What is Inventory Turnover Rate?
Inventory Turnover Rate Definition
Inventory turnover rate (ITR) is a ratio measuring how quickly a company sells and replaces inventory during a given period.
The formula for calculating the inventory turnover rate is as follows:
For example, a company with $20,000 in average inventory with a COGS of $200,000 will have an ITR of 10.
The Purpose of Inventory Turnover Rate
The purpose of calculating the inventory turnover rate is to help companies make informed decisions about pricing, manufacturing, marketing, and purchasing new inventory.
A low ratio can imply weak sales and/or possible excess inventory, also called overstocking.
This could be due to a problem with the goods being sold, insufficient marketing, or overproduction.
A high ratio can imply strong sales, but also insufficient inventory.
While strong sales are good for business, insufficient inventory is not.
Investors may also like to know the inventory turnover rate to determine how efficiently one company is performing against the industry average.
Define Inventory Turnover Rate in Simple Terms
The speed at which a company is able to sell its inventory is a crucial measurement of business performance.
The longer an item is held, the higher its holding cost will be, and so companies that move inventory relatively quickly tend to be the best performers in an industry.