Inventory Turnover: How Much Cash Is Stuck in Slow Stock?
For each item, divide the units in stock by what you sell in a month: that is how many months the stock lasts. Multiply the units by what one unit cost you to see the cash it holds. In the example, $930 of $1,330 sits in one item that sells slowly and one that has not sold for six months.
Principle and explanation
Stock is cash you have already paid that comes back only when the items sell. An item that covers many months of sales holds that cash for as long, and stock costs money and space and can expire. An item with no sales may never return its cash at full price. Inventory turnover is a year's cost of goods sold divided by average stock at cost. Days of stock are 365 divided by turnover. Counting what is actually on the shelf matters more than the stock list.
Worked example
Illustrative scenario. These are fictional inputs, not customer results.
A hardware shop counts three items on its shelves.
| Item | Units | Sold a month | Months of stock | Cost a unit | Cash held |
|---|---|---|---|---|---|
| Paint | 40 | 20 | 2 | $10 | $400 |
| Tile adhesive | 60 | 5 | 12 | $8 | $480 |
| Door hinges, one finish | 30 | 0 for six months | none sold | $15 | $450 |
Two items hold $930 of the $1,330, while paint, which sells, holds $400.
For the whole shop, the goods it sold in the year cost $36,000. Stock at cost was $10,000 at the start of the year and $8,000 at the end, an average of $9,000. Turnover is $36,000 ÷ $9,000 = 4 times a year, and 365 ÷ 4 gives about 91 days of stock.
What this does not show
- It uses what the stock cost you, not what it would sell for now; how to value or write it off is your accountant's ground.
- It assumes the stock is paid for and recent sales continue; seasonal items can look slow out of season.
- It sets no target months of stock or turnover, and a turnover for the whole stock can hide one item that has not sold for months.
First step
Count your ten largest stock items on the shelf, note what each sold in the last three months and what one unit cost. Mark the items with the most months of stock and any with no sales.
Sources
- FDIC and SBA: Money Smart for Small Business, Module 10 Managing Cash Flow (opens in a new tab)How long stock is held before a sale, and the average number of days a business takes to sell its stock.
- OpenStax Principles of Financial Accounting 10.5: Inventory Management Using Financial Ratios (opens in a new tab)Inventory turnover as cost of goods sold divided by average stock, with average stock as the start and end of the year, halved. Days of stock as average stock divided by average daily cost of goods sold.
- Australian Government: Manage your inventory (opens in a new tab)Australian government guidance on stocktakes: a physical count shows whether the stock on hand matches the inventory record. Compared with sales records, the count points to outdated stock, such as expired products, and rearranging stock after the count can use space better.