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All trading basics

Inventory Turnover Ratio

Inventory Turnover Ratio = Cost of Goods Sold ÷ Average or Current Period Inventory

An important and often overlooked ratio that indicates inventory levels.

Things to remember

  • A low turnover is usually a bad sign because products tend to deteriorate as they sit in a warehouse.
  • Companies selling perishable items have very high turnover.
  • For more accurate inventory turnover figures, the average inventory figure, ((beginning inventory + ending inventory)/2), is used when computing inventory turnover. Average inventory accounts for any seasonality effects on the ratio
Balance Sheet
Consolidated balance sheet and consolidated income statement for Cory’s Tequila Co. for 1998 and 1999
Income Statement
Consolidated income statement for Cory’s Tequila Co. for 1998 and 1999

For Cory's Tequila Co.: $4,240 ÷ $652 = 6.50

Inventory Analysis

Cory's Tequila Co. inventory has gone up almost 100% since last year, this could mean nothing or something. There could be something fundamentally wrong. Perhaps sales are slowing. A change of 100% is quite substantial and should be a cause for concern if sales are slowing. But if we look more closely at Cory's Tequila Co.'s sales it shows that product sales have increased almost 50% since last year. In other words the higher inventory could simply be a factor of higher demand.