WHAT IS INVENTORY TURNOVER: Examples, Turnover & Complete Guide

Any business that sells products has one of the highest capital expenditures: inventory. This sort of business balance sheet is most likely to indicate that inventory consumes a significant amount of working capital, therefore, making up a sizable component of current assets. Besides, finding a sweet spot between stock and sales is essential in retail. It is crucial to get your stock orders just right in order to maximize sales and profitability while effectively managing your warehouse and inventory. That’s why inventory turnover is such a crucial measure for effective inventory management. In this piece, you will find out all you need to know about inventory turnover in accounting, types, the rate as well as control.

What Is Inventory

The term “inventory” is used to describe both the raw materials and finished commodities that are kept on hand for potential customers to purchase. A company’s inventory is a valuable asset since it is directly linked to the development of sales and, ultimately, profits for shareholders.

In accounting, inventory refers to items that have not yet been sold but are in the process of being prepared for sale.

Inventory management involves keeping track of all of a company’s raw materials, finished goods, as well as components. When you’re in charge of a company, it’s basically your job to practice inventory management so you always know how much stock you have and can react quickly if you run out.

Both retailers and manufacturers can stay in business if they have inventory on hand to sell or use in production. While for many companies, stock on hand represents a sizable asset, carrying a surplus of items can be a burden.

What Is Inventory Turnover

Inventory turnover is a financial ratio that demonstrates how frequently a company turns over its stock in relation to its cost of goods sold (COGS) over the course of a specific period.

The accounting term “inventory turnover” is a measure of the number of times inventory is sold or used in a time period such as a year. It Determines whether or not a company has an excessive amount of inventory in relation to its sales volume. By dividing the inventory turnover ratio by the number of days in the period (usually a fiscal year), a company can get an idea of how long it takes to sell its stock on average.

In business, the inventory turnover ratio relates to the rate at which an organization sells and replenishes its stock of items. It measures how quickly a company sells its stock of goods and can indicate how well it is moving products or a warning sign of difficulties ahead if sales are slow and stockpiles build up.

The competitiveness and intra-industry performance can be evaluated by comparing the inventory turnover to historical ratios, planned ratios, and industry averages. However, depending on how their operations, the rate at which an industry turns over its inventory might vary widely.

Types of Inventory in Accounting

Generally, there are four basic types of inventory in accounting; raw materials, work-in-progress (WIP), merchandise and supplies, and finished goods. Organizations can use these four primary groups to better organize and keep tabs on their supply and projected demand. However, to aid businesses in more precisely and efficiently managing their inventory, it is possible to subdivide the primary categories further.

#1. Raw Materials

Raw materials are the basic components from which a company manufactures its goods or products. Rany raw ingredients, such as oil used to make shampoo, are often indistinguishable from their original form in the final product.

#2. Safety Stock and Anticipation Stock

Safety stock generally refers to the surplus of goods that a business keeps on hand in case of emergencies. Although there are storage fees associated with safety stock, they help keep customers happy. Similarly, raw materials or completed goods that a company buys in advance of need based on projections of future demand make up anticipation stock. A company may invest in safety stock if the price of key raw materials is expected to rise or if the timing of a sales peak is imminent.

#3. Decoupling Inventory

The term “decoupling inventory” refers to the surplus materials or work-in-progress held at each station of a production line. While it’s common practice for businesses to keep some sort of emergency supply on hand, only those that have to do with product manufacturing can benefit from decoupling inventory in the event that separate elements of the production line operate at different rates.

#4. Components

Components are similar to raw materials. This is in the sense that they are also the materials a company uses to manufacture its product. However, unlike raw materials, components like a screw are still easily identifiable in the finished product.

#5. Work In Progress (WIP)

The term “work in progress” (WIP) inventory refers to products that are currently being produced. These items can include labor, overhead costs, raw materials or components, and perhaps even packing supplies.

#6. Finished Goods

Products that are considered “finished” are basically ones that have been manufactured and are now available for purchase.

#7. Maintenance, Repair, and Operations (MRO) Goods

MRO stands for “materials, tools, and supplies.” Basically, it refers to the inventory necessary for the production of a good or the operation of a company.

#8. Service Inventory

Service inventory is a management accounting term. It describes the amount of a particular service that a company is able to supply during a specific time period. For instance, a hotel that has 20 rooms has a service inventory of 140 one-night stays each week.

#9. Packing and Packaging Materials

Generally, there are three different kinds of materials used for packing. Primarily, primary packaging safeguards the product and allows for its practical application. Secondary packaging is the packaging that is used for the final product. And this may include labels or information regarding the SKU. Tertiary packaging refers to the packaging of goods in large quantities for delivery.

