What is inventory turnover?

Inventory turnover measures how many times a business sells through its average stock during a period, usually a year. A higher number means money is not sitting idle in goods. It is a key ratio in operations and finance, because stock that moves slowly costs money to store and may lose value.

How it works

The formula is inventory turnover = cost of goods sold / average inventory value. Dividing 365 days by the turnover gives days of inventory, the average time an item stays in stock. A faster turnover frees cash and cuts storage costs, but pushing it too high risks stockouts and lost sales.

What counts as a good value depends on the industry. A grocery store turns stock many times a year, while a maker of heavy machinery turns it a few times. Comparisons are therefore most useful against the same business in earlier periods or against close peers.

Example

Say a hardware retailer has a yearly cost of goods sold of $2,400,000 and holds an average inventory of $400,000. Turnover is 2,400,000 / 400,000 = 6 times a year, so an item stays in stock about 365 / 6 = 61 days. If the retailer trims average stock to $300,000 with the same sales, turnover rises to 8 and days of inventory fall to about 46, freeing $100,000 in cash. The numbers are an illustration.

How to model it in Machinations

Represent stock as a Pool, with a Source for purchases and a Drain for sales at cost. Add a Register that divides the yearly sales flow by the average Pool level and another that gives days of inventory. Make the purchase rate or target stock a Lever. Play and chart the Registers to see turnover change as stock levels change.