Understanding Inventory Turnover Ratio

Maintenance programs rely on a variety of metrics to track equipment utilization, measure maintenance team performance, and identify opportunities for process improvements. Inventory turnover ratio is a particularly valuable metric, providing meaningful insights into both the efficiency of your equipment and the effectiveness of your maintenance program.

By closely monitoring this ratio, organizations can better understand how effectively they utilize assets, manage inventory, control costs, and more. These insights can provide the basis for process improvement and greater profitability.

Why is tracking inventory turnover ratio important?

An organization’s Inventory or stock turnover ratio measures how often items are used over a specific period–usually a year. Generally speaking, a high inventory turnover ratio indicates that your organization is managing its inventory levels effectively, using resources efficiently, and minimizing the carrying costs associated with excess inventory or last-minute orders.

A low inventory turnover ratio may suggest underlying issues.Using the inventory ratio metric to track equipment performance can help your maintenance team make long-term operational improvements by supporting:

• Data-driven decisions regarding maintenance schedules and resource allocation
• Proactive maintenance strategies including routine serving and regularly scheduled inspections
• A culture of accountability where all team members have a quantifiable way of understanding how their efforts impact inventory turnover and overall equipment efficiency
• Continuous monitoring and an improved ability to forecast future maintenance needs
• Improved alignment between maintenance schedules, production schedules, and inventory management

What is inventory turnover ratio?

Inventory turnover ratio is a metric that companies use to calculate how many times their inventory is replaced over a specific period of time. The most common time period is one year.

Formula for inventory turnover ratio

The formula for calculating inventory turnover ratio is expressed as follows:

• Inventory Turnover Ratio=Cost of Goods Sold (COGS)/Average Inventory
  • Where:
    • Cost of Goods Sold (COGS) represents the sum of costs used directly for the production of goods produced by the company
    • Average Inventory is calculated by adding the total number of items included in the company’s inventory at the beginning and end of the period in question and dividing by two.

Generating maintenance insights from calculating inventory turnover ratio

Inventory turnover ratio is commonly used to improve budget management and purchasing decisions. Inventory turnover ratio provides maintenance teams with valuable insights into:

• Resource allocation
• Operational efficiency
• Equipment utilization and performance
• Preventive maintenance scheduling practices
• Cost management
• Future maintenance budgeting needs including decisions about equipment upgrades or replacements

Are inventory turnover ratio and stock turnover ratio the same?

Yes. The terms inventory turnover ratio and stock turnover ratio are effectively interchangeable. Both metrics are used to measure how efficiently organizations replace their inventory and both are calculated using the same formula. Why might an organization choose one term over the other?

• Different industries may have preferences for one term over the other. For example, retailers may prefer "stock turnover" to describe the movement of customer-facing products and manufacturers may prefer “inventory turnover” to describe the use of consumables in the production process.
• Inventory type may also influence language choice, with a manufacturing organization preferring to use “inventory turnover” to describe the use of raw materials in the production process and "stock turnover" to describe the movement of the finished goods resulting from that process.
• Area of operation may also influence the preferred terminology, with “stock turnover” being more applicable in sales and other customer-facing areas of operation and “inventory turnover” applying more aptly in areas like production, asset management, and maintenance.  

How is inventory turnover ratio calculated?

Below, we provide a step-by-step guide to calculating your stock or inventory turnover ratio:

Step 1: Gather the data

You will require two key pieces of data to calculate inventory turnover ratio:

• Cost of Goods Sold (COGS) refers to the total cost of all goods sold during a given period–which includes the expenses associated with purchasing and production.
• Average inventory refers to the average amount of inventory held during the given period and is calculated using the inventory values at the beginning and end of that period.

