Inventory Turnover Calculator

How many times the shelves empty

Inventory turnover counts how many times a business sold through and replaced its entire stock in a year.

A turnover of 6 means the whole warehouse emptied and refilled six times. A turnover of 1.2 means it took most of a year to sell what was sitting there in January.

It matters because stock is money standing still. Every unit on a shelf is capital that has been spent and not yet recovered, and it is also space, insurance, handling and the risk that nobody ever wants it.

Two inputs, one division. What the rest of this page covers is which two numbers, because the most common way to get this wrong is to put the right kind of figure in the wrong slot.

Two boxes

1. Annual Cost of Goods Sold. What the goods you sold during the year cost you.
2. Average Inventory. The typical value of stock held across the year, at cost.

Inventory turnover = cost of goods sold ÷ average inventory

The answer is a multiple rather than a percentage, so a result of 6 means six times a year.

Both figures must be at cost, not at selling price. That is the point of the next section and it is the error that produces the most misleading answers.

The numerator has to be cost, not sales

The top of this fraction is cost of goods sold. Not revenue. People substitute revenue constantly because it is the number closest to hand, and it inflates the result predictably.

Take a business with 960,000 of sales, 576,000 of cost of goods sold and 96,000 of average inventory.

The wrong version says stock sits for 36 days when it actually sits for 61.

The reason is that inventory is carried at what it cost you. Revenue includes your margin, so dividing revenue by a cost-based figure compares two things measured on different scales.

There is a neat relationship in the size of the error. The overstatement is exactly one divided by one minus your gross margin. This business runs a 40 percent gross margin, and 1 divided by 0.60 is 1.67, which is precisely how much too high the revenue version came out.

Which means the higher your margin, the worse the error. A business at 70 percent gross margin using revenue would overstate its turnover by more than three times.

What average inventory actually means

The second box asks for an average, and how you work it out changes the answer.

The usual method is the opening and closing balances divided by two. A business that started the year with 80,000 of stock and ended with 112,000 has an average of 96,000.

Use the closing figure alone and you get something different:

• Average of opening and closing, 96,000: turnover 6.00x
• Closing balance only, 112,000: turnover 5.14x

Nearly a whole turn apart, from the same business in the same year.

Two situations where the two-point average is not good enough.

Seasonal businesses. A toy retailer's stock in November bears no resemblance to its stock in February. Averaging just two dates can land you on an unrepresentative pair. Where you have monthly figures, average all twelve.

Year ends chosen for tidy accounts. Plenty of businesses time their financial year to end when stock is naturally at its lowest, which flatters every stock-based ratio. Nothing improper about it, and worth knowing when you compare against a competitor whose year ends in a different month.

Whatever method you choose, use the same one every period. A trend built on inconsistent averages shows movements that did not happen.

Five businesses

Look at the three middle rows. Identical sales, identical costs, three different stock levels. The overstocked version has 192,000 more capital sitting in a warehouse than the lean one, producing exactly the same trade.

That 192,000 is the practical meaning of a turnover ratio. It is money that could be in the bank, or paying down debt, or funding something that earns.

Then look at the jeweller. A turnover of 1.2 would be a catastrophe for a grocer and is entirely normal for jewellery, where individual pieces are expensive, slow to sell and do not spoil. Comparing across those two businesses tells you about the products.

Turning it into days, which is the more useful number

A turnover of 6 is abstract. Sixty-one days of stock is something you can picture.

Days of inventory = 365 ÷ turnover

It answers how long the average item sits before it sells, and it is the version worth quoting internally because everybody understands a day.

Days also connects directly to cash. If your stock sits for 61 days and your customers take 45 days to pay, you have money tied up for over three months from the moment you buy. Set your supplier terms against that and you can see whether the business funds itself or needs an overdraft to bridge the gap.

That is the calculation behind the cash conversion cycle, and inventory days is its largest component in most product businesses.

High is not automatically good

The instinct is that more turns are better. Mostly true, and there is a ceiling.

Rising turnover usually means stock is being managed more tightly, less capital is tied up, and less will end up marked down. Good.

