Inventory Turnover Formula

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What is the Inventory Turnover Formula?

Inventory turnover refers to the number of times an enterprise sells any particular stock of goods and replaces it in a given period of time. The inventory turnover formula helps you determine how effectively an e-commerce business manages its inventory.

Significance of Inventory Turnover Formula

The inventory turnover ratio formula is instrumental for e-commerce businesses in the following ways:

  • The formula for inventory turnover ratio can be used to understand how quickly an enterprise is selling out its inventory.
  • It helps in making pricing decisions. For instance, if your inventory turnover is too low, you can lower your pricing in order to generate more sales. 
  • It also helps companies optimize their manufacturing and marketing strategies. Therefore, if a company has low inventory turnover, it can change re-evaluate its marketing strategy or lower its manufacturing or purchasing quantities.  

Application of Inventory Turnover Ratio Formula

The inventory turnover formula is applied to:

  • Calculate liquidity, which is the amount of cash any enterprise possesses.
  • Warehouse and inventory management, since it gives precise data on the number of times an inventory is replaced.

Inventory Turnover Formula

The formula to calculate inventory turnover is:

Inventory Turnover =

Cost of goods sold / Average inventory

Definition of Each Element in the Inventory Turnover Formula

The two elements in the inventory turnover formula are described below:

  • Cost of Goods Sold: It refers to the direct cost involved in producing goods.

 Cost of goods sold =

Beginning inventory + purchases – Ending inventory

  • Average Inventory: Average inventory refers to the average cost of goods during specified periods. It is calculated by:

Average Inventory =

[ Beginning inventory + Ending inventory] / 2

How To Use Inventory Turnover Formula: An Example

Take, for example, your cost of sales for the year 2022 is ₱10,000. Additionally, your beginning and ending inventories were ₱100 and ₱400, respectively. Therefore, your inventory turnover ratio would be:

10,000/250= 40

This indicates your inventory has been replaced 40 times in a given period. 

How To Interpret Results Obtained From Inventory Turnover Formula?

A higher inventory turnover ratio points to greater sales or inadequate inventory stocking. Conversely, a lower turnover ratio means lower sales or excess inventory stocking. The ideal inventory turnover ratio for most businesses is between 5-10. 

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