Key Points
- The ratio equals cost of sales divided by average inventory; a higher figure indicates faster stock movement and lower holding risk.
- Manufacturing companies in Europe typically report inventory turnover between 4 and 8 times per year, though the range varies widely by sector.
- A declining ratio often signals obsolete or slow-moving stock that may require a write-down to net realisable value under IAS 2.9.
- Auditors use the ratio during planning analytics (ISA 520) to flag unusual inventory build-ups that could indicate overproduction or demand problems.
What is Inventory Turnover?
The formula divides cost of sales for the period by average inventory (opening plus closing inventory divided by two). Some practitioners use closing inventory alone when interim data is unavailable, but the average produces a more representative figure for businesses with seasonal stock patterns. IAS 2.34 requires disclosure of the total carrying amount of inventories and the amount recognised as an expense during the period, which gives the auditor both inputs without relying on management schedules.
A falling inventory turnover ratio between periods raises two questions the auditor needs to answer. First, has the entity accumulated stock it cannot sell? If so, IAS 2.28 requires a write-down to net realisable value, and ISA 540.13 requires the auditor to evaluate whether the entity's method for estimating that write-down is appropriate. Second, has the cost allocation method changed? IAS 2.25 permits FIFO or weighted average cost but prohibits LIFO under IFRS. A switch between permitted methods or an error in overhead allocation under IAS 2.12-14 will distort both the numerator and the denominator.
ISA 520.5 requires the auditor to design analytical procedures as risk assessment procedures. Inventory turnover is one of the most direct signals available. When the ratio drops by 20% or more year-on-year without a corresponding change in the business model, the auditor investigates the ageing profile of inventory on hand and tests whether the provision for obsolescence is adequate.
Worked example: Fernandez Distribucion S.L.
Client: Spanish wholesale distribution company, FY2025, revenue EUR 34M, IFRS reporter. Fernandez distributes consumer electronics to independent retailers across the Iberian peninsula.
Step 1 — Gather the inputs
Cost of sales for FY2025 is EUR 26.8M per the draft income statement. Opening inventory at 1 January 2025 was EUR 5.4M; closing inventory at 31 December 2025 is EUR 7.1M. Average inventory is (EUR 5.4M + EUR 7.1M) / 2 = EUR 6.25M.
Step 2 — Calculate the ratio
EUR 26.8M divided by EUR 6.25M produces an inventory turnover of 4.29 times. In FY2024, the ratio was 5.51 times (cost of sales EUR 25.1M, average inventory EUR 4.55M). The decline of 1.22 turns (22%) is significant.
Step 3 — Investigate the decline
The engagement team identifies two drivers. First, Fernandez pre-purchased EUR 2.0M of a new product line in Q4 2025 in anticipation of a January 2026 marketing campaign. Second, EUR 0.9M of older-model tablets remain in stock with no active purchase orders from retailers. Management has not recorded a write-down for the older models.
Step 4 — Quantify the potential write-down
The older tablets cost EUR 0.9M. The most recent resale transactions for comparable models averaged 45% of original cost. Net realisable value is EUR 0.9M multiplied by 45%, producing EUR 0.41M. The required write-down is EUR 0.49M. After recording this write-down, closing inventory falls to EUR 6.61M, average inventory becomes EUR 6.01M, and the adjusted turnover ratio rises to 4.46 times.
Conclusion: the adjusted inventory turnover of 4.46 is defensible because the pre-purchased stock has confirmed future demand and the obsolete stock has been written down to supported net realisable value.
Why it matters in practice
Teams accept management's inventory provision without testing whether the turnover ratio supports the provision level. An entity reporting stable or rising turnover alongside a growing provision balance (or the reverse, declining turnover with no provision increase) presents a logical inconsistency that ISA 520.A5 requires the auditor to investigate. The ratio and the provision must tell the same story.
The FRC's 2023 inspection cycle flagged inventory valuation as a recurring deficiency, noting that audit teams frequently test the existence of inventory at the count date without adequately testing the net realisable value assertion. IAS 2.28-33 requires measurement at the lower of cost and NRV at the individual item level (or at the level of groups of similar items where IAS 2.29 permits). Testing count accuracy alone does not address the valuation risk that a declining turnover ratio signals.
Inventory turnover vs. receivable days / DSO
| Dimension | Inventory turnover | Receivable days (DSO) |
|---|---|---|
| What it measures | Speed at which the entity converts inventory into cost of sales | Speed at which the entity collects cash from credit sales |
| Formula | Cost of sales / average inventory | (Trade receivables / revenue) x 365 |
| Where the risk sits | Obsolescence, overproduction, or demand decline requiring IAS 2 write-down | Credit risk and recoverability requiring IFRS 9 expected credit loss assessment |
| Audit procedure link | Inventory count observation and NRV testing (ISA 501.4) | Trade receivable confirmation and ageing analysis (ISA 505) |
| Going concern signal | Persistent build-up suggests the entity cannot convert stock to cash | Persistent extension suggests customers cannot or will not pay |
Both ratios feed into the cash conversion cycle. An entity with slow turnover and long receivable days ties up cash at both ends of the operating cycle, directly affecting the working capital position the auditor evaluates under ISA 570.
Related terms
Frequently asked questions
How do I document inventory turnover in the audit file?
Record the formula, both the current and prior-year ratios, and the percentage change. ISA 520.5 requires the auditor to develop an independent expectation based on prior-period results and known changes in the business. Document what you expected, what you found, and why any variance is or is not indicative of a misstatement risk.
Does inventory turnover apply to service companies?
Rarely in a meaningful way. Service entities carry minimal or no inventory on the statement of financial position. Where a service entity does hold consumable supplies, IAS 2.3 may scope those items in, but the amounts are usually immaterial. The ratio is most relevant for manufacturing, distribution, and retail engagements where inventory is a significant balance sheet item.
When should a low inventory turnover trigger a write-down?
A low or declining ratio does not automatically require a write-down. It signals that the auditor should test net realisable value under IAS 2.28. If the expected selling price less costs to complete and sell exceeds cost, no write-down is needed regardless of how slowly the item moves. The write-down obligation arises from the NRV comparison, not from the turnover figure itself. ISA 540.13(a) requires the auditor to evaluate whether management's method for the NRV estimate is appropriate given the circumstances.