Calculating your inventory turnover can help you optimise everything from your pricing and product range to your profit margins. In this guide, you’ll learn about inventory turnover and how to calculate your inventory turnover ratio.
What is inventory turnover?
Inventory turnover refers to how long stock stays on shelves. A high turnover is generally a sign that a product is in demand — the faster it sells, the more often you need to restock. A low turnover suggests weak sales or too much inventory. However, what might be considered a high or low turnover rate can vary by industry and product category.
Why is calculating inventory turnover important?
Calculating inventory turnover is important because it can help you make smarter decisions. For example, if an item has a slow turnover, you might adjust the price or run a promotion to shift stock. Inventory turnover may help you benchmark your business against others in your industry.
For example, if your inventory turnover is lower than the industry average, it could be a sign that your product is no longer competitive. It could also indicate operational inefficiencies or supplier issues.
Improved inventory decision-making can positively impact everything from cash flow management, pricing, sales and marketing to forecasting and warehouse management.
What does inventory turnover identify?
Inventory turnover can help you identify and understand how well you manage stock over a specific period. Generally, a higher inventory turnover ratio is better. However, you need to analyse inventory turnover alongside other factors like industry and product category.
For example, if your business sells high-end handbags, your inventory turnover may be much lower than a business offering lower-cost bags.
How to calculate inventory turnover
To calculate inventory turnover, you’ll need two numbers from your financial statements: cost of goods sold (COGS) and average inventory.
Cost of goods sold (COGS)
Cost of goods sold (COGS) refers to the direct costs of manufacturing your products over a specific period. Direct costs include raw materials, storage and manufacturing labour.
Average inventory
Average inventory is the average value of your inventory over the same period. To calculate average inventory, add your beginning and ending inventory values, then divide by two.
Tip: Use MYOB AccountRight's inventory management software to track your inventory turnover.
With MYOB, you can define your order quantities, safety stock and lead times to fine-tune your stock replenishment and avoid stockouts.
Inventory turnover ratio and formula
The formula for the inventory turnover ratio is:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
To find the inventory turnover ratio, divide the total cost of goods sold (COGS) by the average inventory value.
Examples of inventory turnover ratio
Here are some examples of inventory turnover ratios:
Business A:
Imagine you’re a shoe retailer that sells men, women and children’s shoes. Over three months, your cost of goods sold is $150,000 and your average inventory is $16,000.
You’d calculate your inventory turnover ratio like this:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
$150,000/ $16,000 = 9.38
This means that you’ve sold and replenished your inventory 9.38 times over this period.
Business B:
Your business specialises in made-to-order, custom furniture. In your busiest quarter, you recorded $47,000 in COGS and $22,000 in average inventory.
You’d calculate your inventory turnover ratio like this:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
$47,000 / $22,000 = 2.14
Compared to Business A, Business B has a much lower inventory turnover ratio. This means Business B made fewer sales than Business A over three months.
What are the limitations of the inventory turnover ratio?
There are four main limitations of the inventory turnover ratio:
Seasonal fluctuations
Seasonal fluctuations can affect the accuracy of inventory turnover ratios. Sales during peak seasons will drive turnover ratios higher. Then, during slower months, ratios will drop significantly, skewing the average turnover ratio for the year.
It doesn’t account for carrying costs
The inventory turnover ratio doesn’t account for carrying costs — the expenses of buying and storing stock. This means if you don’t account for carrying costs, you could be missing the bigger financial picture.
While a high inventory turnover ratio may reduce carrying costs, it could lead to stockouts and missed sales. Likewise, though, a low inventory turnover ratio increases carrying costs and the risk of inventory becoming obsolete and unsellable.
Industry variability
Industry variability means what’s expected for one industry may not apply to another. For example, a grocery store with high sales volumes will have a much higher inventory ratio than a luxury car manufacturer.
It only provides an average
The inventory turnover ratio provides an overall average – how quickly your whole inventory turns over. This means it doesn’t help you spot lower or higher-performing items. You can, however, calculate the inventory turnover ratio for specific items within your inventory. This can help you see which items are moving quickly and which may be overstocked and underperforming.
Tip: With MYOB AccountRight, you can easily generate inventory reports to see what’s selling, what’s not, and what stock you have on hand.
Inventory turnover FAQs
What is a good inventory turnover ratio?
A good inventory turnover ratio depends on your industry and business type. For example, high-end goods and big-ticket items may have a lower turnover ratio than fast-moving and lower-priced items.
Is it better to have a higher inventory turnover ratio?
Generally, a higher inventory turnover ratio is better because it’s a sign that your items are in demand and sales are strong. However, if the ratio is too high, it may show that your stock replenishment isn’t keeping up with your sales rate or that you’re underpricing your items.
How can you better optimise inventory turnover?
To better optimise inventory turnover, consider the following:
Are your prices competitive? You may be able to adjust pricing to increase margins on in-demand stock and lower prices to get slow-moving items off the shelves.
Work with reliable suppliers, so you always have stock on hand to deliver to customers.
Use sales and inventory data to inform inventory forecasting. If your business is seasonal, you’ll also need to consider demand forecasting.
Automatic reordering removes the busy work from stock control, while helping you minimise carrying costs and avoid stockouts.
Tip: MYOB AccountRight can automatically reorder items, support inventory and demand forecasting and ensure you have data on hand to adjust pricing.
What else can the inventory turnover ratio be used for?
The inventory turnover ratio can also determine how long it’ll take to sell your current inventory. Say, for example, you have an inventory turnover ratio of 3. To calculate how many days it’ll take to sell inventory on hand at the current rate, divide 365 days by 3. The answer is 121.67. This means it’ll take a business around 122 days to sell its entire inventory.
Optimise inventory turnover with MYOB
While some products may fly off the shelves, others can take months to sell – even if they’re heavily discounted. It’s part of what makes inventory turnover ratios an important indicator of how efficiently you manage your stock. While it does have some limitations, your inventory turnover ratios can help you see how changes to pricing, processes and products improve your business overall.
MYOB AccountRight makes inventory management and optimisation faster and simpler. MYOB gives you easy access to actionable insights and built-in automation, removing busywork, errors and missed opportunities.
Check out our plans and pricing and get started today.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.