Efficiency indicator
Inventory turnover reveals how quickly a company’s products move from shelves to customers. High turnover signals strong sales or lean inventory, while low turnover may indicate overstocking or weak demand.
The inventory turnover process
1
Calculate COGS
Sum the cost of all goods sold during the period (from the income statement).
2
Determine the average inventory
Add beginning and ending inventory values for the period, then divide by two.
3
Apply the formula
Divide COGS by average inventory to get the turnover ratio.
Impact on business and profitability
Profitability: High turnover cuts holding costs and risk of obsolescence, boosting profits.
Cash flow: Rapid sales cycles release cash for growth initiatives.
Operational efficiency: Indicates effective inventory management and demand forecasting.
Example calculation
Scenario:
- COGS: ₹5,00,000
- Beginning Inventory: ₹1,55,000
- Ending Inventory: ₹2,45,000
Average inventory:
(₹1,55,000 + ₹2,45,000) / 2 = ₹2,00,000
Inventory turnover ratio:
₹5,00,000 / ₹2,00,000 = 2.5
This means the company sold and replenished its inventory 2.5 times during the year.
Frequently asked questions about inventory turnover?
It usually indicates strong sales and efficient inventory management, but could also signal insufficient stock to meet demand.
It may point to weak sales, overstocking, or poor merchandising. However, in some industries, low turnover is normal due to high-value or specialized goods.
Yes. Extremely high turnover might mean frequent stockouts and lost sales opportunities, especially if inventory levels are too low to meet demand.
By optimizing purchasing, pricing, and marketing strategies, and focusing on fast-moving products while reducing excess or obsolete stock.