What Is Inventory Turnover? - Definition, Formula & Calculation

What Is Inventory Turnover? - Definition, Formula & Calculation
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  • 0:03 Inventory Turnover Defined
  • 0:51 Inventory Turnover Formulas
  • 1:52 Calculating Inventory…
  • 3:52 Lesson Summary
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Lesson Transcript
Instructor: Kimberly Winston
Inventory turnover is a financial equation used in accounting to understand how long it takes for a business to convert its inventory to cash. This lesson will explore what inventory turnover means, how it is used, and how it is calculated.

Inventory Turnover Defined

One of the most important parts of a business is its inventory. Businesses need to be able to keep track of how long it takes to convert inventory into cash because it affects performance. Inventory turnover is used by firms as a way to understand how they are performing over time and relative to other firms in the same industry. Once they know how they compare to other industries and how long products take to sell, changes can be made to improve efficiency and profitability.

Inventory turnover may be defined as how fast a business sells its products within a specific period of time. Although it is possible to calculate how fast this happens in a day, week, or month, inventory turnover most often refers to an annual rate of turnover.

Inventory Turnover Formulas

There are two formulas used to calculate inventory turnover. However, this lesson will focus on the most common formula:

Inventory Turnover = Cost of Goods Sold/Average Inventory

Cost of goods sold, or COGS is the annual cost a business spends to produce goods and encompasses every cost associated with making the finished product. The cost of direct labor and raw materials are examples of costs included in COGS. The average inventory is calculated by totaling the annual sum of inventory and averaging it out.

Inventory varies at different times of the year. During Christmas or other holiday periods, for instance, retailers are more likely to forecast greater demands for products and increase inventory to meet increased demand. Using the average annual cost of inventory allows businesses to minimize the impact of seasonal inventory variances and get a more accurate understanding of inventory turnover.

Calculating Inventory Turnover

Calculating inventory turnover is simple once you know where to obtain the necessary data. COGS can be found on the balance sheet. Average inventory is when monthly inventory is totaled and averaged and is obtained from the income statement.

Company XYZ is having trouble balancing supply and demand. They want to look at their inventory turnover so that they can increase their efficiency. According to their balance sheet and income statement, we get these figures:

COGS = $250,000

Average Inventory = $35,950

Inventory Turnover = $250,000/$35,950

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