Inventory turnover

A ratio compares two figures to reveal something neither number shows on its own. Inventory turnover compares how much a company spends producing or buying goods against how much inventory it holds, showing how quickly that inventory moves.

Inventory turnover divides cost of goods sold by average inventory. It shows how many times a company sells through its entire inventory over a given period.

The formula is: Cost of goods sold / Average inventory.

A higher inventory turnover generally means goods are moving quickly, tying up less cash in unsold stock and reducing the risk of that inventory becoming obsolete or having to be sold at a discount. A lower inventory turnover can signal weak demand, overstocking, or slow-moving product, though a very high inventory turnover isn't automatically better either, it can also mean a company is understocked and at risk of missing sales when demand picks up.

Inventory turnover only applies to businesses that actually hold physical inventory. For a retailer, distributor, or manufacturer it's a core efficiency measure, for a software or services business with little to no inventory it's not meaningful at all. Like other efficiency ratios, it is most useful compared against close industry peers or tracked over time for the same company.