Inventory Turnover Ratio

The inventory turnover ratio is one of the most important indicators that help companies and stores assess inventory management efficiency, as it measures how many times inventory is sold and replaced during a specific period.

Simply put:

Inventory turnover ratio = Cost of goods sold ÷ Average inventory

If the inventory turnover ratio is 6 times annually, this means the business sold and replaced the equivalent of its average inventory approximately 6 times during the year.

However, a higher ratio is not always good, and a lower ratio is not always bad; the result must be interpreted according to the nature of the business, product sales velocity, purchasing policy, and seasonal demand.

To understand this indicator within the complete inventory cycle, you can review the guide to Warehouse Management and Inventory Organization, which explains item movement from receiving and storage through issuing, stocktaking, and reporting.

What Is the Inventory Turnover Ratio?

The inventory turnover ratio is a financial and operational indicator that measures how many times average inventory is sold and consumed during a specific period.

This indicator helps answer important questions, such as:

• Are we holding quantities greater than we need?
• Do products move quickly or remain in the warehouse for a long time?
• Are there any non-moving items?
• Should we reduce or increase the quantities purchased?
• Is inventory management efficiency improving over time?

The turnover ratio is usually calculated annually, but it can also be calculated monthly or quarterly if accurate data for the period is available.

What Is the Inventory Turnover Formula?

The most commonly used formula is:

Inventory turnover ratio = Cost of goods sold ÷ Average inventory

Average inventory is usually calculated as follows:

Average inventory = (Beginning inventory + Ending inventory) ÷ 2

A Quick Example

If:

• Beginning-of-year inventory = 100,000 riyals
• End-of-year inventory = 140,000 riyals

Then:

Average inventory = (100,000 + 140,000) ÷ 2 = 120,000 riyals

And if the cost of goods sold during the year is:

600,000 riyals

Then:

Inventory turnover ratio = 600,000 ÷ 120,000 = 5 times

Therefore, inventory turned over 5 times during the year in this example.

Why Do We Use Cost of Goods Sold Rather Than Sales?

Because inventory is recorded at cost, the most logical comparison is between:

Cost of goods sold

And

Average inventory value

Using sales value may inflate the result because the selling price includes a profit margin.

Example:

If a product costs 100 riyals and sells for 150 riyals, using sales instead of cost creates a comparison between two figures calculated on different bases.

Therefore, using cost of sales or cost of goods sold is more accurate when calculating the turnover ratio.

A Practical Example of Calculating Inventory Turnover

Suppose a company has the following data:

First, we calculate average inventory:

(200,000 + 300,000) ÷ 2 = 250,000 riyals

Then:

1,500,000 ÷ 250,000 = 6

Therefore:

Inventory turnover ratio = 6 times annually

This means the company sold and replaced the equivalent of its average inventory approximately six times during the year.

What Are Inventory Turnover Days?

Alongside the turnover ratio, you can calculate the approximate number of days inventory remains before being sold.

The formula:

Average inventory holding days = 365 ÷ Inventory turnover ratio

In the previous example:

365 ÷ 6 ≈ 61 days

This means average inventory remains for approximately 61 days before being sold or replaced.

This indicator makes the result easier for management to understand.

What Does a High Inventory Turnover Ratio Mean?

A high turnover ratio may be a positive indicator because it may mean the business:

• Sells products quickly.
• Holds smaller quantities of non-moving inventory.
• Uses capital more efficiently.
• Reduces storage costs.
• Reduces the risks of damage or obsolescence.

However, an excessively high ratio may also indicate a problem.

If inventory is too low, the company may face:

• Stockouts.
• Lost sales.
• Delayed customer orders.
• Repeated reliance on urgent purchase orders.
• Higher shipping or procurement costs.

Therefore, the goal is not to achieve the highest possible ratio, but to reach a balanced ratio that suits the business and its level of demand.

What Does a Low Inventory Turnover Ratio Mean?

