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Concept
Inventory turnover
Summary
In accounting, the inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year. It is calculated to see if a business has an excessive inventory in comparison to its sales level. The equation for inventory turnover equals the cost of goods sold divided by the average inventory. Inventory turnover is also known as inventory turns, merchandise turnover, stockturn, stock turns, turns, and stock turnover.
The formula for inventory turnover:
or
or
Inventory Turnover = Cost of Material − Change in inventories (of 1/2 and 1/1 goods)/Inventories
The most basic formula for average inventory:
or just
Multiple data points, for example, the average of the monthly averages, will provide a much more representative turn figure.
The average days to sell the inventory is calculated as follows:
A low turnover rate may point to overstocking, obsolescence, or deficiencies in the product line or marketing effort. However, in some instances a low rate may be appropriate, such as where higher inventory levels occur in anticipation of rapidly rising prices or expected market shortages. Another insight provided by the inventory turnover ratio is that if inventory is turning over slowly, then the warehousing cost attributable to each unit will be higher.
Conversely a high turnover rate may indicate inadequate inventory levels, which may lead to a loss in business as the inventory is too low. This often can result in stock shortages.
Some compilers of industry data (e.g., Dun & Bradstreet) use sales as the numerator instead of cost of sales. Cost of sales yields a more realistic turnover ratio, but it is often necessary to use sales for purposes of comparative analysis. Cost of sales is considered to be more realistic because of the difference in which sales and the cost of sales are recorded. Sales are generally recorded at market value, i.e. the value at which the marketplace paid for the good or service provided by the firm.
Official source
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