- By: Sheri Blaho
- The inventory turnover ratio, which is also known as stock turnover ratio, is one of the key metrics used to measure the effectiveness of a company in handling the goods it manufactures or buys to resell. In general, the higher the inventory turnover, the more effective and therefore profitable the operation. A high ratio means that the operation is holding a low level of average inventory in relation to overall sales. High inventory means money tied up in stock. This money is either borrowed and carries an interest charge, or is money that could have earned interest in a bank or invested in other parts of the organization. Items in inventory carry associated storage cost, and the risk of getting spoiled, breaking, being stolen, or obsolesce.
- Do I know what my inventory turn is?
Inventory turns over a specific period of time is calculated by the following formula:
Inventory Turnover = Cost of Goods Sold / Average Inventory
This measure tells you the number of times your inventory is sold or used during a specific time. The number that is calculated has to be put in context. A higher inventory turnover ratio indicates that inventory does not languish in the warehouse. On one hand, too little inventory in stock can lead to lost sales if product is not there to meet customer demand. This can also lead you to be caught flat-footed if there is a sudden spike in demand. A lower ratio can mean that you have a lot of capital tied up in inventory or that you have done a poor job forecasting demand. You should benchmark your ratio against your industry’s standard.