The ratios that measure the effectiveness of a firm's management in turning over inventory are called inventory turnover ratios.
Inventory turnover is an example of an activity ratio. Activity ratios are financial ratios that are used to measure the rate of efficiency with which a firm carries out its day to day operations.
Inventory turnover is the cost of goods sold divided by average inventory.
Inventory turnover = cost of goods sold / average inventory
Where: Average inventory = (beginning inventory + ending inventory) / 2
The higher the inventory turnover ratio is, the more efficient the firm is in converting inventory to sales. If a company's turnover ratio is below the average inventory turnover ratio in the industry in which it operates, it is a negative indicator.
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