Inventory turnover measures the number of times a company sells its average level of inventory during a year. This number varies greatly by industry. As you might imagine a fast food chain having a significantly higher inventory turnover than a jewelry store. Inventory turnover is a measure of efficiency. The formula is cost of goods sold divided by average inventory. Average inventory is calculated by taking beginning inventory plus ending inventory and dividing by two. This is one of the ratios where the higher the number the better. Here is an Income Statement from a sample company. I’ve highlighted Cost of Goods Sold (COGS) and we’ll use that information to determine the inventory turnover. Additionally, we need some information from the current assets section of the Balance Sheet. I’ve highlighted two years’ worth of inventory balances. For 2016, COGS is divided by the average inventory which gives us inventory turnover of 8.66.
It’s hard to know if this is a strong ratio because we need to know what industry the company is in, and what the industry averages are. A variant of inventory turnover is Days’ Sales in Inventory (sometimes called days’ inventory outstanding or DIO). It is calculated by taking 365 days and dividing it by the result of inventory turnover. Here the results tell us that this company takes about 42 days to sell through its inventory. Or it has about 42 days of inventory on hand. You can think of that number either way..