The inventory turnover ratio measures how often stock is sold and replaced over time. It’s a vital inventory accounting metric for monitoring sales and managing perishable goods – without it, your business will struggle to operate efficiently and could start losing money fast.
This guide reveals how the inventory turnover ratio works, why it’s important, and how to improve it.
In this inventory turnover ratio guide:
What is inventory turnover?
Inventory turnover is the speed and regularity with which your organisation sells its physical goods. The purpose of measuring inventory turnover is to identify how many units of inventory your business has sold in a specific period compared to your units of inventory on hand.
Inventory turnover is expressed as a financial ratio.
The inventory turnover ratio reflects the frequency of your inventory turnover – the number of times your inventory turns over within a specified period – relative to its cost of goods sold (COGS) for that same period.
This ratio helps you to determine how efficiently you are managing and selling inventory and is a key indicator of the overall health of your business.
Inventory turnover period
The inventory turnover period is the time taken from when you purchase inventory until the time those goods are sold. It tells you how many days it takes for you to sell your on-hand inventory stock.
The inventory turnover period for your business divides the days within the sales period by your inventory turnover ratio. It calculates the average number of days it takes you to sell your inventory and highlights how efficiently you use your inventory assets.
High inventory turnover or low inventory turnover – what’s better?
Do I want my inventory turnover to be high or low? What’s the difference?
A low inventory turnover indicates two things: either sales are weak, or you have excessive inventory. Conversely, a high inventory turnover suggests strong sales – but this could also be attributed to inadequate inventory levels.
A low inventory turnover can be an advantage during periods of inflation if it reflects larger inventory purchases ahead of supplier price increases, anticipated supply chain disruptions, or periods of higher demand.
The cause of either a high or a low inventory turnover rate may also denote problems with your current sales and marketing strategy. However, ensuring you have sufficient inventory to meet sales demand is better than having to scale down inventory because your business sales have slowed.
Inventory turnover ratio
The inventory turnover ratio is a financial ratio showing how many times a company turned over its inventory relative to its cost of goods sold (COGS) in each period. To calculate how many days it takes, on average, to sell your inventory you divide the days in the accounting period, by your inventory turnover ratio.
The inventory turnover ratio formula looks like this:
Cost of Goods Sold / Average Inventory = Inventory Turnover Ratio
The inventory turnover ratio is an efficiency ratio that measures how effectively your business is using its assets. It helps you to make better purchasing, manufacturing, pricing, and marketing decisions based on the data revealed.
What is a good inventory turnover ratio?
The optimal inventory turnover ratio for your business will largely depend on the industry you’re in and the size of your business. An inventory turnover ratio of between 4–6 is usually a good indicator that your sales and inventory orders are balanced. However, most industries view a good inventory turnover ratio as between 5–10 which strikes a nice balance between having enough inventory on hand to meet customer demand without the need for frequent reordering.
Data from CSI Market revealed that the Services and Energy sectors had the highest inventory turnover ratios on average in Q1 of 2023, while Conglomerates and Capital Goods had the lowest inventory turnover ratios.
There are many reasons why your turnover ratio could be low.
When your inventory turnover ratio is low, you should undertake an inventory analysis to determine the cause. If your competitors are offering a lower price, then it’s time to revisit your pricing strategy. Where market demand has declined for certain products look at what alternatives you can add to your inventory mix.
If your inventory is piling up, you might need to rethink your purchasing strategy to prevent too much capital tied up in inventory.
Inventory turnover ratio vs inventory days
The inventory turnover ratio establishes the number of times you sell and replace your inventory within a specific timeframe. Inventory days or Days Sales in Inventory (DSI), on the other hand, measures the average number of days it takes your business to convert your entire inventory to sales.
While the two appear similar, you need to establish your inventory turnover before you can determine inventory days, as the turnover ratio is an element of the DSI formula:
Number of Days in the Accounting Period / Inventory Turnover = Day Sales in Inventory
DSI is inversely proportional to inventory turnover, meaning that when your DSI is low your inventory turnover will be high. Conversely, when your DSI is high your inventory turnover will be low.
A high DSI may indicate insufficient demand for your product and is an opportunity for you to assess factors such as pricing and promotion.
WIP inventory turnover ratio
The Work-In-Process (WIP) inventory turnover ratio measures the rate at which your inventory of WIP materials moves on to the completion or finished goods stage and is replaced within a specific timeframe.
WIP inventory turnover is typically measured the same way as the turnover ratio used for finished goods inventory. It’s calculated as the COGS for the period and then divided by the average on-hand WIP material value.
The WIP inventory turnover formula looks like this:
Cost of Goods Sold / Average On-hand WIP Value = WIP Inventory Turnover Ratio
This value is measured at factory cost for the most recent financial year and includes all materials, components, and subassemblies representative of partially completed production. Factory or plant costs include both material and labour, as well as factory overheads.
How to calculate inventory turnover
The two simple ways to calculate inventory turnover are by using the inventory turnover formula or an inventory turnover calculator.
