Inventory Turnover Ratio: What It Is, How It Works, and Formula

Someone on our team will connect you with a financial professional in our network holding the correct designation xero config in actionstep practice pro + accounting and expertise. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications. Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others.

Understanding the Inventory Turnover Ratio

Because the inventory turnover ratio uses cost of sales or COGS in its numerator, the result depends crucially on the company’s cost accounting policies and is sensitive to changes in costs. For example, a cost pool allocation to inventory might be recorded as an expense in future periods, affecting the average value of inventory used in the inventory turnover ratio’s denominator. As is the case with other financial ratios, accounting practices do have an influence on results. The inventory turnover ratio is a financial ratio showing how many times a company turned over its inventory relative to its cost of goods sold (COGS) in a given period. A company can then divide the days in the period, typically a fiscal year, by the inventory turnover ratio to calculate how many days it takes, on average, to sell its inventory. The inventory turnover ratio formula is calculated by dividing the cost of goods sold for a period by the average inventory for that period.

Inventory is one of the biggest assets a retailer reports on its balance sheet. This measurement shows how easily a company can turn its inventory into cash. Businesses with an optimal turnover rate often have a better cash flow and reduced storage costs, indicative of effective operations. Simply put, the higher the inventory ratio, the more efficiently the company maintains its inventory.

Create a Free Account and Ask Any Financial Question

Getting demand forecasting right is crucial for businesses looking to balance their inventory with actual customer demand. That said, low turnover ratios suggest lackluster demand from customers and the build-up of excess inventory. You can calculate average inventory by adding your beginning and ending stock levels over a specific period together and dividing them by two. This signals that from 2022 to 2024, Walmart increased its inventory turnover ratio. 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 appears to be positive.

If it’s too low, you may be carrying too much stock and tying up valuable capital with unsold items. This ratio helps you measure how quickly your products are selling and how efficiently you’re managing your inventory. For the fiscal period ending Dec. 31, 2020, Ford had an inventory of $9.99 billion and total revenue of $127.14 billion. Secondly, average value of inventory is used to offset seasonality effects.

Strategies to Improve Inventory Turnover Rate

Alliteratively, we could pull in additional carmakers to get a broader representation of what a “good” inventory turnover ratio is in the auto industry. General Motors had an inventory of $10.40 billion and total sales of $122.49 billion for that same fiscal period. After all, high inventory turnover reduces the amount of capital that they have tied up in their inventory.

In both types of businesses, the cost of goods sold is properly determined by using an inventory account or list of raw materials or goods purchased that are maintained by the owner of the company. That helps balance the need to have items in stock while not reordering too often. Discover how Excel can help you forecast demand and optimize your stock levels like a pro. It’s difficult to determine what a good inventory turnover is because it depends on your industry and whether you manufacture your products yourself or buy them to resell.

1. Retailers that turn inventory into sales faster tend to outperform comparable competitors.
2. The inventory turnover ratio formula is calculated by dividing the cost of goods sold for a period by the average inventory for that period.
3. A higher inventory-to-sales ratio suggests that the company may be holding excess inventory relative to its sales volume, meaning there may be inefficiencies in its inventory management.
4. These two account balances are then divided in half to obtain the average cost of goods resulting in sales.
5. This ratio helps you measure how quickly your products are selling and how efficiently you’re managing your inventory.

ITR is calculated by dividing a company’s Cost of Goods Sold by its Average Inventory. While strong sales are good for business, insufficient inventory is not. For example, a company with $20,000 in average inventory with a COGS of $200,000 will have an ITR of 10. This formula gives a clear picture of how effectively a company’s inventory is being utilized in relation to its sales. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.

Rather than being a positive sign, high turnover could mean that the company is missing potential sales due to insufficient inventory. It plays a key role in enabling managers to truly appreciate the efficiency (or lack thereof) of their organization’s stock management practices. Therefore, storekeepers and other officials should deliberate on whether to retain or dispose of such items in order to save further storing or handling costs. It is in the best interest of the organization to compare the turnover of different types of (and grades of) material as a measure of detecting stock that does not move regularly. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.

Formula to Calculate Inventory Turnover Ratio

Note that Excel is a powerful tool that allows for quick and easy calculations of ratios and formulas. Taking this analysis a step further, we could better assess Ford and General Motors’ respective inventory turnover by looking at historical numbers. Inventory turnover is only useful for comparing similar companies, because the ratio varies widely by industry. For example, listed U.S. auto dealers turned over their inventory every 55 days on average in 2021, compared with every 23 days for publicly traded food store chains. Such materials do not have any demand at present and represent a zero turnover ratio. In governmental accounting fund types other words, their average stock is one-third or one-quarter of their annual cost of sales.

Access and download collection of free Templates to help power your productivity and performance. Her work has been featured on US News and World Report, Business.com and Fit Small Business. She brings practical experience as a business owner and insurance agent to her role as a small business writer. Next, enter inventory into cell A3, Total Sales into cell A4, and Inventory Turnover Ratio into cell A5. Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

The inventory turnover rate (ITR) is a key metric that measures how efficiently a company sells and replenishes its inventory over a specific period, typically a year. Plus, it improves cash flow, allowing businesses to reinvest in new opportunities swiftly. The inventory turnover ratio is used in fundamental analysis to determine the number of times a company sells and replaces its inventory over a fiscal period. To calculate a company’s inventory turnover, divide its sales by its inventory.