How To Calculate Inventory Turnover Ratio With Examples

Sometimes, a full stock becomes a burden. Other times, companies don’t have enough items to fulfill customer demands. But knowing how much you need at what times can keep you at a balance. So, whether you’re running a restaurant or retail shop, you must know how to calculate inventory turnover.

It is one of the best metrics to rely on for making informed decisions and avoiding chaotic situations.

It tells you how your business performs and gives you ideas of what you must do to make things better. And it’s not even hard to calculate. You just have to keep an eye on your sales and stock.

So, if you’re ready to learn what inventory turnover measures and how to calculate it, let this article guide you.

What Inventory Turnover Tells You and Why Is It Important?

If the words stock turn, stock turnover, or inventory turn ring a bell, you’re already familiar with this topic. That’s because these are other words for inventory turnover. These numbers are important industry benchmarks that tell you how good your business is doing.

All these terms mean the same thing: the number of times you sell and refill your inventory.

In simpler terms, it’s a measure of how fast or how slow you’re selling. You might calculate it for a month, a quarter, or a year, but the resulting value will always work wonders for you.

Firstly, it saves you from entering financial tight spots. If you know how fast you’re selling, you won’t be buying too much or too little. You’ll also be dodging the risks that excess inventory brings with it.

With the right amount of items in your inventory, you’ll efficiently manage all customer demands. After all, that’s what business is all about, isn’t it?

Secondly, it helps you increase your profits. When nobody will leave disappointed due to a shortage of an item, your sales will increase. Moreover, you won’t be wasting money on extra items. If you find your turnover isn’t good, you can make better decisions accordingly and, again, increase your profits. No matter how you look at it, there will be more money in your pocket.

How To Calculate Inventory Turnover Ratio From Balance Sheets?

Now that you know what inventory turnover is and why it’s important, it’s time to take your calculators out. But before that, there’s one other thing you must keep in mind.

All seasons are not the same. You might get massive sales of a particular item in one season. But the next season, the same item might be lying idle in your warehouse. That’s why seasonal pricing is an effective strategy to increase performance. However, to cater to this, you must calculate the average inventory value. This is independent of seasonal changes. Here’s how to calculate it.

Add the value of the beginning inventory to the ending inventory during a period (year, month, or quarter). Then, divide this value by 2. Now, using this value, you can take two routes to calculate the inventory turnover ratio.

Sales is the first one. Just divide the sales you made in a particular year by the average inventory value.

The other answer for how to calculate the inventory ratio from balance sheets is the cost of goods sold (COGS). These are all the costs you bear to sell the items. Again, divide this value by the average inventory value, and you’ll have your inventory turnover ratio.

If you’re unsure which method to use, the second one is generally more accurate. This is because you don’t include any additional profits when calculating COGS.

Therefore, you get a better picture of how much you’re spending on the inventory and how fast you’re selling it.

Example of Inventory Turnover Ratio To Make It Clearer

Seeing a calculation in action always makes it easier to understand. So, here’s an example of an inventory turnover ratio with both methods.

Suppose the income statement of a hypothetical company shows that it made $2 million in sales in the last year. The cost of goods sold was $550,000. Moreover, it has a current inventory of $60,000, whereas last year, it had an inventory of $65,000.

Using this data, the average inventory value will be $62,500. Dividing the sales and average inventory value, we get 32. This means that the company sells and refills its inventory 32 times a year.

But this number might not be accurate since sales include the profit values as well.

If we take the COGS method, we’ll get a value of 8.8. Here, the company is selling and refilling its inventory almost nine times. This value is more accurate and believable, but is it any good? We’ll discuss this later in this article.

How To Calculate Inventory Turnover Days?

While calculating the inventory turnover ratio isn’t hard at all, you can make things even clearer with another metric. This new metric is the number of days it takes for a company to sell all of its inventory.

If you’re wondering how to calculate inventory turnover days, you just have to add a step to the above calculation.

Start by calculating the inventory turnover ratio. Then, divide 365 (the number of days in a year) by it. Let’s extend the example above.

The turnover ratio with sales was 32. Dividing 365 by 32, you’ll get 11.4. This means it takes the hypothetical company 11 days to sell all of its inventory.

But if we take the COGS method, the answer will be different. Here, we’ll divide 365 by 8.8 to get 41.4. According to this, the company takes 41 days to sell all of its inventory, which is more accurate and believable.

How To Analyze the Results From an Inventory Turnover Calculator?

Now that you know how to calculate the inventory turnover ratio, let’s see what counts as a good ratio.

As a rule of thumb, the ideal turnover ratio for most industries is from 5 to 10. A ratio lower than five means you’re selling slowly. It might be because you’ve bought too much of a product or your consumer profile has changed.

On the other hand, a high turnover ratio means your business is selling well. Since you’re exhausting your inventory multiple times throughout the year, you have more sales.

But even a high ratio can sometimes be inconvenient. Thinking you need more of an item might tempt you to overstock. Besides, even if you’re selling more but don’t have a large profit margin, you won’t make that much money. Moreover, frequent high sales can lead to shortages.

However, expensive products are an exception here. You won’t expect even the richest people to stock up on luxury cars every other week.

Or a restaurant won’t need a new coffee machine every month. So, a lower-than-industry average turnover ratio isn’t that alarming for these niches. If you don’t want to calculate it manually, you can use an inventory turnover calculator. Zoho and Omni Calculator provide good ones.

Here’s What To Do for a Low Inventory Turnover Ratio

By now, you probably don’t need any further help on how to calculate the inventory turnover ratio. To recap, divide your sales or cost of goods sold by the average inventory value.

Moreover, a ratio lower than five isn’t good in most cases. But even if you’re in such a situation, you don’t need to panic yet.

Investing in inventory management software can be a good first step. It can help you keep an eye on how much you’re buying and selling. Moreover, you can rethink your pricing strategy since a high price also discourages customers from buying.

If you want to improve the marketing of your company, attract more customers and make more sales, check out Beambox. It allows you to automate your campaigns, grow your online reputation, and more. Start your free trial now!

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