1. Inventory turnover formula
Calculating inventory turnover using the inventory turnover formula is as simple as dividing your COGS by the average value of your inventory. The resulting figure tells you the number of times your inventory was turned over within the measured period.
Here’s the inventory turnover formula:
COGS / Average Inventory Value = Inventory Turnover
Here’s how it works in an example scenario. Let’s say your COGS is $300,000 for the financial year and your average inventory value is $75,000. Your inventory turnover formula would look like this:
300,000 / 75,000 = 4
2. Inventory turnover calculator
Use the inventory turnover calculator below to work out your inventory turnover ratio in seconds:
- See more: Visit our Inventory Formulas & Calculators hub for more useful stock management tools.
How to improve inventory turnover
Improving your inventory turnover can help to reduce waste and inventory carrying costs. It also assists you to better manage your inventory levels, leading to more efficient operations.
Once you know it, measure your inventory turnover against industry benchmarks and look for opportunities to better position your business by managing your inventory more strategically.
Here are 8 strategies for improving your inventory turnover:
1. Optimise sales forecasting
The more proficient you are at forecasting what your customers will want and when, the fewer SKUs you’ll need to keep in stock. If you can optimise sales forecasting your inventory will turn over more regularly because it will sell, rather than sit on your shelves.
- Use inventory software to gather accurate inventory information on your products.
- Analyse historical sales data and inventory reports to determine seasonal trends that can help you improve your inventory forecasting accuracy.
- Conduct market research to gather information about consumer preferences.
2. Streamline your supply chain
Suppliers who offer the lowest prices aren’t necessarily the best choice if they can’t deliver on time or in the quantities ordered.
Cheaper is not always better when you have a product that is fundamental to your sales or one that experiences high seasonal demand and your supplier is unable to guarantee fast delivery. The best suppliers don’t just offer low prices, but also high-quality products with short lead times.
But streamlining your supply chain is not just about price and delivery. Reviewing your supply chain processes helps uncover and eradicate bottlenecks and inefficiencies to improve your sales, profits, and overall margins.
3. Automate purchasing
Automated purchasing will maximise efficiencies by speeding up your procurement processes.
Automation not only increases productivity but also provides greater visibility into your inventory spend and improves collaboration between internal teams and external suppliers.
Automating your purchasing activities produces cost efficiencies because it streamlines the purchase-to-pay process and reduces the risk of misplaced orders and late deliveries. It eliminates manual errors and removes approval bottlenecks, while centralised data ensures consistency and improves contract management.
4. Marketing and promotions
A simple way for you to improve your inventory turnover ratio is by increasing your sales. This can be achieved through the formulation of smart marketing strategies to increase product demand and drive sales.
Analyse your customer’s existing purchasing habits and seasonal trends to guide marketing strategies. A perfectly executed marketing campaign, with targeted promotions, should increase sales and, as a result, your inventory turnover.
5. Understand your product life cycle phase
Consumer demand for a product changes as the item moves through its life cycle. Items in the growth stage experience upward demand that often levels off at the maturity phase. When your product has reached its decline phase, demand will become more erratic and then fall off.
By focusing on the product life cycle of your SKUs, you can monitor their demand to develop strategies specific to each life cycle phase. When inventory is approaching the decline stage it is best to implement tactics to reduce stock levels before the inventory becomes obsolete.
6. Bundle products
Product bundling provides you with the opportunity to shift slow-moving inventory and means you can increase sales revenue by increasing the average order value amount.
Product bundling is useful for improving inventory turnover. But it’s also valuable for your consumers who benefit from purchasing related products that are bundled together. They’re more likely to spend a larger up-front amount rather than buying individual items over time.
However, it’s good practice to offer customers the option to purchase individually any product that is part of a bundle.
7. Reduce shipping times
Fast and reliable shipping helps to increase sales and is essential to the efficient turnover of your inventory stock.
Speedy deliveries are particularly important to ecommerce businesses – nearly 50% of shoppers are more likely to shop online if offered same-day delivery.
One way to improve B2B fulfilment and expedite your shipping activities is to outsource this task to third-party logistics (3PL) company. Most 3PLs are shipping large volumes so tend to have special pricing arrangements with freight companies and carriers that can make outsourcing a financially viable option even for the smallest manufacturer.
Additionally, 3PL providers often have multiple fulfilment centres, enabling them to ship from the location closest to your customer. Shorter distances and fewer shipping zones mean you can get your product to customers faster and cheaper.
8. Implement software solutions
Software solutions for inventory management are key to improving inventory turnover. An inventory management system will maximise efficiencies and minimise waste.
Inventory software tracks your stock levels and provides you with accurate, real-time data to help improve inventory turnover. It can optimise your inventory management, par levels, and replenishment processes.
Look for tools that use historical sales data, seasonal trends, and fluctuating demand to help predict your future inventory needs. The right inventory system will also integrate with your accounting software and third-party logistics providers.