Definition:
Inventory turns is a measure of how many times inventory turns over in a year. If every item of inventory was processed at exactly the same rate, inventory turns would be the number of times per year you sold out your stock and had to replenish it.
On the balance sheet, inventory is an asset. However, think of it as a liability. It ties up cash that might be used for other purposes. It also requires additional expenses such as costs for warehousing space, utilities, insurance, and staff to manage the inventory. Inventory is also subject to obsolescence and shrinkage. On the other hand, too little inventory means a company may not be able to meet customer needs. The goal is to meet customers’ needs and minimize inventory. The ability to free inventory investment allows a company to invest in other ways.
Example:
The formula for inventory turns is:
360 / Days in Inventory or DII
Assuming a DII of 60 (in other words, the inventory stays in-house for 60 days per year on average):
Inventory turns = 360 / 60 = 6
This means inventory turns over 6 times per year, or has to be replaced 6 times throughout the course of a year to keep up with demand.
Book Excerpt
(Excerpts from Financial Intelligence, Chapter 24 – Efficiency Ratios)
What are we actually measuring here? Both ratios [DII and inventory turns] are a measure of how efficiently a company uses its inventory The higher the number of inventory turns – or the lower the inventory days – the tighter your management of inventory and the better your cash position. So long as you have enough inventory on hand to meet customer demands, the more efficient you can be, the better. In the retail business, a difference in the inventory turnover ratio can spell the difference between success and failure. If your responsibilities are anywhere near inventory management, you need to be tracking this ratio carefully.