#10. Cycle Inventory

Businesses typically order their cycling goods in bulk to save money on shelving space. When companies order cycle inventory, they do it in lots to ensure that they have the appropriate quantity of goods while maintaining the lowest possible storage cost.

#11. Theoretical Inventory

Theoretical inventory is the smallest amount of stock that a corporation needs to have in order to finish a procedure without having to wait. It is also known as book inventory. The production sector and the food business are the most common users of theoretical inventory. When measuring it, the real formula is used rather than the theoretical one.

#12. Excess Inventory

The term “excess inventory” refers to unsold or unused commodities or raw materials that a company does not anticipate using or selling but is nevertheless required to pay to hold. This type of inventory is also known as “obsolete inventory.”

#13. Transit Inventory

Transit inventory, also known as pipeline inventory, refers to goods that are in the process of being transferred from the manufacturer to the warehouses and then to the final distribution points. It could take weeks to relocate stock in transit between warehouses.

What Is Inventory in a Business?

Inventory is a broad term that encompasses all of the commodities, goods, merchandise, and materials that are kept by a business with the intention of selling them in the market in order to make a profit.

Inventory in a manufacturing business includes not only the finished product that has been produced and is now available for sale but also the raw materials that are utilized in production as well as the semi-finished goods that are stored in the warehouse or that are produced on the factory floor.

How Can Inventory Turnover Be Improved?

To optimize profits without overinvesting or taking excessive risks, some stores use purchase budgeting or inventory management software that allows for “open-to-buy” purchases. A pull-through production method is an option for businesses with streamlined supply chains and quick manufacturing timelines, this delays the acquisition of raw materials until after a consumer has placed an order for the product.

What Are the Two Main Inventory Methods?

The two basic methods of inventory are;

FIFO
LIFO

While using the FIFO method, it is assumed that the things that were bought first will be the ones to be shipped out of the warehouse. In other words, according to the FIFO system, anytime you make a sale, the items will be deducted from the first list of products that entered your store or warehouse.

In LIFO, you assume the reverse, that the last items or goods that enter your store will be the ones to exit first.

What Is the Main Purpose of Inventory?

The inventory is there to act as a safety valve between manufacturing and retail. This is by soaking up excess capacity and keeping products on hand for when they are needed most by customers. A company can only accomplish this through meticulous inventory management plus, if necessary, the implementation of a dedicated IT infrastructure.

What Is Another Word for Inventory in Business?

Inventory turnover is also known as inventory turns, merchandise turnover, stockturn, stock turns, turns, and stock turnover.

What Are the Functions of Inventory?

Inventory management’s primary purpose is to ascertain the right quantity and kind of raw materials, work-in-progress, and finished goods to have on hand for manufacturing, assembly, and retailing activities while keeping overhead to a minimum.

What Is Inventory Control

Stock control, or inventory control, refers to the act of keeping track of the items a business has on hand at any given time. This is regardless of whether they are physically located in one central warehouse or in multiple locations. Inventory control involves taking care of goods from the moment you receive them until they are either sold to customers or discarded (not ideal). Inventory control systems also help track their ( the goods) circulation, utilization, and storage.

Having tight control over your inventory means always having just the right amount of each product on hand. Besides, maintaining a healthy supply chain requires careful inventory management to keep track of purchase orders. Hence, you can set up systems to aid in predicting and provide you the ability to specify reorder points.

The overarching objective is to increase earnings while keeping as little inventory in your warehouse as is practical. For your company to succeed, this, however, cannot come at the expense of happy customers. While manual inventory management is an option, automated methods are also available. And they are both options to assist reduce the likelihood of making costly mistakes when tracking stock levels.

The Importance of Inventory Control

Inventory control allows businesses to make more strategic purchases. This method is sometimes referred to as “stock control.” It helps maintain optimal stock levels, cut down on storage expenses, and avoid running out of essential items.

Inventory control effectively enables businesses to maximize their profits. It helps businesses examine their ongoing assets, account balances, and financial reports while minimizing the cost of stock investments. It’s vital since it keeps you from spending a fortune on a stock that you won’t utilize and instead makes it easier to focus on what you need.

It’s a method for making sure a business can keep up with demand from its customers. And also stretch its finances in response to changes. With proper stock management, you can maximize your earnings with minimal stock while keeping your customers happy. If done properly, it can help businesses evaluate their present asset allocation, cash flow, and financial statements.

Conclusion

A company’s inventory turnover rate is a good indicator of how regularly its physical goods are sold. The turnover rate indicates to the company whether or not its products sell quickly. The data in turn assist the business in making decisions.

Even though the “sweet spot” for inventory turnover varies by market and business size, a decent rule of thumb is anywhere from four to eight times every year.

When a company has a high inventory turnover rate, it means that it is selling its products quickly and making a strong profit. However, if inventory turns over too quickly, that could mean the company isn’t carrying enough of the goods that customers want.