How to Calculate Inventory Turnover Ratio From the Balance Sheet
A business operates more efficiently when it experiences a higher return on its equity and other assets because faster inventory turnover occurs. An inventory turnover ratio, also known as inventory turns, provides insight into the efficiency of a company when converting its cash into sales and profits.
For example, a company that sells all of its inventory every 30 days has better cash flow and less risk than the one that takes 60 days to do so if the two companies each have $20 million in inventory.
The Inventory Turnover Formula
The inventory turnover formula is a straightforward method for determining how often a company turns over its inventory over a specified period of time.
Inventory Turnover Formula
Inventory Turnover = Cost of Goods Sold / Average Inventory for the Period
Start with the total cost of goods sold for the fiscal year, then divide that number by the average inventory for the same time period. This will give you an annual number.
The cost of goods sold, sometimes referred to as cost of sales or cost of revenue, is typically found beneath the revenue figure on a company's income statement.
Add the current inventory balance to the previous period's inventory balance and divide by two to get the average inventory balance.
Some analysts use total annual sales instead of the cost of goods sold. This includes a company's markup and can lead to a different result. Use ratios calculated the same way to avoid inconsistent or faulty results when you're comparing two companies.
Normal Ratios Vary by Industry
The time it takes a company to sell its inventory can vary greatly by industry. Retail stores and grocery chains typically have a much higher inventory turn rate because they sell lower-cost products that spoil quickly, requiring far greater managerial diligence.
Companies that manufacture heavy machinery, such as airplanes, will have a much lower turnover rate because each product might sell for millions of dollars and take extended periods of time to produce and sell. Hardware companies might turn their inventory three or four times a year, while department stores might turn their inventory six or seven times per year.
A Real-World Example
Coca-Cola's income statement from 2017 showed that the cost of goods sold was $13.256 million, and its average inventory value between 2016 and 2017 was $2.665 million.
Dividing 13.256 million by 2.665 million equals 4.974 million—Coca-Cola's total number of inventory turns for that year. You would compare this ratio to others in the same industry to understand how well Coca-Cola is doing.
You might find that the average inventory turns for competitors was 8.4 annually. This means that they're selling the product more quickly than Coca-Cola throughout the year. This is typically due to several different factors, so it's important to read a company's financial statements and accompanying disclosure notes to get a full picture.
Also look at the percentage that current assets inventory represents when you're analyzing a balance sheet. Companies with a lot of assets tied up in inventory need faster turnover.
Although Coca-Cola's inventory turn rate was lower, you might find other metrics that show that it was still financially stronger than the other averages for its industry. It's not likely that the company's inventory has an issue with losing value with such strong economics.
It's also useful to examine how the inventory turnover calculation changes for a company over a period of many years.
Days' Sales of Inventory
Take inventory analysis a step further by using the inventory turn rate to calculate the number of days it takes for a business to clear its inventory. This is known as the days' sales of inventory ratio.
Using Coca-Cola as an example again, divide 365—the number of days in a year—by the company's inventory turn ratio, which was 4.974. The answer—73.38—represents the average number of days it took Coca-Cola to sell its inventory.
The inventory turnover ratio shows how well Coca-Cola turns its inventory of beverages and other products into sales during a given year, and the days' sales ratio translates it into a daily view of the company's efficiency.
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Stock Analysis on Net. "Coca-Cola Co. (KO)." Accessed March 29, 2020.
National Association of Credit Management. "The Basics of Financial Statement Analysis." Accessed March 29, 2020.