The metric Inventory Turnover tries to evaluate how many times a company's inventory is sold and replaced over a period of time.
There are generally two ways of calculating the Inventory Turnover Ratio:
1) Basic calculation:
Inventory Turnover = Sales / Average Inventory
In this formula "Sales" is being used as the numerator. This is not an optimal approach, because sales are normally recorded at market value. This means that that the recorded value is higher than the actual value of the inventory, which will make the Inventory Turnover Ratio higher than it really is.
2) Alternative calculation:
Inventory Turnover = Cost of Goods Sold / Average Inventory
In this alternative calculation the numerator "Cost of Goods Sold" is assessed by the actual costs of the inventory. Accordingly, the alternative calculation is more precise in evaluating how often the actual worth of the average inventory is sold and replaced over a period of time.
A low turnover implies poor sales compared with the value of the inventory. A high turnover implies strong sales compared to the value of the inventory.