7 Turnover Ratios in 19 Minutes
Turnover ratios, also called efficiency or activity ratios, show how quickly a company uses its assets. They tell you how many times a year inventory is sold, receivables are collected and suppliers are paid, and the first three convert neatly into a number of days.
Turnover ratios explained simply
Turnover ratios show how fast a company uses its assets: how many times a year it sells its inventory, collects from customers and pays suppliers. Divide 365 by a turnover to turn it into days. In the example, inventory sits about 61 days, customers pay in 50 days, suppliers are paid in 50 days, and each $1 of assets brings in $1.25 of sales.
What this turnover ratios lesson covers
- How to calculate inventory turnover and days' sales in inventory
- How receivables turnover links to days' sales in receivables
- How payables turnover tells you the average days to pay suppliers
- What total asset turnover says about how hard assets are working
- How inventory, receivables and payables turnover flip into days: 365 ÷ turnover
Turnover ratio formulas, explained
- COGS
- Cost of goods sold for the year
- Inventory
- Inventory on the balance sheet (some courses use the average of opening and closing)
- Sales
- Annual sales (ideally credit sales)
- Accounts receivable
- Money customers still owe the company
- Accounts payable
- Money the company still owes suppliers
- Total assets
- Everything the company owns on the balance sheet
How to calculate turnover ratios step by step (worked example)
A company has sales of $3,650, COGS of $2,190, inventory of $365, receivables of $500, payables of $300 and total assets of $2,920. Find its turnover ratios.
- Inventory turnover = 2,190 ÷ 365 = 6 times; days in inventory = 365 ÷ 6 ≈ 60.8 days
- Receivables turnover = 3,650 ÷ 500 = 7.3 times; days in receivables = 365 ÷ 7.3 = 50 days
- Payables turnover = 2,190 ÷ 300 = 7.3 times; average days to pay = 365 ÷ 7.3 = 50 days
- Total asset turnover = 3,650 ÷ 2,920 = 1.25 times
Answer: Inventory sits about 61 days (rounded), customers pay in 50 days, the company pays suppliers in 50 days, and each $1 of assets generates $1.25 of sales.
Inventory vs receivables vs payables turnover
| Inventory turnover | Receivables turnover | Payables turnover | |
|---|---|---|---|
| Formula | COGS ÷ Inventory | Sales ÷ Receivables | COGS ÷ Payables |
| In days | Days in inventory | Days to collect | Days to pay suppliers |
| In the example | 6 times, about 61 days | 7.3 times, 50 days | 7.3 times, 50 days |
| Higher usually means | Stock sells quickly | Customers pay quickly | The company pays quickly |
| Too high can mean | Running out of stock | Credit terms too strict | Not using supplier credit |
Does a bigger budget mean more output? David's take
Total asset turnover asks a question I like: how much output do you get for what you put in? Here each $1 of assets brings in $1.25 of sales. A bigger budget doesn't automatically mean more output. I've seen it in marketing departments: the bigger the budget, the more gets wasted on low-quality reach. The same can happen with assets. If this company doubled its assets and sales stayed flat, turnover would drop to about 0.6. More money would have bought weight, not results.
From David's concept: Budget Is Not Output. This is David's opinion, alongside the standard textbook answer above.
Harder turnover ratio questions
What is the cash conversion cycle, and what is it here?
It's how long cash is tied up between paying suppliers and collecting from customers: days in inventory + days to collect − days to pay. Here it's about 60.8 + 50 − 50 = 60.8 days. A shorter cycle means the business needs less cash to run.
How much cash is freed up if customers pay in 30 days instead of 50?
Receivables would be about 3,650 ÷ 365 × 30 = $300 instead of $500, so $200 of cash is released. Turnover ratios are more than scores: they show where cash is stuck.
Why can a very high inventory turnover be a bad sign?
It can mean the company keeps too little stock, loses sales when items run out, or orders in small, expensive batches. Compare it with similar companies and with stock-outs or lost sales before calling it good.
Common turnover ratio questions
How do you calculate days sales in inventory?
First find inventory turnover by dividing cost of goods sold by inventory. Then divide 365 by that turnover. If inventory turns over 6 times a year, the average item sits on the shelf for about 365 ÷ 6 ≈ 61 days before it is sold.
Is a high inventory turnover good?
Usually it means goods sell quickly and little cash is tied up on shelves. But a turnover that is far above the industry may mean the company keeps too little stock and risks running out. Compare it with similar businesses before judging.
Should I use ending or average balances in turnover ratios?
Both are used. Many corporate finance textbooks use ending balance sheet figures for simplicity, while accounting and CFA material often uses the average of opening and closing balances. Follow your course, and use the same method when comparing companies.
Why does inventory turnover use COGS instead of sales?
Inventory is recorded at cost, so dividing cost of goods sold by inventory compares like with like. Using sales would mix selling prices with cost figures and overstate how fast inventory moves. Some sources still use sales, so check what your instructor expects.