Turnover that is too high means you are running out. Empty shelves are lost sales, and lost sales do not appear anywhere in your accounts, which makes them the most expensive kind. A business proudly reporting 24 turns may be turning customers away every week.

Falling turnover is the signal to investigate. Either sales slowed and stock stayed put, or somebody over-ordered. Both are fixable and both get worse with time, since ageing stock loses value and eventually gets written off.

The other trap is the average. A single company-wide figure of 6 can hide fast-moving lines turning 20 times and dead stock turning once. Run the calculation by product category and you will usually find a small tail of items holding a disproportionate share of the capital.

As with every ratio in this family, the comparisons worth making are against your own history and against direct competitors in the same trade. A general benchmark across industries tells you nothing.

What it is really telling you about your cash

Turnover is presented as an efficiency measure and it is really a cash measure.

Work backwards from a target. If your cost of goods sold is 576,000 and you want to move from 6 turns to 8, the stock you need falls from 96,000 to 72,000. That releases 24,000 of cash, once, permanently, without selling anything extra or raising a price.

Which is why stock reduction is usually the fastest source of cash inside a struggling business. It requires no lender, no investor and no customer. It requires deciding what not to reorder.

Three things that move the number, in rough order of how quickly they work:

Clear the dead lines. Anything that has not sold in a year is not going to. Marking it down converts it to cash and frees the space, and the markdown calculator will tell you what the discount costs in profit terms so the decision is made with open eyes.

Order more often in smaller quantities. Bulk discounts are real and so is the capital cost of holding six months of stock to earn them.

Look at the tail. Most ranges have a long list of slow items that individually seem harmless. Together they are frequently most of the warehouse.

This is a measurement of figures you supply rather than an assessment of a business, and nothing here is financial advice.

Questions people ask

How is inventory turnover calculated?

Cost of goods sold divided by average inventory. With 576,000 of cost and 96,000 of average stock, the turnover is 6, meaning stock sold through six times in the year.

Can I use revenue instead of cost of goods sold?

No, it overstates the result. Inventory is valued at cost while revenue includes your margin, so the two are on different scales. The overstatement equals one divided by one minus your gross margin.

How do I work out average inventory?

Opening plus closing, divided by two, is the usual method. For seasonal businesses, average the monthly figures instead, since two dates can be unrepresentative.

How do I convert it into days?

Divide 365 by the turnover. A turnover of 6 is about 61 days of stock on hand.

What is a good turnover ratio?

Entirely dependent on what you sell. Groceries turn several times a year, jewellery might turn once. Compare against your own history and against direct competitors rather than against a general figure.

Can turnover be too high?

Yes. Very high turnover often means stockouts, and lost sales never appear in your accounts, which makes them easy to miss and expensive.

How much cash would improving it release?

Divide your cost of goods sold by the turnover you want, and compare against the stock you hold now. Going from 6 turns to 8 on 576,000 of cost releases 24,000.

Should I calculate it for the whole business?

Do both. A single figure hides the spread, and running it by product category usually reveals a small group of slow lines holding a disproportionate share of the capital.

References

Cost of goods sold is defined as the cost of the goods actually sold during the period, and inventory is valued at cost under the methods set out in Internal Revenue Service guidance, which is why both sides of this ratio must be measured at cost rather than at selling price. The retail inventory method, and the treatment of markups and markdowns in valuing goods on hand, come from IRS Publication 538. The relationship between margin measured against revenue and markup measured against cost, which determines the size of the error when revenue is substituted for cost of goods sold, follows guidance published by the US Chamber of Commerce and the Corporate Finance Institute.

1. Internal Revenue Service, Publication 334: Tax Guide for Small Business. https://www.irs.gov/publications/p334
2. Internal Revenue Service, Publication 538: Accounting Periods and Methods. https://www.irs.gov/publications/p538
3. US Chamber of Commerce, Pricing Markups Explained: Definition and Similar Terms. https://www.uschamber.com/co/start/strategy/what-are-pricing-markups
4. Corporate Finance Institute, Markup: How to Calculate Markup and Markup Percentage. https://corporatefinanceinstitute.com/resources/accounting/markup/