How to Calculate Inventory Turnover: Formula and Ratio Calculation Requirements

Calculation Inventory turnover RatioThe Inventory Turnover Ratio
Inventory turnover can be a confusing concept to grasp, especially those new to the business world. What it basically means is the amount of goods sold based on the average inventory investment.

Below we have outlined the basics to understanding the inventory turnover so you can understand if your inventory is hurting, or harming your business.

To get your inventory turnover formula you first need to understand your average inventory investment. This should be taken within a twelve month period. For example, if you spend ,000 on inventory investments in January and ,000 on inventory in December, then your average inventory for the year will be ,000 (first investment + last investment / 2).

The Inventory Turnover Ratio can be demonstrated with the following formula:
Cost of Goods Sold from Stock Sales during the Past 12 Months
Average Inventory Investment during the Past 12 Months

For example: Cost of Goods Sold for the year: 0,000
Average Inventory Investment: ,000
This would an inventory turnover of 10, which is quite high.

This ratio will let you know how high or how low your inventory turnover rate is. If the number is too low, it means you are overstocked. If the number is too high, it might indicate that you are not delivering enough business and thus, you may be losing sales.

Things to Consider with the Inventory Turnover Calculation
Before you go plugging away your yearly numbers and seeing what your inventory turnover is, there are a few things you should consider.

First of all, the inventory turnover should only include goods that were in your inventory, not goods that were shipped directly to a customer. For example, if you own a book publishing company and shipped 10,000 items to your warehouse and 10,000 items directly to a customer, then the inventory would only be for 10,000 items, not 20,000.

Also, with reference to cost of goods, this number is usually more accurate if you use the cost of what you paid for an item rather than what you sold them for. The former is generally called cost while the latter is called sales dollars.

How to Calculate Multi-Item Warehouse Inventory
If your warehouse is filled with several different items all bought at different prices, the inventory can get a little confusing. If it’s possible, try to calculate inventory turnover separately for every product line.

For example, if you bought 10,000 items for .00 and 20,000 items for .00, you should have two different inventory turnover rates.
What this Formula means for your Inventory
Every company has a different inventory turnover goal. For fast moving stock items, the inventory turnover rate should be around 12 per year. For slow moving items, the turnover should only be once, maybe twice.

Most distributors strive for an overall inventory turnover rate of 5 or 6. Of course, every business is different and thus your inventory turnover rate will adapt with your business’s needs and capabilities.