Product turnover is an accounting term that describes the process of selling inventory that you have on hand. This term is another way to describe and measure sales, but it does so in relation to your capacity to buy and store products, and it tells you whether your inventory is moving out the door or sitting unsold on your shelves.
Businesses succeed by earning money, and turning over product means that your company is generating sales. With some businesses such as bakeries and others that sell perishable products, quick inventory turnover is particularly important, because inventory you don't sell becomes stale. Wasted products represent a complete loss.
Even if your business does not work with perishable products, it still costs you money to keep unsold inventory on your shelves. Space that you use to store unsold products could be used for better-selling items, and unsold inventory also creates unnecessary clutter. In addition, business funds tied up in unsold inventory are not liquid and are unavailable for day-to-day business expenses such as rent and payroll.
If you own a business that offers customers multiple options, it may be difficult to achieve a healthy turnover rate because you need to carry so much inventory. Some businesses, such as auto dealerships, may only need to keep a limited amount of inventory on hand as they can always order additional models that customers want. Other businesses, such as clothing stores, offer customers instant gratification, and customers like to have plenty of inventory to choose from. If you own a business that offers a wide range of inventory, your success will depend on having certain items that turn over quickly and pay for the cost of storing slower-moving options.
The inventory ratio is the average number of times that a company turns over its inventory during a year. Calculate your inventory ratio by dividing your cost of goods sold -- or the total amount your business spends on inventory in a year -- by the average amount of inventory you keep on hand. Determine your average inventory by counting and calculating its value periodically. A high inventory turnover ratio indicates that your business is doing well and selling its product quickly. A low inventory turnover ratio indicates that your inventory is sitting on your shelves for too long and not selling well.
