INVENTORY TURNOVER: Formula & Example

inventory turnover
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Inventory turnover is just your average annual inventory. It shows the number of times a company’s inventory sells over time. This number is significant since it allows firms to plan their financial strategies. Finding the ideal balance between inventory levels and sales is crucial to the retail industry. It’s critical to get your stock orders just right if you want to maximize sales and, thus, profiting while controlling your warehouse and inventory capacity. The formula for inventory turnover, ratio, and rate are all the details of this article.

What is Inventory Turnover?

Inventory turnover is a financial statistic that shows how many times a company’s inventory sells and replaces over a certain period. The inventory turnover formula is used to calculate the number of days it will take to sell the current inventory.

In addition to calculating inventory turnover, it can also assist firms in making better pricing, production, marketing, and inventory purchase decisions. The number of times a company’s inventory is turned over is known as inventory turnover. It is vital to maximize efficiency when selling perishable and other time-sensitive commodities. Eggs, fruit, rapid fashion, autos, and periodicals are just a few examples.

Formula for Inventory Turnover

There are things to be considered when we want to use the formula for inventory turnover. 

  • Select a time frame for your calculations. 
  • Calculate your cost of products sold for the specified time period.
  • Divide your COGS by your average inventory.

This measures how well a company can convert its inventory purchases into revenue. The formula for inventory turnover figures out how long it takes for a company to sell its entire products and the need to place more orders.

Avg. Inventory = (Beginning Inventory + Ending Inventory) / 2

I.T Ratio = (Cost of Goods Sold/Avg Inventory)

 Inventory Turnover Formula 

I.T = Net sales/Average inventory at the selling price

Inventory Turnover Ratio

The ideal inventory turnover ratio for most businesses is between 5 and 10, which means that the products are out of stock and restocked every one to two months. The appropriate ratio for perishable goods companies, such as florists and grocers, will be higher to avoid inventory losses due to spoiling.

Therefore, the inventory turnover ratio is the efficiency ratio that gauges inventory management efficiency. You can calculate the turnover ratio using a mathematical formula that divides the cost of items sold by the average inventory during the same time period. A higher ratio is preferable to a lower ratio since a high ratio indicates robust sales. Effective inventory control is also stock control, where the organization has a strong understanding of what is on hand and what it requires to determine its turnover ratio.

The inventory turnover ratio is a measure of a company’s inventory management efficiency. Higher rotation rates minimize storage and other holding expenses, so achieving a high ratio is critical. It is critical to compare ratios across companies in the same industry rather than between organizations in different industries. The benchmark ratio varies significantly per industry.

Inventory can assist in evaluating a company’s liquidity depending on the industry it works in. If a retailer reports a low inventory turnover ratio, the goods may be out of date, resulting in lost sales and increased holding expenses.

For instance, to calculate it, you ought to divide the total ending inventory by the annual cost of goods sold. For example, if your ending inventory is $20,000 and your cost of goods sold is $40,000. Divide $40,000 by $20,000, which equals 2. In most cases, when a firm’s assets are entangled in its inventory, the more it relies on faster turnover.

Limitations

  • The amount of time it takes for a corporation to sell through its inventory can vary.
  • Not knowing the average inventory turn of the company makes it hard to calculate the inventory turnover ratio using the formula. 

Advantages and Disadvantages of the Inventory Turnover Ratio

#Advanatages

  • It helps in evaluating companies’ efficiency: It is a technique that helps investors assess the success of a firm. In other words, the company needs to reduce inventory levels. 
  • It helps manage the inventory: storing too much inventory will impact the company’s working capital.
  • It also helps in managing the working capital: a company needs to spend money on the purchase and keep the inventory, which will help to generate a sale. If the inventory only stays in the warehouse, it means the company is cashless.

#Disadvantages

  • Manipulation: If management wants to maintain a favorable ratio, they will try to deduct inventory at the end of the year. It just takes into account the inventory ending balance, which may not be accurate.
  • A high ratio isn’t always a positive thing: the company will have a high ratio when the inventory balance decreases. However, it does not mean the company may not have enough inventory to fulfill customer orders.
  • Making inventory move slowly.

Inventory Turnover Ratio Formula

The amount of goods sold is equal to the inventory turnover ratio formula. It calculates the number of times inventory is out of stock within a given period by dividing the material cost by the total or average inventory. However, it can also help to determine whether inventory levels are excessively high in contrast to sales.

You can calculate the inventory turnover ratio by dividing the inventory days ratio by 365 and flipping the ratio.