A low ratio may indicate that products remain for a long time before being sold.

This may happen because of:

• Purchasing quantities that exceed demand.
• Weak sales.
• Poor product selection.
• High prices.
• Non-moving products.
• Lower seasonal demand.
• Poor forecasting of requirements.

Holding inventory for long periods may also lead to:

• Increased storage costs.
• Tied-up capital.
• A higher likelihood of damage.
• Some products reaching their expiration dates.
• Product obsolescence.

Therefore, the items causing the low ratio should be analyzed instead of looking only at total inventory.

Discover: The Best Accounting Software Programs in Saudi Arabia

Is There an Ideal Inventory Turnover Ratio?

There is no single ideal figure for all companies.

The appropriate ratio varies depending on the business.

For example:

Supermarkets and Food Products

Products tend to move quickly, particularly everyday goods and perishable items.

Clothing and Footwear

Turnover speed may be affected by seasons, sizes, colors, and styles.

Electronics

Management may need to avoid holding products for too long because technology and prices change rapidly.

Spare Parts

The business may have to hold some slow-moving items to ensure their availability when requested.

Wholesale and Distribution

The ratio is affected by warehouse size, the supply cycle, and customer contracts.

Therefore, it is best to compare the business's ratio:

• With previous periods.
• With similar items.
• Across branches.
• Against the sales plan.
• Against the nature of the sector.

Discover: The Best Accounting Software in Saudi Arabia

The Difference Between Inventory Turnover and Non-Moving Inventory

The inventory turnover ratio measures how quickly inventory moves overall or at the category or item level.

Non-moving inventory refers to products that have not moved or have moved very slowly over a long period.

A company's overall ratio may be good while dozens of non-moving items remain, because a small group of fast-moving products raises the average.

Therefore, it is preferable to analyze:

The turnover ratio for each item or product group

Rather than relying only on the overall figure.

How Does Inventory Turnover Affect Capital?

Money used to purchase goods remains tied up in inventory until the products are sold and payment is collected.

If turnover is slow, this means part of the capital remains in the warehouse for a longer period.

When turnover improves in a carefully planned way, the business may be able to:

• Reduce excess inventory.
• Free up part of its capital.
• Improve cash flow.
• Direct funds toward faster-moving products.
• Reduce storage requirements.

However, inventory levels must also remain sufficient to meet customer demand.

How Is Inventory Turnover Calculated for a Single Item?

The same concept can be applied to a specific product.

Example:

The cost of the quantities of the product sold during the year:

60,000 riyals

The average inventory value of the product:

10,000 riyals

Therefore:

60,000 ÷ 10,000 = 6 times

This product can be compared with another product whose turnover ratio is only 2 to determine which moves faster.

This comparison helps with decisions about:

• Purchasing.
• Pricing.
• Promotions.
• Product clearance.
• Distributing items across branches.

How Is the Turnover Ratio Related to Stocktaking?

The inventory turnover ratio cannot be relied upon if recorded inventory quantities are inaccurate.

If the system shows inventory worth 500 thousand riyals while a physical count confirms only 400 thousand, the turnover ratio calculation will be inaccurate.

Therefore, the quality of this indicator is directly linked to the quality of stocktaking.

You can review the guide to Types of Warehouse Stocktaking , to understand the differences between comprehensive, periodic, continuous, partial, and surprise stocktaking.

How Can You Improve Inventory Turnover?

1. Analyze Sales for Each Item

Identify products that are:

• Fast-moving.
• Moderately moving.
• Slow-moving.
• Non-moving.

Then adjust purchasing quantities accordingly.

2. Improve the Reorder Point

Do not wait until a product runs out, and do not order large quantities unnecessarily.

Determine the reorder level based on:

• Average sales.
• Supplier lead time.
• Safety stock.

3. Reduce Non-Moving Inventory

Non-moving products can be addressed through:

• Promotions.
• Discounts.
• Bundled sales.
• Reducing repeat purchases.
• Moving the product to a branch where it sells faster.

