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Inventory turnover is meaningful on several levels. One is the measure of management's ability to convert an asset into either cash or accounts receivable. Another is the measure of the company's management of an important part of the sales process. You want to compare inventory metrics within an industry to really understand the significance. A wholesaler may turn inventory weekly whereas a wine store may only turn inventory 4 x during the year. So with that being said, the formula for inventory turnover is:Inventory turnover = Cost of goods sold / average inventory
Example:
CVS Corp inventory for fiscal years ended December 31, 2005 and 2006 were $5,720 and $7,109 million respectively. Cost of goods sold (COGS) for fiscal year end December 31, 2006 was $31,875 million. What was CVS's inventory turnover for 2006?:Inventory turnover = $31,875 / (($5,720 + $7,109)/2)
Inventory turnover = $31,875 / $6,415
Inventory turnover = 5
If calculating the inventory turnover turnover ratio on an intra-period basis you need to account for the period (generally the ratio equation is used for a year-to-year calculation).
CVS Corp inventory for the quarters ended June 30, 2007 and September 30, 2007 were $7,749 and $7,892 million respectively. Cost of goods sold was $16,300 million. CVS's inventory turnover for the September 30, 2007 quarter was:Inventory turnover = $16,300 / (($7,749 + $7,892)/2)
Inventory turnover = $16,300 / $7,821
Inventory turnover = 2 - remember this is for a quarter ... so multiple by 4
Inventory turnover (Annualized) = 8
So, during 2007 CVS has improved its inventory turn. This may be an example of bad management resulting in stock-outs etc. But, this is CVS and I think they run a good company - in my opinion the increase in turn is just good management.
