What is Inventory Turnover Ratio?

The Inventory Turnover Ratio is a financial metric that measures how efficiently a company manages its
inventory. Specifically, it shows how many times a company's inventory is sold and replaced over a given
period, typically a year. A higher turnover ratio suggests that the company is selling goods quickly and
efficiently, while a lower ratio indicates slower sales or overstocking, which may tie up capital in unsold
goods.

The inventory turnover ratio is the number of times a company has sold and replenished its inventory
over a specific amount of time. The formula can also be used to calculate the number of days it will take
to sell the inventory on hand.

The turnover ratio is derived from a mathematical calculation, where the cost of goods sold is divided by
the average inventory for the same period. A higher ratio is more desirable than a low one as a high ratio
tends to point to strong sales.

Why is inventory turnover important?

Why is it so important we understand our inventory turnover? For retailers, especially those with
multiple retail channels, optimizing inventory volumes in accordance with consumer demand is
absolutely imperative, both in terms of profitability and operational efficiency. And your inventory
turnover ratio is a key indicator of just this. Understanding this central metric is the key to optimizing
your resources once and for all.

No retailer wants to waste money and resources on unnecessary storage costs. Likewise,
no retailer wants to underestimate consumer demand. So, instead of leaving order volumes down to
pure guesswork, retailers can seek to optimize their inventory turnover rates.

The benefits are many. Understanding inventory turnover ratios will help you increase profitability and
make better business decisions in the long term.

Inventory turnover calculation B: sales

Inventory turnover = total sales/average inventory

Example of an Inventory Turnover Calculation

For fiscal year 2022, Walmart Inc. (WMT) reported cost of sales of $429 billion and year-end inventory of
$56.5 billion, up from $44.9 billion a year earlier.5 Walmart’s inventory turnover ratio for the year was:

2022: $429 billion ÷ [($56.5 billion + $44.9 billion)/2], or about 8.5

Dividing the 365 days in the year by 8.5 shows that Walmart turned over its inventory about every 42
days on average.

Fast-forward to 2024, Walmart reported cost of sales of $490 billion for the fiscal year ending January
2024. It also reported ending inventory of $54.9 billion, up from $56.6 billion a year earlier.6 So its
inventory turnover ratio for 2024 was:
2024: $490 billion ÷ [($54.9 billion + $56.6 billion)/2], or about 8.8

This signals that from 2022 to 2024, Walmart increased its inventory turnover ratio. Dividing the 365
days in the year by 8.8 shows that Walmart turned over its inventory about every 41 days on average

What is a bad inventory turnover ratio?

An inventory turnover ratio any lower than two could indicate that sales are weak and product demand
is waning. This could result in excess inventory on the warehouse shelves and wasted space and
resources.

On the other hand, an inventory turnover ratio any higher than six is an indication that the consumer
exceeds supply. That means your inventory purchase levels might actually be too low, leading to lost
sales opportunities as a result—or negative customer experiences from delayed deliveries.

Challenges when using inventory turnover

The first challenge associated with inventory turnover is comparison. What exactly meant by this?

It’s important to remember that any time you want to compare your inventory turnover with that of
another business, it must be on a level playing field. In other words, there’s no use comparing your retail
operation with a business that sells completely different products. Inventory turnover ratios are relative.
For example, high-price items like cars can, by nature, be slower to leave the warehouse whereas fashion
items and perishable goods move off the shelves much faster.

Challenge # 2: management

The way you manage your warehouse can have a direct effect on your inventory turnover. Even if
demand is high, if your warehouse is inefficient and struggling to move goods off the shelves quickly
enough, your inventory turnover ratio is going to suffer as a result.

Brightpearl as a Retail Operating System helps you manage every aspect of your warehouse and back-
office operations for maximum efficiency.

Challenge # 3: seasonality

For some items, demand is led by the seasons. In other words, demand is not going to be steady all year
round. Depending on the product, the high-demand season might be in winter, fall, summer, or spring.
For example, if you’re a retailer specializing in Christmas trees, then yup, you guessed it, your sales are
going to spike in December. Your inventory turnover ratio will undoubtedly be impacted by seasonal
demand. As such, it is essential to track and fully understand your seasonal demand patterns.
Challenge # 4: high-cost items

As mentioned above, higher-cost items tend to move off the shelves more slowly. Customers tend to do
their research and take their time before investing in big-ticket items like cars and electronics. As such,
a lower inventory turnover is likely. You need to do your research and be sure that these items are worth
the potential wait on the warehouse shelf. After all, nobody wants an expensive product when it’s
obsolete.

Challenge # 5: over-ordering

Excess inventory (overstocking) is the enemy of profit and efficiency. If you bulk-buy too many items,
your inventory turnover ratio is going to suffer. With all the capital tied up in bulk inventory, it could take
a very long time to get that money back. In general, it’s better for retailers to reduce their carrying costs
by resisting the urge to buy in bulk, even where there are economies of scale or discounts to be had. If
those products aren’t going to shift, those potential savings from the manufacturer could be
meaningless.

Challenge # 6: inaccurate data

If you’re not tracking your inventory accurately then your inventory turnover ratio isn’t going to be
accurate, either. Having precise inventory data at your fingertips is absolutely essential. And the best—
and easiest—way to achieve this is by using an inventory management system to track and analyze all of
your inventory-related data in a single place.

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