Chartered Financial Analyst (CFA) Level 1 Practice Exam 2025 - Free CFA Level 1 Practice Questions and Study Guide

Inventory turnover is an essential measure of how efficiently a company manages its inventory. The correct formula for inventory turnover is calculated by dividing the cost of goods sold (COGS) by the average inventory during a specific period. This allows businesses to understand how many times inventory is sold and replaced over a certain timeframe.

Using cost of goods sold in the numerator provides an accurate reflection of the inventory that has been utilized in generating sales. The average inventory in the denominator accounts for fluctuations in inventory levels over the period, giving a more balanced view of inventory management.

This calculation can indicate whether a company is effectively converting its inventory into sales, which is critical for assessing operational efficiency and liquidity. A high inventory turnover rate suggests strong sales, efficient inventory management, or a potential risk of stockouts, while a low rate may indicate overstocking or sluggish sales. Understanding this metric is vital for financial analysis and effective inventory management strategies.