How To Calculate Inventory Turnover (With Formula and Examples)
By Indeed Editorial Team
Updated December 29, 2021 | Published April 14, 2020
Updated December 29, 2021
Published April 14, 2020
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
As a business owner, it is helpful to calculate your business' inventory turnover rate. This helps you determine whether or not you're effectively able to manage your product stock, how quickly your products are selling, how great the product demand is for the goods you sell and how quickly you're able to sell products in comparison to other companies in your industry. In this article, we will define inventory turnover and provide you with the steps in calculating the inventory turnover rate for your business.
What is inventory turnover?
Inventory turnover refers to your company's ability to replace its inventory in a given period. The rate of this, known as the inventory turnover rate, is the number of times this turnover happens. In other words, it's the rate at which your company's inventory is "turned" or "sold" to consumers. The inventory ratio helps you to determine how well your inventory is being turned into sales. It also lets you know whether you're keeping too much inventory on hand and having to pay storage and other fees because of this.
Why is inventory turnover important?
Inventory turnover is important for several reasons. For starters, if your company receives a large stock of products, your sales department will have to sell a large stock of products. If a lot of these products aren't sold, you'll begin to pay for the cost of keeping these goods on store shelves or in storage. Additionally, the number of sales made for a particular good needs to align with the number of goods in stock. This ensures a consumer's demands are being met. For example, if you sell a customer a pair of pants but later determine you don't have any in stock, your inventory turnover will be off because there wasn't any inventory to "turn" or give to the customer.
Ultimately, inventory turnover helps make sure you're not overbuying inventory and spending excessive amounts of money to keep it in stock with no one interested in purchasing it.
Related: Learn About Being an Inventory Clerk
How to calculate inventory turnover
To evaluate the rate at which you're able to turn your inventory into a sale, you'll need to accurately calculate your inventory turnover rate. Here are the steps you'll need to take:
1. Determine the cost of goods sold
To calculate your inventory turnover ratio, you'll need the cost of goods your company sold. The cost of goods sold refers to the cost it took to produce said goods. This can include the cost of labor, materials and more. You can find this number on your company's income statement.
2. Determine your company's average inventory
Rather than using an exact amount of inventory, you'll need the average inventory for your company. This is because it's common for businesses to have fluctuating amounts of inventory throughout a given period. For example, you could have a large inventory of swimsuits in June but by summer's end, the inventory for this product could be nearly depleted. Using the figures from June or the end of summer wouldn't be an accurate representation of your average inventory.
3. Calculate your inventory turnover rate
Once you have the variables above, determine your inventory turnover rate by dividing the cost of goods sold by the average inventory. Use the following formula to calculate your inventory turnover rate:
Inventory turnover ratio = (cost of goods sold) / (average inventory for the period)
What is considered a good inventory turnover rate?
Typically, an inventory turnover rate between 4 and 6 is considered ideal. However, this is highly dependent upon the type of business and the industry you're in. For example, if you own a grocery or convenience store, you're more likely to have a high inventory turnover rate because they sell items that people need to purchase frequently and many of these items need to be replenished before they go bad.
A company's high inventory turnover rate is desirable because this means they are selling products at a good rate. This also means their products are in high demand. The higher the inventory ratio, the more sales are being made. However, a high inventory turnover rate could also mean insufficient inventory. In contrast, a low inventory turnover rate means a company is having a hard time selling their products because they're not in demand. Therefore, inventory turnover helps determine how the popularity of a product relates to the need for purchase by consumers.
The ultimate goal is for a company's purchasing and selling departments to have a harmonious relationship. This ensures that demand is not only high but that it's met, too.
Here are some examples of inventory turnover rate calculations:
Let's say you own a large corporation and in 2018 you had an annual cost of goods sold of $100 million. You also had an inventory of $10 million. To determine your inventory turnover rate, you'll need to divide your cost of goods sold ($100 million) by your average inventory ($10 million). This will result in an inventory rate of 10.
You own a local supermarket with a cost of goods sold worth $500,000 for this year. The cost of inventory at the beginning of the year was $50,000. By the end of the year, the cost of inventory $20,000. To calculate your inventory turnover ratio, you'll need the average inventory, so you add 50,000 and 20,000 and divide by two to get an average inventory of $35,000. After you do this, you can divide the cost of goods sold ($500,000) by the average inventory ($35,000) to get your inventory turnover ratio of 14.29.
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