"Inventory Turnover" Explained

Inventory turnover is a measure that will give you a sense of how quickly a company's products are flying off the shelves. Here's how you'd crunch this number:

From the company's income statement, find the "cost of goods sold" (or COGS), which is usually listed near the top, below "sales" (which are sometimes called "revenues"). You'll want the last 12 months' worth. If the fiscal year has just ended, you can use the figures in the annual report or 10-K report. If it's mid-year, just re-create the last year's results by adding together the numbers from the last four quarters' reports. Once you have this number, jot it down.

Next, you need to calculate the average value of inventory for the 12-month period you're looking at. If, for example, you're using the cost of goods sold for the 2002 fiscal year, you'd want to take the inventory value from the end of fiscal 2001 and average it with the inventory value from the end of 2002. This way, your numbers address the same time period -- the duration of fiscal 2002.

Once you have the cost of goods sold, divide it by the average inventory, and you'll get the inventory turnover rate. A company with high and growing inventory turnover rates would appear to be well managed, freeing up its working capital for other uses.

As an example, consider Wal-Mart (NYSE: WMT  ) . For fiscal 2004, it reported on its income statement a total cost of goods sold of $199 billion (yes, billion -- yowza). Moving to its balance sheet, we see inventory at the end of fiscal 2004 of $26.6 billion, and $24.4 billion for 2003. Average those together and we get $25.5 billion. Now, dividing COGS by average inventory, we get 7.8. That's Wal-Mart's inventory turnover for the period, showing us that essentially, the company filled and sold everything on its shelves about eight times in the year.

To make more sense of that number, compare it with a competitor. Target's (NYSE: TGT  ) inventory turnover, for example, was 6.3 -- which seems solid but isn't as strong as Wal-Mart's number. We can also compare Wal-Mart's current inventory turnover with its past figures. Two years ago, its turnover was 8.1, suggesting that there may be a slight slowdown in progress.

To learn more about how to make sense of financial statements, check out our "Crack the Code: Read Financial Statements Like a Pro" how-to guide (also known as an online seminar). We offer a money-back satisfaction guarantee.

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