Inventory turnover shows how many times per year a company converts its inventory into sales. It is one of six main calculations used to determine short-term liquidity—the ability of a company to pay its bills if they all came due immediately.
Inventory turnover is calculated as follows:
Inventory turnover = cost of goods sold (COGS) / average inventory
A higher inventory turnover number indicates that a company’s inventory has good liquidity.
More about inventory turnover
In the example below, ABC Co. has an annual COGS of $140,000 and an average inventory value of $55,000, so its inventory turnover would be:
$140,000 / $55,000 = 2.5
This means it has turned over its inventory 2.5 times during the year. It indicates low liquidity, so ABC Co. might want to generate more sales or reduce the amount of inventory it carries.
Inventory turnover can also be used to calculate the number of days sales in inventory, which shows how many days a company’s inventory will meet its sales, on average:
Number of days sales in inventory = Number of days per year / Inventory turnover
Using the inventory turnover figure above, ABC Co.’s number of days sales in inventory would be:
365 / 2.5 = 147 days
This means that ABC Co. has enough inventory to supply 147 days worth of sales.