Inventory Turnover Ratio, also known as Inventory Turnover Ratio in English, is a financial indicator that measures a company's ability to generate sales revenue from inventory. Inventory turnover is calculated by dividing the cost of goods sold during a specific time period by the average inventory for the same period, and its value means the number of times a company sells and replaces its inventory of goods in a given period. Usually a specific period is each financial year, but different companies can calculate monthly, quarterly or semi-annual inventory turnover rates based on actual usage needs. At the same time, it is not limited to calculating the company's overall inventory turnover rate, but can also calculate the inventory turnover rate of specific commodities to provide the company with a more detailed analysis of its operational capabilities. The lower the inventory turnover rate, it indicates that the company's sales capabilities have problems or may even have stagnated, which has a negative impact on the company's operating income. The higher the inventory turnover rate, it indicates that the company has strong sales capabilities and can effectively convert inventory into profits. However, an excessively high inventory turnover rate may indicate that the company does not have enough costs to replenish inventory in a timely manner to meet market demand. It is also a medium or negative signal and requires timely adjustment of the operating model. Inventory refers to all assets in a company's inventory, including raw materials, goods in progress, and goods for sale, while average inventory refers to the average of the beginning inventory and ending inventory for a specific period of time. For public companies, it can be found on the balance sheet in their financial reports. In actual use, a specific period is usually calculated as each financial year, and you can get the relevant values from the company's financial reports, such as COGS and opening and closing inventory. Inventory turnover rate calculation example This chapter will perform example calculations by using Apple's 10-K financial report released in September 2021: The income statement and balance sheet in AAPL's financial report are as follows: Income statement: Balance Sheet: It can be seen from the financial statements that Apple's cost of sales COGS in the 2021 financial year is $212,981 M, the beginning inventory is the ending inventory of the previous financial year, which is $4,061 M, and the ending inventory is $6,580 M. So the average inventory level is: Average inventory = (beginning inventory + ending inventory) / 2 = ($4,061 M + $6,580 M) / 2 = $5,320.5M Inventory turnover = cost of sales / average inventory = $212,981 M / $5,320.5 M = 40 In other words, Apple completed the sale and replacement of its inventory products 40 times during the 2021 financial year. What investment guidance does inventory turnover rate have? When using inventory turnover to measure a company's operating capabilities: A low inventory turnover rate means that the company cannot sell its inventory products in a timely manner, resulting in a large backlog of inventory products and poor operating profitability of the company. A higher inventory turnover rate means that the company has strong sales capabilities, fast inventory replacement, lower holding costs, better corresponding profitability, and a good overall operational capability. However, an excessively high inventory turnover rate indicates that the company's inventory is insufficient to meet sales demand, which will hinder the company's operating capabilities due to insufficient inventory and may miss some opportunities for rapid development and expansion. When using inventory turnover rate to measure different companies, different standards of excellence and disadvantage will appear due to different industries. For example, for companies that produce or sell perishable goods, such as flowers, fresh food, etc., a higher inventory turnover rate is required, while for companies that sell large equipment such as excavators, a lower inventory turnover rate does not necessarily mean that sales capabilities are unsatisfactory. When the company uses the inventory turnover rate internally, it can be classified and calculated according to time or product type, thereby formulating a more detailed operating strategy for the company: When calculating inventory turnover based on time, the company's inventory can be adjusted according to different seasons to achieve the optimal inventory turnover. This is especially true for companies that produce or sell seasonal goods, such as companies that sell surfboards or snowboards.
When calculating the inventory turnover rate based on product types, consumers' attitude towards the product can be judged based on the inventory turnover rate of different products in the same period. Products with a higher inventory turnover rate indicate that consumers prefer them. On the contrary, products with a lower inventory turnover rate indicate that consumers do not accept the product. Then the company can use this to adjust the inventory of different products to maximize profits. Companies like department stores that have a large number of different products are ideally suited to using inventory turnover to adjust the inventory levels of different items and even their placement.