The ratio describing how efficiently a business utilizes its inventory is determined by dividing the cost of goods sold (COGS) over a specific period by the average inventory value during that same period. For example, if a company’s COGS is $1 million over a year and its average inventory value is $250,000, the ratio would be 4. This signifies that the company sold and replaced its inventory four times during the year.
This efficiency metric is crucial for financial health. A higher ratio generally suggests strong sales, efficient inventory management, and reduced holding costs. Conversely, a low ratio might indicate overstocking, obsolete inventory, or weak sales. Understanding this metric has become increasingly important in modern business due to the complexities of global supply chains and the emphasis on lean inventory practices. Effective inventory management minimizes tied-up capital, reduces storage expenses, and minimizes the risk of obsolescence, ultimately contributing to profitability.