Step 2: Calculate average inventory

You can calculate your average inventory value by:

• Determining your beginning inventory
• Determining your ending inventory
• Implementing the average inventory formula, which is represented as follows:
  • Average Inventory = (Beginning Inventory + Ending Inventory) / 2
    • Example:
      • Assuming a one-year period of measurement, where:
        • Beginning Inventory = $150,000
        • Ending Inventory = $210,000
      • (150,000 + 210,000) / 2 = 180,000
        • Average Inventory = $180,000

Step 3: The inventory turnover ratio calculation

Next, use put your data into the inventory turnover ratio formula:

• Inventory Turnover Formula:
  • Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
    • Example:
      • Where:
        • Cost of Goods Sold (COGS) = $900,000
        • Average Inventory = $180,000
      • 900,000 / 180,00 = 5
        • Average Inventory Turnover Ratio = 5
• Assuming a time period of 1 year, this figure indicates that you sold and replaced your inventory 5 times over the course of a year.

Step 4: Analyze your results

Finally, take a look at your results and use your findings to carry out data-driven process improvements.

What is a ‘good’ inventory turnover ratio?

In any industry, a higher inventory turnover ratio is preferable. We can follow a few general rules for evaluating inventory turnover, regardless of industry:

• Low inventory turnover ratio will usually fall between 1-2 and may be an indication of overstocking or poor purchasing decisions
• Good inventory turnover ratio will usually fall between 3-6 in many industries and typically indicates a balanced inventory management strategy.
• Excellent inventory turnover ratio will typically be 7 or higher and suggests robust inventory movement.

However, as noted above, a good inventory turnover ratio may vary by industry.

Industry standard inventory turnover

Every industry experiences distinct sales cycles, production cycles, profit margins, capital expenses, and seasonal fluctuations. Together, these factors create a level of variance across industries.

Therefore, a “good” inventory turnover ratio must be considered relative to your industry’s standard benchmark.

Striving for optimal inventory turnover ratios

Even incremental improvements in your organization’s turnover ratio may translate into significantly improved efficiency, cash flow, or profitability. However, as also noted above, it’s generally true that a higher inventory turnover ratio is preferable in any context. There are a few strategies that organizations striving for improvement in their inventory turnover ratio can employ in any industry including:

• Using data analytics to track sales trends and adjust inventory accordingly
• Cultivating strong supplier relationships to ensure timely restocking based on real usage and demand
• Implementing Just-in-Time (JIT) inventory practices to reduce overstocking and to align stock levels, production schedules, and maintenance activities with sales and customer demand
• Streamlining inventory management, production, and maintenance using maintenance management software

Why is calculating inventory turnover ratio important?

Calculating the inventory turnover ratio is important because this relatively straightforward formula can provide meaningful insights into the efficiency of your maintenance team, the effectiveness of your inventory management process, and even the overarching performance of your business.

Calculating inventory turnover ratio can help your organization:

• Optimize resource allocation by making data-driven decisions about the best use of capital, physical assets, and personnel
• Plan for seasonal fluctuations by identifying and preparing for predictable patterns in consumer demand and other factors affecting inventory movement
• Reduce holding costs associated with overstocking and storing goods, such as warehousing fees, insurance, and spoilage
• Improve cash flow by turning inventory over faster and reducing the costs of overstocking
• Make coordinated, data-driven decisions about production scheduling, preventive maintenance (PM) scheduling, and stock replenishment
• Identify underlying operational issues and take corrective action

How can maintenance teams improve their inventory turnover ratio?  

If you’re searching for a CMMS that can help improve your inventory turnover ratio, prioritize a platform that includes features like:  

• Just-in-Time (JIT) inventory management
• Real-time visibility into stock levels
• User-friendly, customizable dashboards
• Historical data analysis and demand forecasting
• Automated reorder points based on actual usage rates
• Advanced inventory management tools providing insights into stock levels, usage trends, and ordering needs
• Mobile access to inventory data, stock levels, and order forms

Find out how Limble’s industry-leading CMMS can help your maintenance team streamline inventory management and improve your bottom line.