Inventory turnover is a measure of how many times a business sells and replaces its inventory during a specific period. It matters because inventory ties up money, storage space, labor, and transportation capacity. A warehouse with healthy turnover keeps products moving without running out too often.
Managers use turnover to compare sales activity, purchasing decisions, and warehouse efficiency.
Key Facts
- Inventory turnover = Cost of goods sold / Average inventory
- Average inventory = (Beginning inventory + Ending inventory) / 2
- Days inventory outstanding = 365 / Inventory turnover
- Higher turnover usually means faster sales and less money tied up in stock.
- Very high turnover can signal stockout risk if replenishment cannot keep up with demand.
- Very low turnover can signal overstocking, weak demand, obsolete products, or poor forecasting.
Vocabulary
- Inventory turnover
- Inventory turnover is the number of times a business sells and replaces its average inventory during a period.
- Cost of goods sold
- Cost of goods sold is the direct cost of the products a business sold during a period.
- Average inventory
- Average inventory is the typical value of inventory held during a period, often found by averaging beginning and ending inventory.
- Stockout
- A stockout occurs when customer demand exists but the needed product is not available in inventory.
- Days inventory outstanding
- Days inventory outstanding is the average number of days inventory stays in stock before being sold.
Common Mistakes to Avoid
- Using sales revenue instead of cost of goods sold, which is wrong because inventory turnover compares inventory cost to the cost of items sold, not selling price.
- Using ending inventory only, which is wrong because inventory levels change over time and average inventory better represents typical stock on hand.
- Assuming higher turnover is always better, which is wrong because extremely high turnover can mean too little safety stock and more stockouts.
- Comparing turnover across very different industries without context, which is wrong because groceries, electronics, furniture, and spare parts naturally move at different speeds.
Practice Questions
- 1 A warehouse has cost of goods sold of 120,000, and ending inventory of $180,000. Find average inventory and inventory turnover.
- 2 A distributor has an inventory turnover of 8 times per year. Estimate its days inventory outstanding using 365 days.
- 3 Two warehouses both have the same annual sales volume. Warehouse A has turnover of 14 and frequent stockouts, while Warehouse B has turnover of 7 and very few stockouts. Explain why Warehouse A may not be operating better even though its turnover is higher.