Key takeaways
- Inventory turnover = cost of goods sold ÷ average inventory, both at cost.
- Days of inventory = 365 ÷ turnover, which shows how long stock sits on average.
- Use an average of several stock counts, not just one date, if your stock level swings.
- Work out turnover per product as well as overall; a good average can hide dead stock.
- Higher turnover frees cash, but too high can mean stockouts. Reorder points help balance the two.
The formula
Inventory turnover is cost of goods sold (COGS) for a period divided by the average value of inventory over that period. The answer is how many times the stock “turned over”, or sold through and was replaced.
Average inventory is usually the opening value plus the closing value, divided by two. COGS is on your income statement. For a US business filing Schedule C, it is the figure worked out from opening inventory, purchases and other costs, minus closing inventory, as IRS Publication 334 describes.
The SEC’s guide to financial statements defines inventory turnover in the same way: cost of sales divided by average inventory for the period.
Average inventory = (Opening inventory + Closing inventory) ÷ 2 Inventory turnover = Cost of goods sold ÷ Average inventory Days of inventory = 365 ÷ Inventory turnover
Worked example: a year for a small retailer
A kitchenware shop started the year with $50,000 of stock at cost and finished with $30,000. Its cost of goods sold for the year was $240,000.
Average inventory is ($50,000 + $30,000) ÷ 2 = $40,000. Turnover is $240,000 ÷ $40,000 = 6. The shop sold through its average stock six times in the year.
In days, 365 ÷ 6 = about 61 days. On average, a product sat on the shelf for about two months before it sold.
| Figure | Calculation | Result |
|---|---|---|
| Opening inventory | $50,000 | |
| Closing inventory | $30,000 | |
| Average inventory | ($50,000 + $30,000) ÷ 2 | $40,000 |
| Cost of goods sold | $240,000 | |
| Inventory turnover | $240,000 ÷ $40,000 | 6.0 times |
| Days of inventory | 365 ÷ 6 | About 61 days |
Getting the inputs right
Use cost, not retail price, for both numbers. COGS is at cost, so inventory must be too. Dividing sales revenue by inventory at cost inflates the result, because it includes your markup. Some retailers do work at retail on both sides, which is fine as long as both numbers use the same basis.
Watch out for seasonal businesses. A shop that counts stock on January 1, after the holiday rush, and December 31 will see two low numbers and a turnover that looks better than it is. If your stock level swings, average 12 month-end values or 4 quarter-end values instead of just two.
Keep the period consistent. Quarterly turnover will be roughly a quarter of the annual figure. If you work out turnover for a quarter, use 91 days or so instead of 365 when converting to days.
Average inventory (monthly) = Sum of 12 month-end inventory values ÷ 12
Turnover per product tells you more
A single turnover figure for the whole business is an average. It can hide fast sellers that keep running out and slow lines tying up cash. Working it out per product or per category shows you where the cash is stuck.
In the example below, the shop’s overall turnover looks fine, but the specialty gadgets turn only twice a year, so they sit for about half a year. That is where the cash is tied up.
| Category | COGS | Average inventory | Turnover | Days of inventory |
|---|---|---|---|---|
| Cookware | $120,000 | $15,000 | 8.0 | About 46 |
| Knives | $60,000 | $10,000 | 6.0 | About 61 |
| Tableware | $40,000 | $5,000 | 8.0 | About 46 |
| Specialty gadgets | $20,000 | $10,000 | 2.0 | About 183 |
| Whole shop | $240,000 | $40,000 | 6.0 | About 61 |
What faster turnover is worth in cash
Every dollar of stock on the shelf is a dollar you cannot spend elsewhere. Turnover tells you how much cash your inventory needs for the sales you make.
Rearrange the formula and average inventory = COGS ÷ turnover. If the kitchenware shop keeps COGS at $240,000 but raises turnover from 6 to 8, average inventory falls from $40,000 to $30,000. That frees $10,000 of cash, without selling a single extra item.
There are smaller savings too. Less stock means less storage space, lower insurance, and fewer items that go out of date, get damaged or need marking down.
Average inventory needed = Cost of goods sold ÷ Inventory turnover $240,000 ÷ 6 = $40,000; $240,000 ÷ 8 = $30,000
What is a good inventory turnover?
It depends on what you sell. Fresh food has to turn very quickly. Furniture, jewelry and spare parts turn slowly and still make money, because each sale carries a high margin. Comparing a grocer with a jeweler makes no sense.
More useful checks are your own trend and your margin. If turnover is falling year on year while sales are steady, stock is building up. Look at turnover and gross margin together: a product with low turnover and a high margin can earn as much per dollar of stock as a fast seller with a thin margin.
Turnover can also be too high. If you turn stock very fast but keep running out, you are losing sales and probably paying more for rush orders and small shipments.
How to improve a slow turnover
The aim is to hold less stock for the same sales, without running out of the things customers want.
- Find slow lines with per-product turnover and stop reordering them, or reorder in smaller quantities.
- Clear dead stock with bundles, markdowns or a clearance channel. Cash back today is often worth more than a full-price sale that may never come.
- Set a reorder point for each product, so you reorder when stock reaches a level that covers your lead time, not on a fixed calendar.
- Order closer to the economic order quantity, which balances ordering costs against holding costs.
- Ask suppliers for shorter lead times or smaller minimum orders, which lets you hold less safety stock.
Reorder point = Average daily sales × Lead time in days + Safety stock Example: 10 units a day × 14 days + 40 units = 180 units
Free toolReorder point calculator