A firm’s turnover ratio also tells a lot about its forecasting, management, and sales and marketing skills. A high ratio indicates either strong sales or insufficient sales. A low ratio, on the other hand, suggests low sales, low market demand, or an inventory surplus.

In other words, knowing where the sales winds blow will help you set your company’s sales in either case. You’ll need data from the balance sheet to calculate what it is. It’s crucial to know which turnover method works best for your organization, so it’s crucial to know what these terms and numbers mean to avoid a huge loss.

Terms

Cost of Sold Goods (COGS): The direct cost of producing goods (including raw materials) to be sold by the company is referred to as COGS.

The number of months in the accounting period: beginning inventory + ending inventory

The Inventory Average (AI): The amount of goods on hand is smoothed out by using average inventory over two or more time periods.

The inventory formula ratio can also be calculated using a simple formula.

  • From your annual income statement, calculate the total cost of goods sold (COGS).
  • Divide the beginning and ending inventory balances for a particular month by two to determine the average cost of inventory.
  • Finally, divide the average inventory by the cost of goods sold (cogs).

Inventory Turnover Ratio Formula

The formula for calculating the ratio is as follows:
Inventory turnover ratio = Cost of goods sold/Average inventory 

The Inventory Turnover Rate

The rate at which inventory is sold, used, and replaced is known as the inventory turnover rate. Divide the cost of products by the average inventory for the same period to get the inventory turnover ratio. A larger ratio indicates good sales, whereas a lower ratio indicates dismal sales. There is a quick inventory turnover rate. A poor turnover rate could indicate overstocking, obsolescence, product line, or marketing campaign flaws. However, in some cases, such as when increased inventory levels develop in anticipation of quick For rising prices or anticipated market shortages, a low rate may be appropriate. The ratio also reveals that if inventory is turning over slowly, the warehousing cost associated with each item will be higher. A high turnover rate, on the other hand, could imply poor inventory levels, which could result in a loss of business. This frequently leads to stock shortages.

Some industry data compilers utilize sales as the numerator rather than the cost of sales. However, since the cost of sales produces a more realistic turnover ratio, sales require comparison research. Sales are often reported at market value or the price at which the marketplace pays for the firm’s goods or services.

Simple Ways to Improve the Inventory Turnover Rate

#1. Predict Your Company’s Needs

Forecasting the demands of business and planning for surges and slowdowns are two other ways to increase your inventory turnover rate. Consumer purchasing habits can be influenced by fashion trends, seasonal demands, and holidays. Make projections based on normal fluctuations using your historical sales data and industry trends.

#2.Improve Your Marketing

Buyers’ willingness to purchase things from your inventory can be influenced by effective marketing. Use marketing methods to access new markets, appeal to members of your target audience, and establish what sets your company and products apart from the competition.

#3. Restock More Efficiently

It’s tempting to retain a large quantity of a product that sells quickly in inventory. Restocking smaller quantities more frequently, on the other hand, is often more cost-effective because it lowers excess inventory and overstock. If vendors offer discounts to regular clients, placing more frequent orders may also benefit the business financially.

#4. Always Negotiate Rates

To acquire the best pricing and keep costs under control, make sure to negotiate the rates you receive from your suppliers and distributors on a regular basis. Regular customers often receive higher prices, so if you can demonstrate a pattern of ordering or purchasing from a specific supplier, you may be eligible for a discount.

#5. Review on Prices

If you’re having difficulties shifting inventory, one of the causes could be pricing. To identify the correct price point for your items, use pricing psychology tools and tactics, and compare your prices to the cost of competitors’ items. items. products. To maintain high sales levels, keep checking in on pricing and evaluating it on a regular basis.

#6. Compare the Result to the Industry Average

Based on the target audience and business margins, a number may appear high in one industry and low in another. The average inventory turnover rate for grocery retailers is 20, while the rate for automotive parts companies can be as high as 60. You’ll probably need an industry benchmark before you can determine the success of your ratio.

 Conclusion

This write-up explains the way we can indicate whether a company’s products are selling swiftly or slowly and also keeps track of the company’s sales book and calculates the profits and losses.

Inventory Turnover FAQs

What is Inventory Turnover?

Inventory turnover indicates how frequently a company’s tangible products are sold.

Advantage of the inventory turnover ratio?

It helps in managing the working capital

What is the formula for inventory turnover?

Inventory Turnover = COGs/Average Value of Inventory

  1. 5 Most Effective Ways To Reduce Employee Turnover.
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  3. HOW TO CALCULATE COST OF GOODS SOLD: Definition & Formula.
  4. How To Calculate Average Inventory- A complete Step-by-Step Guide
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