What Is the Inventory Turnover Ratio?

Inventory turnover ratio is a financial ratio showing how many times a company turned over its inventory in a given period. A company can then divide the days in the period, typically a 澳洲幸运5官方开奖结果体彩网:fiscal year, by the inventory turnover ratio to calculate how many days it takes, on averag🅰e, to sell its inventory.

The inventory turnover ratio can help businesses make better decisions on pricing, manufacturing, 澳洲幸运5官方开奖结果体彩网:marketing, and 澳洲幸运5官方开奖结果体彩网:purchasing. It is one of several common 澳洲幸运5官方开奖结果体彩网:efficiency ratios that companies can use to measܫure how effectively they use their assets.

Understanding the Inventory Turnover Ratio

As mentioned, the inventory turnover ratio measures the number of times a company's inventory is sold and replaced over a certain period. A higher inventory ratio is usually better, although there may also be downsides to a high turnover.

Analyzing an inventory turnover ratio in conjunction with industry benchmarks and historical trends can provide valuable insights into a company's operational efficiency and competitiveness. On its own, the turnover ratio may not mean much. However, tracking it over time or comparing it against a similar company's ratio can be very useful.

Inventory Turnover Formula and Calculation

The inventory turnover ratio is calc♈ulated🍸 as follows:

$\begin{aligned} &\text{Inventory Turnover} = \frac{ \text{COGS} }{ \text{Average Value of Inventory} } \\ &\textbf{where:} \\ &\text{COGS} = \text{Cost of goods sold} \\ \end{aligned}$​Inventory Turnover=Average Value of InventoryCOGS​where:COGS=Cost of goods sold​

澳洲幸运5官方开奖结果体彩网:Cost of goods sold (COGS) is also known as cost of sales. Analysts use COGS instead of sales in the formula for inventory turnover because inventory is typically valued at cost, whereas the sales figure includes the company's markup. Some companies may use sales in♑stead of COGS in the calculation, which woul🐈d tend to inflate the resulting ratio.

Additionally, 澳洲幸运5官方开奖结果体彩网:average value of inventory is used to offset 澳洲幸运5官方开奖结果体彩网:seasonality effects. It is calculated by adding the value of inventory at the end of a period to the value of inventory at the end of the prior period and dividing the sum by 2.

What an Inventory Turnover Ratio Can Tell You

A low inventory turnover ratio might be a sign of weak sales or excessive inventory, also known as overstocking. It could indicate a problem with a retail chain's 澳洲幸运5官方开奖结果体彩网:merchandising strategy or inadequate marketing. Simply put, a low inventory turnover 🅺ratio meꦐans the product is not flying off the shelves, for whatever reason.

A 澳洲幸运5官方开奖结果体彩网:high inventory turnover ratio, on the other hand, suggests strong sales. Alternatively, it could be the result of insufficient inventory. As problems go, ensuring that a company has sufficient inventory to support strong sales is a better one to have than needing to scale down inve༒ntory because business is lagging.

The speed with which a company can turn over inventory is a critical measure of business performance. Retailers that turn inventory into sa𒊎les faste🎶r tend to outperform comparable competitors.

The 澳洲幸运5官方开奖结果体彩网:fast fashion business is an example. Competitors such as H&M and Zara typically limit runs and replace depleted inventory quickly with new items. Slow-selling items equate to higher holding costs. There is also the 澳洲幸运5官方开奖结果体彩网:opportunity cost of low inventory turnover; an item that takes a long time to sell delays the stocking of new merchandise that might prove more ꧟popular.

A decline in the inventory turnover ratio may signal diminished demand, leading businesses to reduce output.

Inventory Turnover and Dead Stock

Inventory turnover is an especially important piece of data for maximizing efficiency in the sale of perishable and other time-sensitive goods. Examples include groceries, fashion, autos, and periodicals. An overabundance of cashmere sweaters, for instance, may lead to unsold inventory and lost profits, especially as seasons change and retailers restock accordingly. Such unsold stock is known as obsolete inventory, or dead stock.

The inventory turnover ratio can be one way of better understanding dead stock. In theory, if a company is not selling a lot of a particular product, the COGS of that good will 🎃be very low (since COGS is only recognized upon a sale). Therefore, products with a low turnover ratio should be evaluated periodically to see if the stock is obsolete.

