to improve. Optimizing those areas will boost turnover ratios and profitability.
High turnover means you're selling through inventory quickly—and that can lead to increased cash flow and profitability. But extremely high turnover can signal potential inventory shortages and stockouts. Balancing high turnover with adequate inventory levels is crucial to keep customers satisfied and avoid supply chain disruptions.
That balance requires effective inventory management strategies. Several factors influence inventory turnovers—demand, marketing strategies and inventory management practices. High demand and effective promotions can boost turnover, while poor inventory management and over-purchasing can lower it.
Maintaining an optimal balance of inventory levels is essential for preventing stockouts and overstocking. Inefficient warehouse management and inaccurate inventory records can impact turnover calculations. Reviewing historical and current sales velocity helps you forecast and improve inventory turnover.
Improving inventory turnover ratios involves implementing effective inventory management strategies—streamlining procurement processes, reducing lead times and maintaining accurate inventory records. Effective forecasting and adjusting stock levels based on seasonal trends also help prevent excess inventory and ensure availability during peak demand.
Calculating inventory turnover comes with challenges—inaccurate data collection, seasonal variations and industry comparisons. Retailers often face incorrect calculations and poor inventory management—which impacts turnover accuracy. External conditions like supply chain reliability and market trends also affect inventory turnover efficiency.
Recognizing these challenges is vital for accurate and meaningful turnover calculations. Accurate data collection is crucial for determining the precise cost of goods sold—which directly affects inventory turnover calculations. Reliable figures for both average inventory and COGS allow businesses to assess operational efficiency and the effectiveness of inventory management.
Inaccurate data can lead to skewed turnover ratios—resulting in poor business decisions and potential revenue loss. Regular inventory audits and inventory management software enhance data accuracy.
Seasonal variations can significantly affect inventory turnover ratios. Recognizing these patterns helps accurately track inventory turnover and adjust stock levels. Calculating average inventory by summing inventory levels over a specific period and dividing by the number of periods also helps manage seasonal variations.
Industry comparisons are crucial for evaluating inventory turnover ratios. Industry-specific benchmarks provide context for assessing turnover effectiveness and identifying areas for improvement. Different product characteristics result in varied turnover rates across industries—making these comparisons essential.
Several tools and software are available to help businesses analyze and manage inventory turnover. Extensiv Order Manager synchronizes inventory data across various sales channels. SkuVault tracks crucial inventory data to prevent overselling.
Inventory Planner helps businesses get demand forecasting and reordering right. That means you can rely on Shopify POS and Daasity for user-friendly inventory analytics—that give you the insights you need to make smart decisions and really turn over your inventory efficiently.
Implementing inventory turnover in your business can be a game-changer for optimizing inventory levels, reducing costs, and improving profitability. Here are some steps to help you get started:
Calculate Your Inventory Turnover Ratio: Use the inventory turnover ratio formula: Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory Value. This will give you a baseline understanding of your current inventory turnover.
Set a Target Inventory Turnover Ratio: Based on your industry, product type, and business goals, set a target inventory turnover ratio. A good inventory turnover ratio varies from industry to industry, but generally, a higher ratio indicates better performance.
Analyze Your Inventory: Identify slow-moving or dead stock, and consider clearing it out to make room for faster-selling items. This will help improve your inventory turnover ratio and reduce waste.
Implement Inventory Management Software: Consider investing in inventory management software to help track inventory levels, automate calculations, and provide insights into your inventory turnover. This can streamline your processes and improve accuracy.
Optimize Your Ordering Process: Adjust your ordering process to match demand, and consider implementing a just-in-time (JIT) inventory system to reduce inventory levels and improve turnover. This approach minimizes excess inventory and enhances efficiency.
Monitor and Adjust: Regularly monitor your inventory turnover ratio and adjust your strategies as needed. This may involve tweaking pricing, marketing efforts, or inventory levels to optimize turnover.
By implementing these steps, you can improve your inventory turnover ratio, reduce costs, and enhance profitability. Remember to regularly review your inventory turnover ratio and adjust your strategies as needed to ensure optimal performance.
Inventory turnover is where it's at. In this post, we'll cover the key points you need to know about calculating and understanding inventory turnover. And here's the thing: if you don't get it right, you're leaving money on the table.
What keeps you up at night is probably how to use that knowledge to actually improve your inventory turnover. We hope this summary—and the rest of the post—gives you the push you need to take action.
The basic formula is: Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory. This measures how many times your inventory is sold and replaced during a specific period.
Inventory turnover indicates how efficiently a company is managing its inventory. It shows how quickly you're selling products, how well you're managing stock levels, and can highlight potential issues with sales performance or inventory management.
A good ratio varies by industry, but generally, 2-6 is considered healthy for many retailers. Grocery stores might have ratios around 14, while retail averages about 10.86. The "right" ratio depends on your specific business model and industry benchmarks.
A ratio of 1.5 means you're selling and replacing your entire inventory 1.5 times during the measured period. This is generally considered low for most industries and might indicate overstocking or weak sales performance.
An inventory turn of 2 means you're selling through your entire inventory twice during the measured period (usually a year). This is at the lower end of what's considered acceptable for many retailers.
Generally yes, as it indicates strong sales and efficient inventory management. However, extremely high turnover might mean you're not keeping enough stock on hand, potentially leading to stockouts and lost sales opportunities.
Low turnover typically signals weak sales, overstocking issues, or inefficient inventory management. It means your capital is tied up in inventory that isn't selling quickly, increasing carrying costs and reducing cash flow.
A ratio below 1 means you're not selling your entire inventory within the measured period. This is concerning for most businesses and indicates serious overstocking or sales problems that need immediate attention.
Generally, higher is better as it indicates efficient sales and inventory management. However, the optimal ratio depends on your industry, and extremely high ratios might indicate understocking problems.
In Excel, you would use: =COGS/AVERAGE(Beginning_Inventory,Ending_Inventory). For example, if COGS is in cell B1, beginning inventory in B2, and ending inventory in B3, the formula would be: =B1/AVERAGE(B2,B3).
To calculate Days Inventory Outstanding (DIO), use: DIO = 365 / Inventory Turnover Ratio. This tells you how many days, on average, it takes to sell through your inventory.
Inventory turnover is typically expressed as a ratio, not a percentage. A ratio of 0.1 (which would be 10% if expressed as a percentage) would be extremely low and concerning for most businesses.
Average Inventory = (Beginning Inventory + Ending Inventory) / 2. For more accurate results with seasonal businesses, you might calculate the average of multiple points throughout the period.