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What is Inventory Turnover?
Inventory turnover is a financial ratio that measures how many times a company sells and replaces its inventory within a specific period. It indicates how efficiently a business manages its stock and converts it into sales.
Definition
Inventory turnover is the rate at which inventory is sold and replaced over a defined timeframe, typically calculated as the cost of goods sold (COGS) divided by average inventory.
Key Takeaways
- Measures the efficiency of inventory management.
- High turnover suggests strong sales or efficient operations.
- Low turnover may indicate overstocking, weak demand, or poor purchasing.
Understanding Inventory Turnover
Inventory turnover helps businesses understand how quickly their inventory moves through the supply chain. Companies with fast-moving goods—such as retail, FMCG, and e-commerce—typically aim for high turnover ratios to reduce holding costs and avoid stock obsolescence.
On the other hand, industries with long production cycles or high-value items (like machinery or luxury goods) naturally have lower turnover ratios.
A healthy turnover ratio improves cash flow, reduces storage costs, and signals strong demand. Businesses often benchmark their turnover ratios against industry averages to evaluate operational performance.
Formula
Inventory Turnover = Cost of Goods Sold (COGS) / Average Inventory
Where:
- COGS: Cost of items sold during the period.
- Average Inventory: (Beginning Inventory + Ending Inventory) / 2
Real-World Example
Walmart consistently reports high inventory turnover due to its massive sales volume and efficient supply chain system, allowing it to restock frequently while keeping inventories low.
Importance in Business or Economics
Inventory turnover affects profitability, working capital, and operational efficiency. A strong turnover ratio reduces holding costs, improves liquidity, and helps businesses adapt quickly to market demand.
Related Terms
- Cost of Goods Sold (COGS)
- Working Capital
- Supply Chain Management
Sources and Further Reading
Quick Reference
- Purpose: Measure how quickly inventory is sold.
- Higher Ratio Means: Strong demand or efficient stock management.
- Lower Ratio Means: Overstocking or weak sales.
Frequently Asked Questions (FAQs)
What is a good inventory turnover ratio?
It varies by industry, but higher ratios generally indicate stronger performance.
How can a company improve its turnover?
Better forecasting, reducing excess stock, improving marketing, or optimizing supply chains.
Does high turnover always mean profitability?
Not always, thin margins or stock shortages can still hurt profits.