Related Inventory Ratios

The 澳洲幸运5官方开奖结果体彩网:inventory-to-saIes ratio is the inverse of the inventory turnover ratio, with the additional distinction that it compares inventories with🦩 net sales rather than the cost of sales. A higher inventory-to-sales ratio suggests that the company may be holding excess inventory relative to i🦄ts sales volume, meaning there may be inefficiencies in its inventory management. A lower inventory-to-sales ratio implies that the company has a leaner inventory position relative to its sales, which may reflect tighter control over inventory levels and/or more efficient allocation of resources.

Another ratio inverse to inventory turnover is 澳洲幸运5官方开奖结果体彩网:days sales of inventory (DSI), which marks the average n♚umber of days it takes to turn inventory into sales. DSI is calculated as average value of inventory divided by cost of sales or COGS, and multiplied by 365. Companies tend to want to have a lower DSI, and they usually want that DSI to be sufficient to cover short-ter꧃m cash needs.

Limitations of Inventory Turnover Ratios

The inventory turnover ratio is a valuable metric for many cဣompanies. However, it also has limitations that need to be taken into account:

• Industry variability: Different industries have varying norms and practices regarding inventory management, so there will be natural differences in their ideal turnover ratios. Comparing turnover ratios across industries without considering these differences can be misleading. For example, publicly listed U.S. auto dealers turned over their inventory every 63 days on average in 2022, compared with every 32 days for publicly listed food store chains.
• Seasonal fluctuations: Some businesses experience significant seasonal variations in demand, which can affect their inventory turnover ratios. A high turnover ratio during peak seasons may skew the overall ratio, and companies may look worse even though they've adequately planned for the slower seasons.
• Cost variations: The cost of goods sold, on which inventory turnover ratio is partly based, can fluctuate due to changes in production costs, raw material prices, or 澳洲幸运5官方开奖结果体彩网:currency exchange rates. These fluctuations can distort the accuracy and comparability of turnover ratios over time.
• Overlooked carrying costs: While a high turnover ratio is generally seen as positive, it may overlook the costs associated with maintaining low inventory levels. For example, a company may incur high fees related to stockouts, rush orders, and lost sales opportunities. Businesses should consider the balance between inventory turnover and the associated carrying costs to optimize profitability.
• Ignoring lead times: The inventory turnover ratio does not account for 澳洲幸运5官方开奖结果体彩网:lead times or the time it takes to replenish inventory. A high turnover ratio may indicate efficient sales, but if lead times are long, it could lead to stockouts and potential customer dissatisfaction if inventory is not replenished quickly enough.

Example of an Inventory Turnover Calculation

For fiscal year 2022, Walmart Inc. (WMT) reported cost of sales of $429 billion and year-end inventory of $56.5 billion, up from $44.9 billion a year earlier. Walmart’s inventory turnover ratio for the year was:

2022: $429 billion ÷ [($56.5 billion + $44.9 billion)/2], or about 8.5

Dividing the 365 days in the year by 8.5 shows that Walmart turned over its inventory about every 42 days on averaꦏge.

Fast-forward to 2024, Walmart reported cost of sales of $490 billion for the fiscal year ending January 2024. It also reported ending inventory of $54.9 billion, up from $56.6 billion a year earlier. So its inventory turnover ratio for 2024 was:

2024: $490 billion ÷ [($54.9 billion + $56.6 billion)/2], or about 8.8

This signals that 🎐from 2022 to 2024, Walmart increased its inventory turnover ratio. Dividing the 365 days in the year by 8.8 shows that Walmart turned over its inventory about every 41 days on average.

In instances like this, management should further explore the cause. It may be due to more efficient processes, or it may be due to more demand for the products it offers. However, very generally speaking, the movement of this ratio from 2022 to 2024 in Walmart's case appears to be positive.

The Bottom Line

A company's inventory turnover ratio reveals the number of times that it turned over its inventory in a given time period. This ratio is useful to a business in guiding its decisions regarding pricing, manufacturing, marketing, and purchasing. It is of particular importance in retail.