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Inventory turnover

Inventory turnover is a ratio used to tell us how often a company's inventory is sold and replaced over a given period of time, usually based on a quarter or annually.

The formula for inventory turnover is:

cost of goods sold (COGS)/average inventory

Note that the average inventory is calculated by adding the inventory at the beginning of the period with the inventory at the end of the period and dividing this total by two. This can help to account for any seasonal effects.

A higher turnover ratio typically implies better sales, and is therefore preferred over a low ratio which can imply poor sales and/or high inventory levels. High inventory levels means that a company has inventory on the books just sitting there not earning anything. Over time this inventory can become obsolete if it isn't sold, ultimately earning the company nothing and costing something.

The best way to use the inventory turnover ratio is to compare it with other companies in the same market. This can give an indication as to which company may be performing better; more of an apples to apples comparison.