Inventory Turnover Ratio Formula
How to calculate inventory turnover ratio for your business:
Inventory Turnover Ratio Definition and Why it is important?
Inventory turnover ratio can be a powerful performance ratio which displays exactly how efficiently inventory is actually managed simply by comparing COGS along with average inventory during any period of time. It calculates the number of times your average inventory will be turned as well as sold throughout any period of time like month or year.
Controlling inventory levels is crucial for many companies which is really true with regard to retailers as well as any organization which offers actual physical products. The actual inventory turnover ratio can be a essential metric for analyzing exactly how effective management is in managing organization inventory along with making product sales as a result.
Similar to a regular turnover ratio, the inventory turnover points just how much inventory is actually sold within a time period.
It can be measured with the following formula:
COGS / Average Inventory and also Sales / Inventory
Typically, a greater inventory turnover ratio will be desired, since it shows more product sales are made provided the specific amount involving inventory. On the other hand, for any given level of product sales, utilizing fewer inventory to accomplish that is going to increase the ratio.
In some cases a really higher inventory ratio might bring lost product sales, because there isn't sufficient stock to satisfy demand. It will always be vital that you compare the actual inventory turnover ratio towards the industry benchmark in order to asses if the business will be effectively controlling the inventory.
Typically the inventory turnover ratio by itself will take a while to put in perspective. Moving one step further, days inventory is just the inverse from the inventory turnover ratio which is actually multiplied by 360 or 365.
This places the number right into the day-to-day framework:
(Average Inventory / COGS) x 360
It substantially changes among industrial sectors which is crucial to examine it towards peer businesses.
Companies which sell perishable goods such as grocery stores or supermarkets have got lower inventory days compared to company which sells electronics or home equipment.
Here is Inventory Turnover Ratio example:
Your small business reported total annual product sales of $250,000, the inventory at the end of the year is $15,000 and the annual COGS is $160,000.
The inventory turnover for your year is:
160,000 / 15,000 = 10.7
The days inventory is:
(1 / 10.7) x 365 = 34 days.
This means that the total inventory turns within 34 days.
Related inventory metrics and examples here:
Inventory turnover ratio has become the ideal metric showing how effectively a business is actually turning the inventory in to product sales. Better yet, days inventory ratio places this right into day-to-day framework.