The inventory turnover ratio indicates how efficiently a company uses its inventory. It is calculated by dividing the cost of goods sold (COGS) by the average inventory for the period. A higher ratio implies that the company sells through its inventory quickly, signaling efficiency, whereas a lower ratio may suggest overstocking or obsolescence. For example, if a company has a COGS of $500,000 and an average inventory of $100,000, its inventory turnover ratio would be 5, meaning the inventory cycles five times during the period.

This ratio is a vital metric in inventory management because it helps businesses minimize carrying costs while ensuring stock availability for production or sales. For instance, a retail firm may analyze this ratio to adjust its inventory procurement strategy to avoid overstocking or stockouts.

The inventory turnover ratio can vary by industry, with sectors like groceries generally having higher ratios compared to industries with more durable goods. Ensuring that the ratio aligns with industry standards is critical for operational efficiency and financial health.