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When we talk about inventory turnover, we talk about the frequency with which stock is sold and replaced in a given period.
In other words, it is an indicator that connects operational management with the company's financial health, since it shows how long it takes to make the capital invested in inventory return as cash.
When inventory rotates fluidly, it promotes liquidity, reducing storage costs and keeping the business moving.
On the other hand, when turnover is slow, it immobilizes money, since it takes up space, and increases the risk of product obsolescence.
To anticipate imbalances, optimize resources and improve profitability, it is necessary to understand, calculate and interpret inventory turnover correctly.
Inventory turnover is a financial reason which calculates how quickly stock converts to sales. In other words, it is an index that indicates the number of times that a company manages to sell and replenish inventory within a given period. Calculating it serves different purposes:
Inventory rotation, sometimes also called stock rotation or stock rotation, condenses the relationship between cost of goods sold (COGS) And the Average inventory value.
Based on this calculation, it can be determined if the stock is moving at a good speed or if it is being stored longer than considered optimal.
As an indicator, it can be used at different levels:
Depending on the result of the inventory turnover index, the results may be:
The inventory turnover rate It's not a universal number. Each calculation has its own dynamics depending on the case:
Inventory rotation allows us to measure operational performance, it is a signal that must be read in each context and used to adjust decision-making.
Calculating inventory turnover is a strategic control practice, in order to detect inefficiencies, anticipate financial problems and make decisions based on data.
One of the main reasons for making this calculation is to evaluate the operational efficiency of the process. Defining the turnover ratio allows you to see how many times inventory is sold and replaced again at any given time.
In this sense, it allows:
When turnover is constant, the supply chain is responding to the market. If, on the other hand, the turnover is low, it may be that there is excess stock or that sales are going slower than they should.
Inventory is money on hold, when a product doesn't sell on time, that invested capital comes to a standstill. With good turnover, liquidity is improved and maintenance costs are reduced.
To prevent these problems, the inventory turnover rate can be used to:
Controlling inventory turnover helps convert inventory into cash at an optimal time.
Keeping track of inventory turnover in different periods provides very valuable information when making decisions thinking about the future.
The inventory turnover index makes it easy to:
Understanding this index allows you to manage inventory strategically.
There is a very simple formula for calculating inventory turnover and it is the most used one.
The equation would be:
Inventory Turnover = Cost of Sales/Average Inventory
The operation of this result can be illustrated with a very simple example.
If in a year the cost of sales is $600,000 and the average inventory is $100,000, the inventory turnover is 6.
This means that the inventory was sold and replenished 6 times during the year.
To this calculation, a complementary formula can be added to give a more complete view of the company's operations, that of Calculation of inventory days:
Inventory Days = (Average Inventory/Cost of Sales) × 365
This formula calculates how many days a product stays in storage on average. The fewer days, the more efficient is the management of that inventory.
How to Calculate Stock Turnover: Step-by-Step Guide
The calculation of inventory turnover must be carried out using a clear methodology. Therefore, the following steps should be taken:
First you have to define the period you want to analyze. It can be:
It is important that when making comparisons over time, the same period is always considered in its historical evolution to obtain accurate results that respond to the intervention and decisions taken and not to changes in the measurement process.
To obtain the COGS, you have to add up all the costs of the products that were actually sold during the chosen period. This includes:
The following should not be included:
This number is the average value of the products during the period.
To calculate it, the following formula must be used:
Average Inventory = (Starting Inventory + Ending Inventory)/2
When inventory levels are very unstable throughout the year, it's best to do monthly averages for greater accuracy.
Now with the necessary numbers, all that remains is to apply the main formula, which will result in how many times the inventory was sold and replenished in the period chosen to be analyzed.
When the inventory turnover index is obtained, it can be used to:
Real example of inventory rotation
Let's look at an in-depth example, starting from the initial calculations.
If you have:
The calculation of Average inventory would be:
(150,000 + 210,000)/2 = 180,000
When applying The inventory rotation formula:
1,200,000/180,000 = 6.66
In this case, the inventory was sold and replaced almost seven times in 1 year.
If you add the calculation of days of inventory:
(180,000/1,200,000) × 365 = 54.75 days
This means that inventory takes 55 days to sell on average.
It could be said that this would be an efficient management because the products move regularly, do not stay in the warehouse for too long and do not generate bankruptcies.
If the result were less than 4 times it could indicate that there is an accumulation of stock or low demand, on the other hand, if it were greater than 10, there could be a risk of shortage.
The inventory turnover ratio is the ratio between sales and available stock at a given time.
It is not an absolute value, it must be interpreted within the context of each business, considering parameters such as delivery times and inventory policies.
When the index is high, it is usually a sign of efficiency, agile sales and good planning. When the index is low, there may be excess stock or a slow rotation.
When inventory turnover is high, it is only positive if it is supported by adequate purchasing and replenishment control. In this case, the products would be selling at an optimal speed and the capital would circulate without stagnating.
The advantages of high inventory turnover are:
But excessively high turnover can lead to shortages when stock levels are too low or when suppliers have long delivery times.
When inventory turnover is low, it is indicative of excess inventory problems, poor forecasting, or low demand.
Some of the consequences of low turnover are:
Not all inventory behaves the same, so it's important to analyze turnover by category to identify which products represent a problem.
Looking for a high turnover should not be the objective, but rather to achieve a turnover with which you can have availability without adding unnecessary costs.
What does good inventory turnover look like?
What is considered a good turnover will depend on the sector, product and business model.
Broadly speaking:
For a rotation to be considered good, it must balance three factors:
What is sought with good turnover, beyond a number, is a stable behavior that is consistent with the company's objectives in financial and operational terms.
There are some strategies to optimize inventory turnover, since it's not about selling more but about having adequate inventory. Some of the main strategies that can be applied are:
Demand forecasting is key in all instances of inventory management. A good prognosis:
For a forecast to be realistic, it must anticipate both excess and scarcity. The closer you get to real demand, the more efficient your inventory turnover will be.
The different products have a different impact on the results, so it is necessary to classify them with several parameters.
Classification makes it possible to direct resources and attention to where profitability is actually most affected.
Manually controlled systems have poor visibility and a slow response speed. That's why automated inventory management tools can make a difference.
These automated systems don't replace human management, but they make it more accurate and timely.
Making informed decisions based on data and not intuition can make a difference. A good purchasing policy:
It is important that when there is slow inventory, a way is found to move it before it becomes obsolete or loses value. For this purpose, you can:
These practices free up space, recover capital and maintain offerings without compromising business profitability.
Identifying the inventory turnover rate is a simple practice that generates great diagnostic power, since it allows us to see if the capital invested in inventory is moving at a healthy pace for the business.
A company can say that it has good turnover when:
The inventory turnover rate is not an isolated number, its value lies in the fact that it allows us to measure, interpret and act accordingly. When the inventory turnover rate improves, money, space and capacity to grow are freed up.
Dividing the sales cost for the period by the average inventory. The result shows how many times the stock was renewed in the period analyzed.
Inventory Turnover = Cost of Sales/Average Inventory
With accurate demand forecasts, adjusted purchases, automated control and replenishment policies.
Measure the efficiency with which the company converts investment made in inventory into effective sales without immobilizing capital.
If it is a high turnover, it improves liquidity and reduces costs. If it is low, it increases expenses, increases risks and slows down the return of capital.
More accurate forecasts and balanced inventories with Artificial Intelligence to align Sales and Operations teams.
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