3.1.5.1. Inventory Turnover Ratio
The inventory turnover ratio, also known as inventory conversion, inventory utilization, inventory turns, or just turns, measures how many times a company’s inventory is sold and replaced over an accounting period, such as a fiscal year. A company with a low inventory turnover ratio compared to similar businesses could be carrying excess (or undesirable) inventory.
To calculate the inventory turnover ratio, you must first calculate the average inventory for the period. To do so, add the beginning and ending inventory balances for the period, as shown on the balance sheet, and divide by two:
(When looking for the inventory numbers, keep in mind that the ending inventory balance for the prior period is the same as the beginning balance for the succeeding period.)
Next, find the cost of goods sold (or cost of sales) figure from the income statement. The following is the equation to determine inventory turnover ratio for the period:
Note: Sales, instead of cost of goods sold, is often used as the numerator for this ratio. The primary reason for this practice is the fact that some financial publishers, such as Dun & Bradstreet, do so when calculating