CandleFocus

Inventory Turnover

Candlefocus Editor

Inventory turnover is an important metric used to measure how efficiently a company utilizes its inventory. It reflects the relationship between a company’s sales and its inventories of goods. Inventory turnover is expressed as a ratio and calculated by dividing the cost of goods sold (COGS) by the average inventory value. The higher the ratio, the more efficiently a company is turning its inventory into sales.

Retailers rely heavily on inventory turnover ratios to assess the efficacy of their inventory practices. A relatively low inventory turnover ratio may signify weak sales or an accumulation of excess inventory, while a higher ratio shows strong sales.

Inventory turnover ratios should only be compared for companies within the same industry or operating in the same industry sector. Companies have different accounting methods and use different parameters for calculating inventory values. Rapid changes in costs and seasonal factors can also distort inventory turnover comparisons.

For example, a retailer might offer promotional discounts on some of their merchandise during the holidays, reducing their overall inventory cost. This could lead to a temporary boost in their inventory turnover ratio, while their competitor’s ratios might remain relatively low due to a lack of promotional discounts. In this instance, it would be misleading to compare the two retailers’ inventory turnover ratios.

A good inventory turnover ratio is considered essential for a company’s ongoing success, as it reflects the company’s ability to generate sales from its inventory. Companies should regularly assess their inventory turnover ratios in an effort to improve efficiency, reduce excess inventory, and make the best use of their resources.

Glossary Index