Inventory Turnover

A ratio showing how many times a company's inventory is sold and replaced over a period.

Investopedia Says:
Although the first calculation is more frequently used, COGS (cost of goods sold) may be substituted because sales are recorded at market value, while inventories are usually recorded at cost. Also, average inventory may be used instead of the ending inventory level to minimize seasonal factors.

This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying.

High inventory levels are unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble should prices begin to fall.

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Ratio of annual sales to inventory, which shows how many times the inventory of a firm is sold and replaced during an accounting period; sometimes called inventory utilization ratio. Compared with industry averages, a low turnover might indicate a company is carrying excess stocks of inventory, an unhealthy sign because excess inventory represents an investment with a low or zero rate of return and because it makes the company more vulnerable to falling prices. A steady drop in inventory turnover, in comparison with prior periods, can reveal lack of a sufficiently aggressive sales policy or ineffective buying.

Two points about the way inventory turnover may be calculated: (1) Because sales are recorded at market value and inventories are normally carried at cost, it is more realistic to obtain the turnover ratio by dividing inventory into cost of goods sold rather than into sales. However, it is conventional to use sales as the numerator because that is the practice of Dun & Bradstreet and other compilers of published financial ratios, and comparability is of overriding importance. (2) To minimize the seasonal factor affecting inventory levels, it is better to use an average inventory figure, obtained by adding yearly beginning and ending inventory figures and dividing by 2.