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The Inventory Turnover ratio calculates how often a business' inventory turns over in the course of a year. As inventory is the least liquid form of asset, a high inventory turnover ratio is generally positive. If your business has significant assets tied up in inventory, tracking turnover is critical to successful financial planning.
According to an article on the Effective Inventory Management, Inc. web site (Why is Inventory Turnover Important? by Jon Schreibfeder), keep the following in mind when calculating turnover:
- Inventory turnover is based on the cost of items (what you paid for them), not what you sold them for.
- Only consider cost of goods sold from stock sales that are filled from warehouse inventory.
- The cost of goods sold figure should include transfers of stocked products to other branches and quantities of these products used for internal purposes.
As inventory turnover depends on the average value of stocked inventory, determine your average inventory by calculating the total value of products in inventory on the same day of every month. (If inventory levels fluctuate within the month, calculate the total inventory value on the 1st and 15th of every month.) Then determine the average inventory investment.
As a general benchmark for inventory turnover, most distributors who have a 20-30% gross margins should have a turnover rate of 5 or 6 turns per year. The lower your your margins are, the more inventory turns you want.
The formula for calculating inventory turnover:
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