Inventory Turnover Ratio

Inventory Turnover Ratio Formula | Example | Analysis | Calculation

Inventory Turnover Ratio

Table of Contents

Inventory turnover ratio is the efficiency ratio which used to find how effectively Inventory Turnover Ratiocompany, firm or other businesses manage their inventory. It finds by comparing the cost of goods sold with average inventory for a period. This ratio is used to find the number of sold of inventory in a period.

Inventory turnover depends upon 2 main factors. Number 1 factor is the stock purchasing. If the company purchase large stock then the company can raise its turnover by selling the total inventory during the year. But if the company can’t sell its overall inventory during the year then it will incur the storage cost and other holding costs.

The second factor is sales for inventory turnover. If the sales of the company are good then inventory turnover for the company is easy.

Formula

Inventory turnover ratio formula can be calculated by dividing the cost of goods sold by the average inventory as

Inventory Turnover Ratio = cost of goods sold/average inventory

In the above formula average inventory is used instead of inventory used. Because companies fluctuate the merchandise.  Average inventory calculated by the sum of the beginning and ending inventory and dividing the result by 2. Whereas from the income statement we get the cost of goods sold.

Analysis

This ratio is used to find the efficiency of the company is to sold inventory. From this investors and management of the company knows how much inventory take time to sell. This ratio shows how efficiently a company sells the inventory which it buys.

This ratio is used to shows liquidity of the inventory of the company. Company’s biggest asset is the inventory which reported on the income statement. If the company can not sell its inventory then it is a worthless inventory for the company. So from this ratio, you can find the ability of the company to convert its inventory into cash.

If for the expansion of the business company required loan then bank looks the invnetory turnover ratio of the company.

Example

Bell has the furniture store and sells the furniture for officed and buildings. Cost of goods sold of Bell reported on the income statement is 1,000,000 dollars. beginning inventory of Bell was 300,000 dollars and the ending inventory is 400,000 dollars. Inventory turnover ratio for Bell is

Inventory turnover ratio = Cost of goods sold/average inventory

= 1,000,000/(3,000,000 + 4,000,000/2)

Inventory turnover ratio = 0.29 times

From the above result, it is clear that bells Inventory turn over ratio is 0.29 which means that Bell takes 3 years to sell its overall inventory.

For more Financial Ratio Check: 

Gross vs Net income

Interest coverage ratio

Internal Rate of Return (IRR)

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