11 Inventory Turnover Ratio: How to measure a company's operating capacity?

Inventory turnover rate is one of the key metrics to assess a company’s operating capacity. It is calculated by dividing cost of revenue by average inventory, showing how many times a company can sell through its inventory in a year.

Two main factors influence inventory turnover: sales speed and inventory management. Quicker sales mean less stockpiled inventory and a higher turnover rate. On the other hand, poor inventory management can lead to excess stock and a lower rate.

The significance of inventory turnover rate varies by industry. For cyclical industries, the inventory turnover rate can be a critical indicator of the industry's current phase within the economic cycle. An accelerating inventory turnover rate may signal a prosperous industry outlook, while a slowing or declining rate could indicate an impending cyclical downturn.

For the retail industry, fashion industry, and industries dealing with rapidly evolving tech products, inventory turnover rate is an indicator of management efficiency. Items in these sectors can quickly become outdated. Poor operations could lead to an excess of unsold goods and the need to write off substantial inventory impairment losses, creating the risk of losses. Conversely, companies with high inventory turnover rates not only have a smaller risk of impairment but also benefit from quick product turnover, which can lead to stronger profitability.