How to Calculate Inventory Turnover

Calculating inventory turnover requires dividing the cost of goods sold at a business by the average inventory value. Both figures used in the equation can be found in a firm’s financial statements. Knowing the inventory turnover rate is important, particularly for investors wishing to compare the relative value of inventory at one company to another. It also is important for company managers, because a higher inventory turnover rate can mean more sales at lower costs.

Finding Cost of Goods Sold

The cost of goods sold is a figure used on business financial statements. It represents the entire cost to a business for acquiring raw materials and manufacturing those materials into a product for sale, or for acquiring a product for sale.

The cost of goods sold figure is found as a line item on a company’s income statement. It typically is between the top line item of total sales revenue and the line for gross profit. Gross profit is calculated as revenue minus cost of goods sold.

Average Inventory Value

Determining the average inventory value, which is one of two variables needed to calculate inventory turnover, requires an initial calculation. Inventory values are listed as a dollar amount on a company’s balance sheet. To calculate the average inventory value, take the inventory value on the most recent financial report and add it to the inventory value of a previous financial report and divide that number by two.

Inventory Turnover

To complete the inventory turnover calculation, take the cost of goods sold from the income statement and divide it by the average inventory value from the calculation of inventory numbers on the balance sheet.

The calculation is:

  • Inventory Turnover = Cost of Goods Sold/Average Inventory
  • Average Inventory = Beginning Period Inventory + Ending Period Inventory/2

Inventory turnover is typically expressed as a number related to a particular time period, months, quarters or years. That time period is determined by the time covered in the average inventory calculation. If using current inventory, and adding it to the inventory value from one year ago, the resulting inventory turnover calculation will yield the number of times the company sells its inventory in a year.

Importance of Inventory Turnover

For investors, the inventory turnover figure offers insight. Two companies in similar industries could have inventories of similar value. However, if one company is turning its inventory over at a faster pace, it is assumed the company is operating more efficiently and possibly more profitably.

Average Days to Sale

The inventory turnover calculation can also be used to quickly determine the days in inventory products spend with a particular company and that can yield the average time a company takes to sell a product. To calculate this figure, take the time period covered by the inventory turnover calculation, for example one year. Then divide that by the inventory turnover figure. In this case, it would 365, for the number of days in a year, divided by inventory turnover. The resulting answer is the average number of days it takes a firm to sell a product.

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