This ratio measures the number of times inventory is turned over during the year. High inventory turnover can indicate greater liquidity or superior merchandising. Conversely, it can indicate a shortage of needed inventory for sales. Low inventory turnover can indicate poor liquidity, overstocking or obsolescence. On the positive side, it can indicate a planned inventory buildup in the case of material shortages.
Why it Matters to You
As an example, if the cost of sales for the month totals $400,000 and you carry $100,000 in inventory, the turnover rate is four, which indicates that a company sells its entire inventory four times every year.