Inventory Turnover Ratio & What it Means to Your Business

Michelle Jaco11/27/2019

Inventory Turnover Ratio Defined

Inventory management is crucial to running any business but it's even more important when running a restaurant. Restaurants should always have fresh produce and dishes, which means constantly staying on top of the inventory. This includes tracking what is currently in stock, ordering replenishments, managing shelflife, and making sure to utilize all products before they go bad.

The inventory turnover ratio indicates how many times your restaurant has sold and replaced its inventory in a specified time period.

With restaurants, high turnover is usually an indicator of high sales, whereas a low turnover is an indicator of low sales.

That's not all they can indicate though. For example, high turnover can indicate bad inventory management, like ordering too much in stock. Contrary to that, low turnover can indicate that you have too little in stock.

How You Can Use Inventory Turnover Ratio to Measure Performance

The inventory turnover ratio is a standardized metric that most restaurants use. As such, you can compare your restaurant to the industry average and see how you compare.

Similarly, you can compare it to your previous measurements and asses your success, or plan an inventory turnover ratio for the future.

Calculating Inventory Turnover Ratio
The equation for calculating the inventory turnover ratio is the following.

Inventory Turnover Ratio = (Cost of Goods Sold) (Average Inventory)

For example, a restaurant has a COGS (Cost of Goods Sold) of $1,000,000 for the year. Their beginning inventory was worth $35,000 and their ending inventory totaled $50,000.

With this information, their average inventory comes to $42,500. Calculating the inventory turnover ratio tells us that this restaurant sells and replaces its inventory 23.5 times in 1 year.

COGS (Cost of Goods Sold)
Every expense directly related to creating a product falls under COGS. This includes the raw materials, and possibly even labor costs for creating the product.

The cost of goods is best determined by keeping a detailed inventory account, which is easily done if you're using a software tool to manage your inventory.

Average Inventory
The cost of goods averaged from two or more specified periods equates to average inventory. With the inventory turnover ratio, the two periods taken into account are

Starting inventory at the start of the period
Ending inventory at the end of the period

These are then divided by the number of periods, two in our case, to obtain the average cost of inventory.

Average inventory can be calculated for any period of time. However, when calculating the inventory turnover ratio, it should be calculated for the same period as the turnover ratio.

Inventory Turnover Days

Inventory turnover ratio is what most businesses use to calculate how many times their inventory gets replaced in a given time period. But there's a different version of this metric.

If you do some research, you will find that inventory turnover can also be calculated in days. What does this mean?

Inventory turnover days are the number of days a business needs to sell its inventory .

Calculating Inventory Turnover Days
To calculate inventory turnover days, you need to divide the average inventory by the cost of goods sold, and then multiply that by 365 (number of days in a year).

For example, if we calculate the turnover days from the previous example, it would look like this

The restaurant has a COGS of $1,000,000 for the year. The beginning inventory was worth $35,000 and the ending inventory $50,000. That gives us an average inventory value of $42,500.

To calculate the inventory turnover days (Average Inventory COGS) 365

(42,500 1,000,000) * 365 0.0425 * 365 = 15.5

With this calculation, we can see that inventory was kept for about 15 days before being sold and replaced.

Convert Turnover Days into Turnover Ratio
Inventory turnover days are a useful equation but you also want to know the inventory turnover ratio.

It's very easy to convert turnover days into turnover ratio. Here's the equation.

Inventory Turnover Ratio = 1 (turnover days days in period)

Continuing with our previous example, here's what we get.

1 (15.5 365) = 23.5

The exact same number as calculating inventory turnover ratio directly.

The Importance of Turnover Ratio for a Restaurant

If there's one way to assess the performance of any business, it's the inventory turnover ratio. It gives you insight into a lot of performance metrics such as

How fast inventory sells
How it meets market demand
How the business compares to similar businesses

Restaurants rely on fresh foods, so this metric is very important. Without this metric, restaurants would be more likely to serve expired food or lose more money by throwing food in the garbage.

As such, higher inventory turnover rates mean that a restaurant has a constant flow of fresh produce and is able to sell it before it expires. It means that the restaurant is performing well with high sales.

A low turnover ratio means that something is preventing the restaurant from racking up more profits. This can be a service problem, cooking problem, or perhaps something else entirely.

Inventory turnover ratio is an industry-standard metric for measuring how many times a business sells and replaces its inventory. It can be calculated in two ways

Inventory turnover ratio indicates how many times inventory has been replaced in a given time period
Inventory turnover days indicates how many days the company needs to sell its inventory

These measurements are important, especially in the restaurant industry which always needs fresh produce in order to provide good service.

Calculating inventory turnover ratio gets much easier if you have a software tool that can automatically generate inventory reports which will help you calculate your average inventory and cost of goods.