Definition of 'Inventory Turnover'
The ratio showing how many times a company’s investor is sold and replaced by new, finished inventory during a period.
TheStreet Explains ‘Inventory Turnover’
Inventory turnover is used by investors to see how healthy sales are. It shows how quickly a company can convert its inventory into sales. The ratio is calculated by dividing sales by inventory or by dividing the cost of goods sold by average inventory. Using cost of goods sold, or COGS, allows investors to use the market price for goods instead of the inventory price, which is recorded at cost. Average inventory offsets the seasonal differences in inventory that some companies and industries experience.
A company with COGS of $50,000 on its income statement and average inventory of $10,000 has an inventory turnover of 5. That means the company produces, sells and replaces inventory 5 times during any given period.
Lower turnover usually implies that a company’s sales are moving sluggishly. However, some kinds of goods simply have longer sales lead times. Investors should look for substantive changes in inventory turnover or differences between companies in the same industry. For instance, a retailer with an inventory turnover of 10 would be considered healthier than one with 5 if they are both selling the same type of merchandise to the same type of customer. The company with the lower number is likely to not be stocking goods that appeal to their customers. It may then be stuck with them and forced to sell below cost, thus hurting profits.
A high number, on the other hand, may not always be a positive sign. It could mean that the company isn’t stocking enough raw materials to meet demand for its goods in a timely fashion.
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COGS is a term that stands for cost of goods sold, and represents t...
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