![]() ![]() Inventory turnover is a very important metric used to determine the data of all the products a business has sold by calculating the cost of goods sold and average inventory. This would also mean that overstocking has occurred in that specific accounting period. Whenever a business reveals a low inventory ratio, you can easily determine that it has been unable to convert its inventory into cash by not being able to sell the products before the next inventory cycle. In simple words, a higher inventory turnover ratio would mean the business has been able to perform quite efficiently compared to those who have a lower inventory turnover ratio. What Does Inventory Turnover Ratio Indicate?Ī company can use an inventory turnover ratio to indicate how well it has been able to perform the sales of all products in its inventory while also keeping in mind its total cost. Moreover, using this inventory turnover ratio, your business can also calculate the total time that your company would take to sell out all the inventory that is still present in hand. That is when the calculation of the inventory turnover ratio comes into the picture, which considers the total cost of goods sold and divides it by the number found from the average inventory. However, when it comes to seasonal fluctuation, a common occurrence for a business, the calculation of average inventory falls slightly short of its accuracy. Therefore, using the formula of average inventory, you can understand quite a few things about your business comprehensively. First of all, the average inventory is used to find out the stock in the business or the number that has been emptied before new inventory could be brought upon based on a few months or days. The inventory ratio works in a simple manner. Using this formula of inventory turnover ratio, your business would be able to find out the actual stock limits on which it has been operating through an end of an accounting year. Inventory Turnover Ratio Formula: Inventory Turnover ratio = cost of goods sold / average inventory.Average Inventory (AI): Average inventory is the method through which a company eases out the calculation by dividing the total number of inventories in hand by consecutive periods.Cost of Goods Sold (COGS): Cost of goods sold or COGS is the total cost incurred by the company for directly selling its products.Inventory Turnover Formula and Calculationīefore you hop onto the details of the formula to calculate the inventory turnover ratio, you must understand the terms included in the formula. The formula of inventory turnover ratio is the total cost of the goods sold (COGS) divided by the average inventory.īy knowing the inventory turnover ratio, you as a business owner can decide better when it comes to pricing your products, manufacturing them, as well as marketing or buying them.Ī low inventory turnover ratio indicates fewer sales and excess inventory, and a higher inventory turnover ratio indicates the company has been generating sales at a greater number. You can use the formula of inventory turnover ratio to find out how many days it would be required for your business to sell out the total inventory in hand. ![]() The inventory turnover ratio tells you how fast the company replaces its inventory by converting it to sales. However, the companies that produce luxury goods are known to produce at a lower inventory turnover because of low demand for their products and higher production time. It tells you how good the company is at managing its inventory.Ĭompanies involved in consumer durable goods generally have a higher inventory turnover due to high demand for their products. To calculate it, you need to divide the COGS by the average inventory for the specific time period. Using this, you can easily determine the rate at which you require inventory for sale before the end of a month.īasically, inventory turnover is a metric that measures how often a company replaces its inventory. To explain in simple terms, inventory turnover reveals the number of times your inventory is sold during a certain time frame in relation to its cost of goods sold (COGS). Keep reading to know all that you need to, on this topic. In this article, we have discussed everything you need to know about the inventory turnover ratio like its formula, tips, examples, limitations, calculations, and more. There can be many instances when companies face irregularities with their inventory because of miscalculations of the average inventory and inventory turnover ratio that is supposed to be maintained throughout an accounting period. Whenever there is talk about inventory, you should take precautionary steps so that the rate of loss can be minimized to a certain level. The inventory turnover ratio is the most important component of inventory management. ![]()
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