What is inventory turnover?

Definition

Inventory turnover is how often, in a period, the shop sells what it holds and replaces that stock with new goods. On the books, it is a reading of inventory against cost of goods sold, not a ledger account you debit.

A shop uses it to see whether goods are moving off the shelf at a healthy pace. A higher figure means the stock turned more times; a lower figure means the same goods sat longer.

It is a count of turns, not a count of days. One slow product line can pull the average balance up and the turns down even when daily sellers move well.

Stay with how often the stock was sold and replaced. Cash comes later, when the sale is collected; this page asks how many times the shelf turned relative to the average pile.

Where it shows up

Balance sheet: Related to inventory turning over.

P&L: Related to cost of goods sold.

Cash flow: Related to cash sitting on the shelf until it sells.

See also: Inventory · Days Inventory Outstanding · Cost Of Goods Sold

When you look at the Balance Sheet, this reading starts from the inventory total. You will not find a line labeled with these turns.

The Income Statement supplies cost of goods sold for the period. Retail prices do not belong in that figure, because the shelf is held at cost.

On the Statement of Cash Flows, more turns usually pair with stock leaving the shelf and cash coming back after the sale. Changes in working capital will show that cash effect even when leftover profit looks fine.

When the figure is high, the shop is selling and restocking often. When it is low, a larger share of last period's purchases is still sitting on the shelf.

How it works

Take cost of goods sold for the period. Divide by average inventory.

How inventory turnover usually works:

• Take cost of goods sold for the period
• Divide by average inventory (beginning plus ending, divided by two)
• Read the result as how many times that average stock was sold and replaced
• Use cost of goods sold, not sales at retail
• Recompute after the period closes with the new average

Average inventory is the beginning balance plus the ending balance, divided by two. A shop that started the year at $12,000 and ended at $18,000 has an average of $15,000.

The result is how many times that average stock was sold and replaced. Twelve times means the shelf turned twelve times in the period.

Use cost of goods sold, not sales at retail. Mixing selling prices into the top number makes the shelf look like it turned faster than the cost sitting there.

Stay with this count of turns. Converting the same relationship into a wait in days is a different reading.

The figure goes up when goods sell through or the average balance shrinks. It goes down when stock piles up or a few slow lines sit.

Finished goods inventory is the usual pile for a shop that buys goods ready to sell. Obsolete inventory still sits in the average until it is written down.

Safety stock raises the average balance on purpose. Extra goods held as a buffer will pull turns down even when daily demand is steady.

After the period closes, recompute with the new average and that period's cost of goods sold. Last year's 12 times is history.

Example

Stem & Petal, a neighborhood florist, holds cut flowers, greenery, and vases. Cost of goods sold for the year was $180,000, and average inventory was $15,000.

Divide $180,000 by $15,000. The result is 12 times.

Those twelve turns mean the average stock on the shelf was sold and replaced twelve times in the year. The shop is not reading days here; it is reading how often the pile turned.

If the same year's cost of goods sold had sat against $30,000 of average inventory, the figure would have been 6 times. The bouquets sold would be the same; the shelf would have turned more slowly.

A $6,000 rental-vase line that sits all season will pull the average balance up and the turns down. Selling those vases later drops the pile without a second year's cost.

If next year cost of goods sold stays $180,000 and average inventory falls to $12,000, the figure rises to 15 times. Stock left the shelf faster without a change in the cost already on the Income Statement.

The shop does not post a line that says these turns. The books already hold the stock and the cost of goods sold; you divide.

Common mix-ups

Inventory turnover is not the inventory balance. The balance is a dollar total; this page is how many times that total was sold and replaced.

Inventory turnover is not days inventory outstanding. Days convert the same relationship into a wait; this page stays on the count of turns.

Inventory turnover is not sales at retail. Cost of goods sold is what left the shelf at cost; the selling price is a different number.

Related terms

• Inventory: Goods held for sale or used to produce goods for sale.
• Days Inventory Outstanding: The average number of days inventory sits before it sells.
• Cost Of Goods Sold: The direct cost of the products sold during the period.
• Finished Goods Inventory: Completed products ready to sell to customers.
• Obsolete Inventory: Stock that no longer sells and is unlikely to move at normal prices.
• Sell-Through Rate: The share of received inventory sold within a period.
• Cash Conversion Cycle: The number of days between paying for inputs and collecting from customers.
• Safety Stock: Extra inventory held as a buffer against demand or supply swings.