How is inventory turnover calculated?

Inventory turnover is a crucial financial metric that measures how efficiently a company is managing its inventory. It is calculated by taking the cost of goods sold (COGS) and dividing it by the average inventory for a specific period. This calculation reveals how many times a company sells and replaces its stock of goods during that period.

Using cost of goods sold provides a more accurate reflection of inventory management because it focuses on the direct costs associated with the products that were sold. By dividing COGS by average inventory, businesses can gain insights into their sales efficiency, helping them assess whether they are overstocking or understocking products. A higher inventory turnover rate typically indicates strong sales or effective inventory management, while a low rate can suggest overstocking or sluggish sales.

Understanding inventory turnover is essential for making informed decisions regarding purchasing, production levels, and sales strategies, ultimately impacting a company's overall financial health and operational efficiency.