How to Calculate Inventory Turnover

The higher the inventory turnover number, the more positive the indication that the company is operating efficiently.

Inventory turnover is represented by a calculated number of how many times a company cycles through its inventory during a given financial reporting period. It can be measured for manufacturing materials and supplies, work in progress, finished products or everything combined. The higher the inventory turnover number, the more positive the indication that the company is operating efficiently. A low ratio means the company has not profited as much, because the inventory in house is not generating revenue and also must be maintained, which imposes additional costs for the company.

Instructions

1. Calculate the cost of goods sold. One way to do this is to count the number of products sold and multiply the total by the cost to produce each one. Another way is to take the total dollar value of inventory to start with, add the cost of production materials and supplies purchased in that period, and subtract the dollar value of the remaining inventory at the end of the period.

2. Calculate the average dollar value of inventory on hand at the time inventory turnover is being assessed.

3. Obtain the inventory turnover ratio by dividing the cost of goods sold by the average cost of products currently in inventory. For example, if the total cost of goods sold during a set time period is $300 and the average current dollar value of the current inventory is $30, your inventory turnover ratio is $300 divided by $30, which equals 10. During this time period, this means the inventory was sold out 10 times.

4. Analyze the inventory turnover ratio in combination with other trends, such as advanced sales, discount-driven sales, supplier-financed inventory and increase in cost of goods sold due to excess waste. These can all be analyzed through financial statements to determine if operations costs are beneficial for business.

Tips & Warnings

• While a high inventory turnover ratio is usually good, too high a turnover may indicate insufficient merchandise and potential lost sales.

• Use the turnover ratio to compare your business to the averages of other companies in your industry.

References

• Fast Trac: Balance Sheet Performance Evaluation