What is Inventory Turnover Ratio?
The Short Answer
Inventory Turnover Ratio explained simply
The Inventory Turnover Ratio tells you how quickly a business sells its inventory. A high ratio means inventory is selling fast, which is usually good. A low ratio might mean slow sales or too much stock. It helps owners see if they are buying too much or too little inventory.
Real-World Example
The T-Shirt Shop Scenario
Imagine a T-shirt shop. Over a year, they sold $100,000 worth of T-shirts (Cost of Goods Sold). Their average inventory value during that year was $25,000.
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
Inventory Turnover Ratio = $100,000 / $25,000 = 4
This means the T-shirt shop sold and replaced its entire inventory 4 times during the year. This is a good sign of efficient inventory management.
Why this matters
This ratio matters because it shows how well a business manages its money tied up in inventory. Efficient inventory management means less money sitting idle and a lower risk of old, unsold stock. It directly impacts cash flow and profitability.
Look at this ratio alongside industry averages. What’s good for a car dealership is different from a grocery store. Context is key.
Look at this ratio alongside industry averages. What’s good for a car dealership is different from a grocery store. Context is key.
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