Inventory turnover is one measure of a company's performance and financial health. Low inventory turnovers generally mean a company is holding too much inventory compared to its sales. Decreasing inventory turnover often means sales are decreasing below expected levels, although that is not always the case. Looking at the company's complete financial statements for several periods will help identify whether the decrease in inventory turns is temporary or indicates a long-term problem.
The inventory turnover ratio is calculated by dividing the cost of goods sold for the period by the average inventory for the period. For instance, if cost of goods sold was $10,000 for the quarter and average inventory was $5,000, $10,000 divided by $5,000 would equal an inventory turn ratio of 2. Two inventories per quarter means a company takes
one and one-half months to use and replenish on-hand inventory
Generally, higher inventory turns equate to higher sales, especially when compared to a competitor in the same market. Inventory turns are also an indicator of how well a company is matching its inventory levels to support its sales. Properly planning production means the company has neither too much or too little inventory on hand.
In a perfect world, a business would end each day with zero inventory by producing exactly what was demanded by the customer each day. Inventory turns have an impact on liquidity, since lower turns mean that more of a company's money is tied up in inventory. Slower-moving inventory increases risk to the company. As inventory ages, the risk of inventory loss, damage or expiration increases.
Causes of Decreasing Turnover