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The inventory turnover ratio answers the question, “How long does my inventory sit before it gets sold?” This is an important question because there are warehousing and other costs associated with holding inventory. The ratio is calculated as follows:

Inventory turnover = Cost of goods sold ÷ Ending inventory

If a business’s cost of goods sold (cogs) during a period is $87,621 and its cost of goods remaining in inventory at the end of the period is $9,783, the inventory turnover ratio would be —

Inventory turnover = $87,621 ÷ $9,783 = 9.0 times

We could say that we can turn over our inventory nine times in a year. A more useful interpretation is to calculate days’ sales in inventory, which is —

365 days/Inventory turnover = 365 ÷ 9.0 = 40.6 days

This tells us that, on average, the inventory sits for almost 41 days before it is sold. Some businesses use the average inventory for the year (beginning inventory plus ending inventory divided by two) and some businesses use the ending inventory for this calculation. It all depends on what you want to track. Using average inventory gives you a historical perspective (i.e., what happened during the year), whereas using the ending inventory gives you a forward look at your current inventory levels.

In general, you would want this ratio to be as low as possible without having chronic shortages of inventory on hand. In a perfect world, inventory would materialize at exactly the time it’s needed for a sale. The inventory turnover ratio tells you how long you generally hold the inventory before it’s sold.