If your business sells products, managing your inventory effectively is crucial to maintaining appropriate stock levels, optimizing order fulfillment, and keeping storage costs in check.

Inventory turnover is an essential metric for understanding how well your business manages inventory, which can impact everything from your customer experience to your bottom line.

Here’s how inventory turnover works.

Inventory turnover: Definition

Inventory turnover is a measure of how often inventory is sold or used, and replaced. It compares the cost of goods sold (how much it costs you to buy inventory) with the average inventory for a particular period, such as weekly (weeks on hand inventory) month, quarter, or year.

For example, an annual inventory turnover ratio of 2 indicates that you sold twice the amount of inventory you stored during that year.

Inventory can be considered ‘turned over’ if it’s sold to customers or removed from sellable stock for any other reason, such as spoilage, damage, or theft.

What inventory turnover can tell you

Tracking inventory turnover can help you make more informed decisions about purchasing, pricing, manufacturing, marketing, and warehouse management.

As a general rule of thumb, a high turnover ratio is good because it means inventory is being sold quickly. This can indicate that:

• Sales are strong
• There is a healthy demand for your products
• Stock levels are optimal
• Cash isn’t unnecessarily tied up in holding inventory

Maintaining a high inventory turnover ratio (i.e. selling stock quickly) also reduces the risk of products being unsellable due to spoilage or becoming obsolete.

That said, in some cases, a high inventory ratio can mean not enough stock is on hand, which could signal supply chain issues, lost sales, or poor customer experience – so it’s important to understand the context for your business.

On the flipside, a low inventory turnover ratio could indicate:

• Weak sales
• Overstocking
• Ineffective marketing strategies
• Inappropriate pricing

Low inventory turnover is usually not ideal because products can deteriorate the longer they’re stored while incurring holding costs at the same time. Excess inventory also ties up cash, which can have a negative impact on your cash flow.

However, there are exceptions to this. For instance, low inventory turnover might not be a big cause for concern if it’s cheaper to order popular stock in bulk, or your business tends to have seasonal dips throughout the year.

How to calculate inventory turnover ratio

There are three steps to calculating your inventory turnover ratio:

1. Get your cost of goods sold (COGS) from your chart of accounts or find out how to manually calculate your COGS.
2. Calculate your average inventory value by adding your beginning inventory and ending inventory balances for a single month, and dividing by two.
3. Divide your COGS by your average inventory.

So the inventory turnover formula is:

Cost of goods sold

–-------------------- = Inventory turnover ratio

Average inventory

Example:

Let’s say a business’s cost of goods sold over a year is $100,000. The inventory value at the beginning of the year is $30,000 and the inventory value at the end of the year is $20,000. 

First we need to calculate the average inventory value:

30,000 + 20,000 / 2 = 25,000

From there, we can calculate the inventory turnover ratio:

100,000 / 25,000 = 4

An annual inventory turnover ratio of 4 indicates that the business sold four times the amount of inventory it stored during that year.

Inventory Turnover Calculator

QuickBooks' Inventory Turnover Calculator can be used to calculate the ratio of inventory turnover. This ultimately gives you a measure of your company's success in converting inventory to sales. 

There are four main values you must enter into the calculator:

• Input the cost of goods sold - multiply the cost of goods produced by the number of units sold in the preceding accounting period. You can also use the QuickBooks COGS calculator to determine this value. 
• Enter the beginning inventory value for the selected accounting period. 
• Input the ending inventory value at the end of the preceding accounting period. 
• Lastly, input the number of days in your financial year.

Based on the above inputs, the QuickBooks online calculator will give you the ratio of inventory turnover in seconds. Our calculator is simple, and self-explanatory – giving you accurate calculations effortlessly. This valuable online tool is guaranteed to save you time and effort, which is something every business needs.

Benchmarking your inventory turnover

As we’ve covered, higher inventory turnover generally indicates better performance and efficient inventory management, whereas lower turnover can signal weak sales or poor business practices.

However, there’s no one ratio for every business, and inventory turnover can vary greatly by industry. With that in mind, it’s best to compare your turnover ratio with historical data for your own business, as well as the average for your industry.

Generally, low-margin industries such as automotive, retail, and groceries have higher average inventory turnover ratios than high-margin industries. This is because they need to offset lower profits with higher sales volume. 

According to CSI Market, the average inventory turnover ratio by industry is as follows:

Streamline inventory management for your business

Whether you want to know your inventory turnover ratio or manage your stock levels, inventory tracking can be time-consuming. 

With QuickBooks inventory management, you always know what’s selling and what you need to order. On top of that, your balance sheet is automatically adjusted as your stock values change, so your financials are always up to date.

Find out more about QuickBooks inventory management software and start a free trial today.