You can assess how marketable your products are and how successful your marketing is using the inventory turnover ratios for each of your products. Inventory turnover is an essential metric for assessing how well your business is doing. This metric can assist you in making more informed choices regarding production, product acquisition, inventory management, marketing, and customer sales.
Inventory Turnover: What Is It?
Inventory turnover is the period of time between when a corporation purchases a product and when it is sold. Having sold all of the merchandise that was purchased, less any items lost to damage or shrinkage is referred to as a complete turnover of inventory.
Inventory turnovers occur frequently in successful businesses, however, the number varies by industry and product category. While particularly high-end luxury items, such as luxury handbags, typically see few units sold per year and lengthy production schedules, consumer packaged goods (CPG) typically have rapid turnover.
Turnover can be impacted by a variety of inventory management issues, such as fluctuating client demand, inadequate supply chain planning, and overstocking.
Main Points
- All products—whether raw or finished—that a business keeps on hand with the intention of selling are considered inventory.
- The rate at which inventory stock is sold, used up, and replaced is known as inventory turnover.
- By dividing the cost of items by the average inventory for the same time period, the inventory turnover ratio is derived.
- A greater ratio typically denotes good sales while a lower ratio generally denotes dismal sales. In contrast, a greater ratio can signify having too little inventory on hand, while a lower one would signify having too much.
What Is the Ratio of Inventory Turnover?
The number of times a business has sold and restocked its inventory over a predetermined period of time is known as the inventory turnover ratio. The number of days it will take to sell the current inventory can also be determined using the formula.
The cost of products sold is divided by the average inventory for the same period in a mathematical formula that yields the turnover ratio. A greater ratio is preferable to a lower one because it typically denotes good sales.
Effective inventory control, also known as stock control, where the business has good visibility into what it has on hand, is necessary to know your turnover ratio.
Explaining Inventory Turnover Ratio
Businesses may make better judgments in a range of areas, such as pricing, production, marketing, purchasing, and warehouse management, by measuring and calculating inventory turnover.
In the end, the inventory turnover ratio gauges how well the business makes sales from its inventory. There are numerous KPIs that can offer information on how to boost sales, enhance the marketability of certain stocks, or improve the overall mix of inventory.
The Workings of Inventory Turnover Ratio
To balance out spikes and dips caused by anomalous changes reflected in a single period of time, such as a day or month, average inventory is generally utilized. Thus, average inventory produces a more steady and trustworthy measure.
In the case of seasonal sales, for instance, stocks of specific commodities, such as patio furniture or artificial trees, are disproportionately pushed up just before the season and are severely reduced at its conclusion. However, ending inventory figures for the same time period as the cost of goods sold (COGS) figure can also be used to compute the turnover ratio.
The method can also be used to determine how long it will take to sell all of the present inventory. Days sales of inventory (DSI) is determined using the following formula in a daily context:
(Average inventory/cost of goods sold) x 365
How is the inventory turnover ratio (ITR) calculated?
Inventory turnover can be calculated by businesses. Either market sales data or the cost of goods sold (COGS) split by inventories are included in this common methodology.
Start by dividing the total of the beginning and ending inventories by two to determine the average inventory during a period:
Average inventory = (beginning inventory + ending inventory) / 2
If there are no seasonal swings in the firm, ending stock can be used in place of average inventory. However, since there are more data points available, multiply the monthly inventory by 12 to get the annual average. then utilize the inventory turnover formula:
Inventory Turnover Ratio = Cost of Goods Sold / Avg. Inventory
Calculations and the formula for inventory turnover
Understanding what these terms and figures mean is crucial because you will need to use the balance sheet to extract data for whatever inventory turnover model works best for your business.
The expense for goods sold (COGS)
The direct costs of producing the goods (including the raw materials) that the company plans to sell are known as COGS.
Standard inventory (AI)
The amount of inventory on hand throughout two or more specified time periods is smoothed out by average inventory.
Beginning Inventory + ending inventory/number of months in the accounting period
The ratio of inventory turnover
The inventory turnover ratio calculates how frequently inventory is sold and replaced during a specific time frame.
Inventory Turnover Ratio = Cost of Goods Sold / Avg. Inventory
Examples of inventory turnover ratios
A specialist in high-end, handcrafted dining sets made of exotic woods is Cherry Woods Furniture. The retailer reported $47,000 in COGS and $16,000 in average inventory during Q3, which was also its busiest quarter. The inventory turnover ratio is calculated by dividing $47,000 by $16,000. Three is the inventory turnover.
We’ll use the same firm and circumstance as in the first example for the second, but this time we’ll compute the average inventory period, or how long it will take to sell the inventory that is now in stock. The inventory turnover ratio is 3, as we already know. By multiplying the number of days in a year by 3, or 3, you get 121.67, which is the number of days it will take to sell the inventory you currently have at the going rate.
