Certified Valuation Analyst (CVA) Practice Exam

How is inventory turnover calculated?

1. Divide total sales by the average inventory

2. Divide the cost of goods sold by the average inventory

3. Multiply cost of goods sold by the ending inventory

4. Add beginning and ending inventory together

The correct answer is: Divide the cost of goods sold by the average inventory

The calculation of inventory turnover is essential for understanding a company's efficiency in managing its inventory levels relative to its sales activity. It reflects how many times a company sells and replaces its inventory over a specific period. The correct method to calculate inventory turnover involves dividing the cost of goods sold (COGS) by the average inventory. This formula provides insight into how effectively a company is utilizing its inventory to generate sales. A higher inventory turnover ratio indicates that a company sells its inventory quickly and may be more efficient in its operations, while a lower ratio might suggest overstocking or a slowdown in sales. The average inventory is generally calculated by adding the beginning and ending inventory for a period and dividing by two, which helps smooth out fluctuations that may occur throughout the year. This is key because mere sales figures do not provide a true picture of inventory efficiency, and using just total sales without incorporating the costs associated with those sales would be misleading. Therefore, dividing the cost of goods sold by the average inventory accurately reflects the relationship between inventory levels and sales generated, making it the appropriate method for calculating inventory turnover.