What Is an Inventory Turnover Ratio?
Inventory turnover ratio is a calculation that measures a company’s ability to sell stock and manage inventory in a given period. It measures the number of times that a company’s inventory is sold and replaced over a specific time period. The higher an inventory turnover ratio, the better it is for a company, as this means that it is selling more and more quickly than it is buying or keeping in inventory.
How Is It Calculated?
An inventory turnover ratio is measured by taking the cost of goods sold (COGS) and dividing it by the average inventory. So, for example, if the company has a COGS of $250,000 and the average inventory is $60,000, the inventory turnover ratio is 4.17 (250,000 / 60,000 = 4.17). This means that, during the specified time period, the company sold its inventory 4.17 times.
What Does This Mean for Your Business?
A company with a higher inventory turnover ratio generally has greater liquidity, as it is able to turn over stocks more quickly and use the revenues to invest in more items for sale. This means that the company is able to smoothly manage its operations with less invested in inventory, which is beneficial in avoiding shortage of items in demand and avoiding losses due to overstocking items.
A low inventory turnover ratio, on the other hand, could be an indication that the company is having trouble selling what it has in stock and is continuously having to restock in order to maintain sales. This could result in build up of stagnant inventory, which often causes losses from outdated goods, storage costs, and other costs associated with maintaining unnecessary stock.
Conclusion
Inventory turnover ratio is an important metric for business owners and financial analysts to consider when assessing a company’s performance. This ratio helps business owners to make sure they are investing the right amount in inventory and are able to effectively turn over their stock to get the maximum returns. Having a high inventory turnover ratio is beneficial for the company as it ensures stock is always readily available for sale and brings in more revenues.