Inventory turnover measures the rate at which a company purchases and resells its

products (or inventory) to its customers. Low inventory turnover can indicate bad
management, poor purchasing practices or selling techniques, faulty decision-
making, or the buildup of inferior or obsolete goods. As a result, investors
usually don't like to see a low inventory turnover ratio in a company; it can
suggest the business is in, or headed for, trouble.

KEY TAKEAWAYS
Inventory turnover is the speed with which a company purchases and resells its
inventory.
Slow inventory turnover could be a sign of poor management or inefficient
purchasing practices.
High volume, low margin industries—such as retailers—tend to have the highest
inventory turnover.
High inventory turnover can signal an industry as a whole is seeing strong sales or
has efficient operations.
It is important to realize that low and high are only relative to the company's
particular sector or industry. No specific number exists to signify what
constitutes a good or bad inventory turnover ratio across the board; desirable
ratios vary from sector to sector (and even sub-sectors).

Investors should always compare a particular company's inventory turnover to that

of its sector, and even its sub-sector, before determining whether it's low or
high. For example, the industries that tend to have the most inventory turnover are
those with high volume and low margins, such as retail, grocery, and clothing
stores.

Calculating Inventory Turnover

There are a couple of ways to calculate inventory turnover:

\begin{aligned} &\text{Inventory Turnover} = \frac{ \text{Sales} }{

\text{Inventory} } \\ \end{aligned}

Inventory Turnover=
Inventory
Sales

\begin{aligned} &\text{Inventory Turnover} = \frac{ \text{COGS} }{ \text{Average

Value of Inventory} } \\ &\textbf{where:} \\ &\text{COGS} = \text{Cost of goods
sold} \\ \end{aligned}

Inventory Turnover=
Average Value of Inventory
COGS

where:
COGS=Cost of goods sold

Using the first method: If a company has an annual inventory amount of $100,000
worth of goods and yearly sales of $1 million, its annual inventory turnover is 10.
This means that over the course of the year, the company effectively replenished
its inventory 10 times. Most companies consider a turnover ratio between six and 12
to be desirable.

Using the second method: If a company has an annual average inventory value of
$100,000 and the cost of goods sold by that company was $850,000, its annual
inventory turnover is 8.5. Many analysts consider the costs of goods method to be
more accurate because it reflects what items in inventory actually cost a company.1

Inventory Turnover Example

In sectors such as the grocery store industry, it is normal to have very high
inventory turnover. According to CSIMarket, an independent financial research firm,
the grocery store industry had an average inventory turnover of 13.56 (using the
cost of goods method) for 2018, which means the average grocery store replenishes
its entire inventory over 13 times per year.

This high inventory turnover is largely due to the fact that grocery stores need to
offset lower per-unit profits with higher unit sales volume. These types of low-
margin industries have proportionately higher sales than inventory costs for the
year.

In addition to high volume/low margin industries needing a higher inventory

turnover to remain cash-flow positive, a high inventory turnover can also signal an
industry as a whole is enjoying strong sales or has very efficient operations. It
is also a signal to investors that the sector is a less risky prospect since
companies within it replenish cash quickly and don't get stuck with goods that can
become obsolete or outdated.

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ARTICLE SOURCES
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Related Terms
Why You Should Use Days Sales of Inventory – DSI
The days sales of inventory (DSI) gives investors an idea of how long it takes a
company to turn its inventory into sales. more
Inventory Turnover
Inventory turnover measures a company's efficiency in managing its stock of goods.
The ratio divides the cost of goods sold by the average inventory. more
Asset Turnover Ratio
Asset turnover ratio measures the value of a company's sales or revenues generated
relative to the value of its assets. more
Understanding Cost of Goods Sold – COGS