Inventory Turnover Rate

Inventory turnover shows how many times a company’s inventory is sold or consumed over the course of a year. This key figure is used to assess the effectiveness of inventory management and how quickly capital tied up in inventory is released. It is particularly relevant for retail and manufacturing companies, where inventory constitutes a significant portion of total assets.

How is the inventory turnover rate calculated?

The calculation is based on cost of goods sold and average inventory:

Inventory Turnover Rate = Cost of Goods Sold / Average Inventory

Cost of goods sold is the total cost of goods sold or raw materials for the period and is reported in the income statement.

Average inventory is typically calculated as (beginning inventory + ending inventory) / 2 and is reported on the balance sheet.

Example:
Cost of Goods Sold: 6,000,000 DKK
Average Inventory: 2,000,000 DKK
Inventory Turnover: 3

This means that inventory is turned over three times a year. In other words, on average, goods remain in stock for about four months.

What does this key figure tell us?

Inventory turnover provides insight into the balance between inventory and sales. A high figure indicates that the company is selling its goods quickly and thus has effective inventory management. This frees up cash flow and reduces the risk of obsolescence and expiry.

A low inventory turnover ratio, on the other hand, may be a sign that the company has too much capital tied up in inventory. This can put pressure on liquidity and increase the risk of losses, especially if the goods lose value over time.

Why is inventory turnover important?

This key ratio is important because it is closely linked to both liquidity and capital tied up in inventory. Inventory that sits idle cannot be used to pay bills or invest in growth. Therefore, inventory turnover is often used to supplement key ratios such as the current ratio and the debt-to-equity ratio.

This is particularly relevant in industries with:

• fast-moving consumer goods, e.g., retail
• high risk of becoming obsolete, e.g., electronics, fashion, and food
• large inventories relative to revenue

What is a “good” inventory turnover rate?

There is no single “correct” level. It depends on the industry, business model, and logistics. Some companies need high inventory levels to ensure delivery reliability, while others operate on a just-in-time basis with very low inventory levels.

The most important thing, therefore, is to:

• compare with the industry average
• track developments over time
• evaluate the figure in the context of earnings and liquidity

Inventory Turnover Rate and Qatchr

In Qatchr—Collectia’s platform for credit reports and financial data—the key figure is not displayed directly. However, you do have access to the financial figures needed to calculate it, including cost of goods sold and opening and closing inventory balances.

When these figures are combined with other key metrics such as gross profit, current ratio, and pre-tax income, you get a more nuanced picture of the company’s inventory management, capital tied up, and financial risk profile. This is particularly useful when evaluating customers, suppliers, or business partners with large inventories.