Inventory Turnover

Inventory Turnover

Ratio defining how many times a company’s inventory is turned over or sold and replaced over a given period.

How Inventory Turnover is calculated

Cost of Goods Sold is a preferable measure to Sales because inventory sales are recorded at market value instead of cost, and Average Inventory smoothes seasonal effects that may be present.

Average Days to Sell Inventory is the amount of days it takes the company to turn over it’s inventory.

How to use Inventory Turnover Ratio?

The lower the turnover ratio the worse the sign it is because then a company is not efficiently managing it’s inventory and has poor sales for it’s inventory. A high ratio implies either strong sales or that a company is not purchasing enough inventory to accommodate demand.

How is it important in investing?

If a company has a low turnover ratio it is a bad sign because products have a tendency to deteriorate or lose value over time and it opens the company up to trouble if prices fall. Inventory turning reduces the holding cost of an item which increases net income and profitability as long as the revenue remains consistent.

It’s important to make distinctions based upon industry and the nature of goods sold. A car dealership has a very different turn rate then a supermarket. Different kinds of inventory possess different types of holding costs.

For instance a tomato can spoil and turned very quickly. A car has a much slower depreciation and does not need to be turned nearly as quickly but does lose value as it gets closer to a new model as well.

It is important to compare Inventory Turnover Ratio to peers of it’s industry.

Examples of Calculating Inventory Turnover

Sample of How to Calculate Inventory Turnover

Here we present Walmart, Sears and Amazon. Three retailers with very difficult profiles. Walmart and Amazon turn their inventories very quickly while Sears is struggling and undergoing a transformation. Walmart turns over it’s inventory every 44.6 days, while Amazon takes 40.1 days, and Sears takes 96.05 days.

One caveat is to remember that retailers with more perishables must turn inventory very quickly.

Example of Inventory Turnover Ratio and Inventory Days

Good: Walmart Inc (7/2014)

Walmart has:

• Net Credit sales (Cost of Goods Sold) of \$361,368 million for the trailing twelve months ending 7/2014
• It’s inventory at period ending 7/2013 and period ending 7/2014 were \$42,793 million and \$45,451 million

Calculate the Inventory Turnover Ratio:

Solution:
Average Inventory = (\$42,793 million + \$45,451 million) / 2 = \$44,122 million
Inventory Turnover Ratio =  \$361,368  million / \$44,122 million = ~8.19
Inventory Days = ~44.6 days

Not So Good: Sears (7/2014)

Sears has:

• Net Credit sales (Cost of Goods Sold) of \$26,773 million for the trailing twelve months ending 7/2014
• It’s inventory at period ending 7/2013 and period ending 7/2014 were \$7,708 million and \$6,383 million

Calculate the Inventory Turnover Ratio:

Solution:
Average Inventory = (\$7,708 million + \$6383 million) / 2 = \$7,045.5 million
Inventory Turnover Ratio =  \$26,773  million / \$7,045.5 million = ~3.8
Inventory Days = ~96.05 days

Amazing: Amazon (9/2014)

Amazon has:

• Net Credit sales (Cost of Goods Sold) of \$60,883 million for the trailing twelve months ending 9/2014
• It’s inventory at period ending 9/2013 and period ending 9/2014 were \$6,068 million and \$7316 million

Calculate the Inventory Turnover Ratio:

Solution:
Average Inventory = (\$6068 million + \$7,316 million) / 2 = \$6692 million
Inventory Turnover Ratio =  \$60883  million / \$6692 million = ~9.1
Inventory Days = ~40.1 days