Inventory Turnover

Learning Outcomes

  • Calculate inventory turnover and number of days sales in inventory

Inventory turnover is a ratio showing how many times a company has sold and replaced inventory during a given period. A company can then divide the days in the period by the inventory turnover formula to calculate the days it takes to sell the inventory on hand. Calculating inventory turnover can help businesses make better decisions on pricing, manufacturing, marketing, and purchasing new inventory.

Inventory turnover is calculated as follows:

[latex]\dfrac{\text{cost of merchandise sold}}{\text{average inventory}}[/latex]

For example: [latex]\dfrac{414,000}{\frac{\left(55,000+48,000\right)}{2}}=8.0[/latex]

Jonick Company
Comparative Income Statement
For the Years Ended December 31, 2019 and 2018
Description 2019 2018
Sales $994,000 $828,000
Cost of merchandise sold 414,000 393,000
Gross Profit Single Line$580,000 Single Line$435,000
Jonick Company
Comparative Balance Sheet
December 31, 2019 and 2018
2019 2018
Subcategory, Current assets:
Cash $373,000 $331,000
Marketable securities 248,000 215,000
Accounts receivable 108,000 91,000
Merchandise Inventory 55,000 48,000
Prepaid insurance 127,000 115,000
      Total current assets Single Line$911,000 Single Line$800,000

The more often inventory is sold, the more cash generated by the firm to pay bills and debts. Inventory turnover is also a measure of a firm’s operational performance. If the company’s line of business is to sell merchandise, the more often it does so, the more operationally successful it is.

Inventory turnover shows how quickly a company can sell its inventory, measuring that velocity by number of times per year the inventory theoretically rolls over completely. Obviously, individual items will differ. For instance, in a grocery store, milk will turn over relatively quickly (we hope) while Holiday cards may turn over much more slowly.

Meanwhile, days of inventory (DSI) looks at the average time a company can turn its inventory into sales. DSI is essentially the inverse of inventory turnover for a given period—calculated as (Average Inventory / COGS) x 365. Basically, DSI is the number of days it takes to turn inventory into sales, while inventory turnover determines how many times in a year inventory is sold or used.

It’s a relatively simple calculation. Just take the number of days in a year and divide that by the inventory turnover.

In our example, an inventory turnover of 8 times per year translates to 45.6 days (365/8).