How to Calculate Inventory Turnover Ratio

Select a specific time period for calculation. Inventory turnover is always calculated over a defined period — this could range from a day to an entire fiscal year or even the lifetime of the business. However, the inventory turnover ratio cannot immediately reflect the current state of business operations. While you can define the inventory value at any given moment, the cost of goods sold is not an instantaneous value, so a time period must be selected for calculation.

• In this article, we will use the following example for illustration and calculation: Let's assume we own a wholesale coffee business. In this case, the selected period is one year of company operations. In the next step, we will calculate the inventory turnover ratio for this one-year period.

Determine the cost of goods sold (COGS) for the chosen period. After selecting the time period, the first step is to calculate the cost of goods sold (COGS) for this duration. COGS refers to the direct costs involved in producing goods. Typically, this includes production costs and any labor costs directly associated with creating the goods.

• COGS excludes costs like transportation and distribution expenses not directly related to the production of goods.
• In our example, we had a productive year for coffee and spent 3 million USD on seeds, pesticides, and other production-related expenses, plus 2 million USD on labor costs for planting the seeds. In this case, our COGS would be 3 million USD + 2 million USD = 5 million USD.

Divide COGS by the average inventory value. Next, divide the COGS by the average inventory value for the period you're analyzing. Average inventory refers to the average financial value of all goods you hold in stock and on the shelves that have not yet been sold within a set time frame. The simplest way to calculate this is to add the inventory value at the start of the period to the inventory value at the end, then divide by two. However, using additional data points during the period can give a more accurate average. If you use more than two data points, sum all the values and divide by the number of data points to find the average.

• In our case, let’s assume that at the beginning of the year we had 0.5 million USD worth of coffee stored as inventory. At the end of the year, the value of inventory is 0.3 million USD. Therefore, the average inventory is (0.5 million + 0.3 million)/2 = 0.4 million USD.
• Next, divide COGS by the average inventory value to find the inventory turnover ratio. In our example, COGS is 5 million USD and the average inventory value is 0.4 million USD, so our turnover ratio for the year is 5 million USD / 0.4 million USD = 12.5. The resulting ratio is a unitless value.

You can estimate the inventory turnover ratio quickly using the formula: Inventory Turnover = Revenue / Inventory. If you don’t have time to perform the full equation as described above, this formula can provide a close approximation of the turnover ratio. However, most businesses avoid using this method as it may not yield accurate results. This is because revenue is calculated based on consumer-facing prices, while inventory is calculated based on wholesale prices, which could result in an inflated inventory turnover ratio. As a general rule, this equation should be used for quick estimates — for more accurate calculations, refer to the formula above.

• For the example above, let’s assume our revenue for the year was 6 million USD. To find the turnover ratio using this alternative formula, we would divide the revenue value by the ending inventory value of 0.3 million USD. The result is 6 million USD / 0.3 million USD = 20. This result is significantly higher than the 12.5 value obtained using the standard formula.

Use multiple data points for inventory to achieve a more accurate result. As mentioned earlier, calculating the average inventory value based on the beginning and end of the period can provide a rough estimate, but it doesn’t account for inventory fluctuations during the selected timeframe. Adding extra data points can make your average more accurate.

• When choosing data points, ensure they are evenly spaced throughout the chosen period. For example, if you are calculating the average inventory for a year, don’t use twelve data points from the same month. Instead, use one data point from the first day of each month.
• Let’s say that at the start of our company’s fiscal year, the inventory value was 20,000 USD, and at the end, it was 30,000 USD. Using the basic method, the average would be 25,000 USD. But adding another data point from mid-year at 40,000 USD changes the picture. In this case, the new average inventory value would be (20,000 USD + 30,000 USD + 40,000 USD)/3 = 30,000 USD — a slightly higher and more representative value than the previous calculation.

Use the formula Time = 365 days / Inventory Turnover Ratio to calculate your average inventory selling time. This step will reveal how long it typically takes to sell your entire inventory. First, calculate the annual inventory turnover ratio as usual. Then, divide 365 days by the turnover ratio. The result will tell you how many days it takes on average to sell all of your inventory.

• For example, if the inventory turnover ratio for a given year is 8.5, divide 365 by 8.5 to get a result of 42.9 days. In other words, on average, it takes about 43 days to sell the entire inventory.
• If the turnover ratio is based on a period shorter than a year, simply replace 365 with the number of days in the chosen period. For example, if the inventory turnover ratio for September is 2.5, the average time to sell all the inventory can be calculated as 30 days / 2.5 = 12 days.

Use the inventory turnover ratio as an approximate measure of operational efficiency. Generally (though not always), businesses aim to sell their inventory quickly rather than slowly. As such, the inventory turnover ratio can be used as a clue about a company's operational efficiency, especially in comparison to its competitors. However, it is important to consider the context when making such comparisons. A low inventory turnover ratio is not always bad, and a high ratio is not always good.

• For example, high-end sports cars typically do not sell quickly because the market for such products is relatively small. Therefore, you might expect the inventory turnover ratio for a dealership selling imported sports cars to be quite low — they may even fail to sell all their inventory in a year. On the other hand, if the turnover ratio for the same dealership suddenly increases significantly, it could be either a good or bad sign, depending on the context. For instance, it could indicate a shortage of products, which might lead to missed sales.

Compare your inventory turnover ratio to the industry average. A useful way to assess a company's operational efficiency is to compare its inventory turnover ratio to the average of businesses within the same industry. Many financial publications (both print and online) regularly publish industry-specific average inventory turnover ratios, which can serve as a benchmark for assessing your company's performance. You can find such rankings at here. However, it’s important to remember that these values represent industry averages, and in some cases, having a ratio significantly lower or higher than the reported value may actually be a good thing.

• Another useful tool for comparing your company's inventory turnover ratio to the industry average is the BDC Inventory Turnover Calculator. This tool allows you to select your industry, enter your company's COGS and average inventory values, and compare your turnover ratio to the industry average.

• Check industry-specific statistics to see how your inventory turnover compares to competitors and similar businesses. Company accountants recommend that you select comparable cases whenever possible to truly assess how your inventory turnover ratio reflects your company’s success in that field.
• Ensure that both the cost of sales and average inventory values are based on the same valuation. For example, if your business is multinational, make sure to use the same currency unit for both values. As both figures are expressed as total values, using consistent units will help correlate them and yield accurate results.