Inventory turnover: how to calculate it and what it tells you
Picture your stock as a bathtub with the tap running and the plug half out. Goods flow in, goods flow out, and the water level is what you hold at any moment. Turnover asks a simple question: how many times a year does the whole tub drain and refill?
A grocer's tub empties every few days. A furniture shop's takes months. Neither number is right or wrong on its own. What matters is whether yours is moving the way you expect.
The formula
Inventory turnover is the cost of the goods you sold in a period, divided by the average value of the stock you held over that period.
$240,000
Cost of goods sold, one year
$60,000
Average stock value
4
Turns per year
An invented shop. Use cost, not selling price, for both numbers.
What the number means
A turnover of 4 means the stock turns over four times a year. Flip it around and divide 365 by 4, and you get roughly 91 days: that is how long an average item sits before it sells.
One year of 365 days. Each block is the time it takes to sell through the stock on hand once.
Higher is usually healthier, up to a point. Cash comes back faster, and stock does not age on the shelf. Too high, and you may be running so lean that you stock out. Lower is not always a failure either. A shop that sells large, high-value, slow items will have a low turnover by nature.
Getting the average
Take the stock value at the start of the period and at the end, add them and halve the result. If your stock swings with the seasons, use more points: each month end, for example, then average them.
Stock value on 1 January: $50,000.
Stock value on 31 December: $70,000.
Average = (50,000 + 70,000) / 2 = $60,000.
- Fasteners8 turns a year
- Paint5 turns a year
- Hand tools2 turns a year
- Specialty tools1 turns a year
Invented figures. These four average out to about four, which describes none of them.
How to use it
- Compare against yourself, quarter by quarter. A trend is more useful than a single number.
- Calculate it by category. Your overall figure can hide a fast group and a stagnant one.
- Compare with similar businesses with caution. Industries differ enormously.
- Pair it with stockout counts. A rising turnover and rising stockouts means you are cutting too deep.
A warning about averages
A single turnover number hides a lot. Suppose half your stock turns eight times a year and the other half turns once. The blend looks like a comfortable four and describes nothing you actually own.
That is why the by-category view is the one to trust. Calculate turnover for each group of items, or at least for your A items against the rest. Fast groups tell you where stockouts hide. Slow groups tell you where cash sleeps.
It is also worth remembering that turnover looks backward. It tells you what happened over the last year, not what to order next week. Use it to ask questions, then use reorder points to act on the answers.