- 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]
| 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 |
| 2019 | 2018 | |
|---|---|---|
| Assets | ||
| 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).