Inventory turnover is the rate at which an inventory is sold, used or replaced in a given period of time. The inventory turnover rate provides many cues that helps a company determine how efficiently their inventory is being managed.
How to calculate inventory turnover rate/ratio
It is calculated using the formula - (Cost of Goods)/ (Average Inventory for the time period)
Cost of goods sold is the total cost of all goods produced by the company in the specified time period.
Average Inventory is the sum of inventory at the beginning and end of the time period, divided by 2.
A high inventory turnover rate is more desirable compared to a low inventory turnover rate. High inventory turnover rates indicates good sales and a strong market demand. But it can also be an indication of inadequate inventory stocking.
Low inventory turnover rate indicates poor sales, low market demand or excess inventory.
However, there are some exceptions that exist in certain industries. For instance, high-volume low margin industries often have higher inventory turnovers compared to low-volume high margin industries. Therefore a good inventory turnover will depend on the industry's benchmark.
This is why the inventory turnover rate is only useful when comparing between two companies in the same industry.