4. Improve Demand Forecasting

Review data from previous periods and seasons before issuing purchase orders.

5. Monitor Suppliers

A supplier that delivers quickly may allow the company to hold less inventory than a supplier that takes months to deliver.

6. Conduct Regular Stocktaking

Periodic or continuous stocktaking helps ensure that purchasing decisions are based on actual stock balances.

How Does an Inventory Management System Help?

When a company has thousands of products, calculating indicators manually becomes more difficult.

An integrated system helps connect:

Purchases → Inventory → Sales → Product costs → Item movement → Reports

This provides better data for analyzing the fastest- and slowest-moving products.

The Accounting and Sales System from Aamal Digital supports tracking items, quantities, warehouses, suppliers, product movement, and sales, providing the essential data needed to analyze inventory performance instead of relying on separate files.

For businesses that need broader reporting and management analysis, the Smart Reporting Portal can be used to monitor sales, inventory, and performance data using information recorded within the system.

Inventory Turnover and Purchasing

Purchasing decisions directly affect the turnover ratio.

If the company purchases:

More than it sells → Inventory increases → The turnover ratio may decrease

Whereas if purchases align with demand:

Excess quantities decrease → Inventory utilization improves

Therefore, it is important to connect sales data with purchasing decisions.

You can review the guide to Sales and Purchases Accounting to understand the relationship between purchasing, selling, inventory, and accounts.

Common Mistakes When Calculating Inventory Turnover

Avoid the following mistakes:

• Using sales instead of cost of goods sold without understanding the difference.
• Using only ending inventory despite significant changes during the year.
• Relying on an inaccurate inventory balance.
• Comparing companies operating in different sectors.
• Assuming that a high ratio is always good.
• Ignoring stockout risks.
• Analyzing inventory as a single whole without examining individual items.
• Failing to account for seasonality.
• Ignoring non-moving products.
• Not comparing the result with previous periods.

Sign up now for the Free Trial without a Visa card and try the complete system to determine how well it fits your workflow, or Contact Our Team to identify the most suitable system for your business.

Frequently Asked Questions About Inventory Turnover

What Is the Inventory Turnover Ratio?

It is an indicator that measures how many times average inventory is sold and replaced during a specific period.

How Do I Calculate Inventory Turnover?

The formula:

Inventory turnover ratio = Cost of goods sold ÷ Average inventory

How Do I Calculate Average Inventory?

Average inventory = (Beginning inventory + Ending inventory) ÷ 2

Is a High Inventory Turnover Ratio Good?

It usually indicates fast product movement, but an excessively high ratio may mean inventory is insufficient and could lead to stockouts.

What Does a Low Inventory Turnover Ratio Mean?

It may indicate slow sales, excess inventory, or non-moving items, but it must be interpreted according to the nature of the business.

How Do I Calculate the Inventory Holding Period?

Inventory days = 365 ÷ Inventory turnover ratio

If the turnover ratio is 5 times, the average period is approximately 73 days.

Does the Turnover Ratio Vary by Business Activity?

Yes. A ratio suitable for a supermarket may not be suitable for spare parts, electronics, or seasonal products.

In Conclusion

The inventory turnover ratio is one of the most important indicators for measuring how efficiently a business converts inventory into sales.

It is calculated using:

Turnover ratio = Cost of goods sold ÷ Average inventory

The result can also be converted into a number of days:

Inventory days = 365 ÷ Turnover ratio

However, the goal is not to maximize the ratio, but to achieve a balance between sales velocity, product availability, and avoiding tying up capital in excess inventory.

This indicator becomes more valuable when sales, purchasing, stocktaking, and warehouse data are connected. Therefore, an Accounting and Sales System can be used to consolidate item movement, sales, purchases, and warehouses within a single system, while referring to the Warehouse Management guide to understand the procedures that help improve inventory accuracy and management efficiency.