- The inventory turnover ratio can be calculated by dividing the cost of goods sold by the average inventory for a particular period.
- Inventory Turnover = Cost Of Goods Sold / ((Beginning Inventory + Ending Inventory) / 2)
- A low ratio could be an indication either of poor sales or overstocked inventory.
Why is inventory turnover important?
Inventory turnover is important for several reasons. To begin with, your sales department will have a large stock of products to sell if your business receives a large stock of products. You’ll start to pay for the cost of keeping these goods on store shelves or in storage if many of them aren’t sold. Additionally, the quantity of sales for a specific good must match the quantity of that same good in stock. This ensures a consumers demands are being met. For instance, your inventory turnover will be incorrect if you sell a customer a pair of pants but later realize you don’t have any in stock because there was nothing to “turn” or give to the customer.
In the end, inventory turnover ensures that you are not overbuying inventory and spending excessive amounts of money to keep it in stock when no one wants to buy it.
What is inventory turnover?
Inventory turnover measures how quickly your business can replenish its stock in a given time frame. The frequency at which this turnover occurs is measured as the inventory turnover rate. In other words, it’s the rate at which consumers buy your company’s inventory. The inventory ratio enables you to assess the efficiency with which your inventory is converted into sales. It also informs you if you’re keeping too much inventory on hand and incurring storage and other costs as a result.
How to calculate inventory turnover
You must precisely calculate your inventory turnover rate in order to assess the rate at which you can convert your inventory into a sale. Here are the steps youll need to take:
1. Determine the cost of goods sold
You’ll need the cost of the products your business sold to determine your inventory turnover ratio. The price paid to produce the goods is referred to as the cost of goods sold. This can include the cost of labor, materials and more. You can find this number on your companys income statement.
2. Determine your companys average inventory
You’ll need the typical inventory for your company rather than an exact amount. This is due to the fact that businesses frequently have fluctuating inventory levels over the course of a given period. For instance, you might have a sizable stock of swimsuits in June, but by the end of the summer, you might have almost run out of them. An accurate representation of your typical inventory wouldn’t be obtained by using data from June or the end of the summer.
3. Calculate your inventory turnover rate
Once you have the aforementioned factors, divide the cost of goods sold by the average inventory to get your inventory turnover rate. Use the following formula to calculate your inventory turnover rate:
Inventory turnover ratio equals (cost of goods sold) divided by (period average inventory).
What is considered a good inventory turnover rate?
Typically, a four to six inventory turnover rate is regarded as ideal. But a lot depends on the kind of business you have and the sector you work in. For instance, if you run a grocery or convenience store, you’re more likely to have a high inventory turnover rate because these businesses sell items that customers frequently need to buy and many of which must be replenished before they expire.
A company should aim for a high inventory turnover rate because it indicates strong product sales. This also means their products are in high demand. More sales are made when the inventory ratio is higher. A high inventory turnover rate, though, might also indicate that there is not enough stock. In contrast, a low inventory turnover rate indicates that a business is having trouble selling its products because there isn’t a market for them. Therefore, inventory turnover aids in determining how a product’s popularity relates to consumers’ need for purchase.
The ultimate objective is for the purchasing and sales departments of a company to work in harmony. This guarantees that demand is not only high but also satisfied.
Example calculations
Here are some examples of inventory turnover rate calculations:
Example 1
Imagine you are the owner of a large corporation with a cost of goods sold of $100 million in 2018. You also had an inventory of $10 million. Divide your cost of goods sold ($100 million) by your average inventory ($10 million) to get your inventory turnover rate. This will result in an inventory rate of 10.
Example 2
You are the owner of a neighborhood supermarket with a cost of goods sold for this year of $500,000. At the start of the year, the cost of inventory was $50,000. By year’s end, the cost of inventory will be $20,000. You must determine the average inventory in order to calculate your inventory turnover ratio, so you add 50,000 and 20,000 and divide by two to arrive at an average inventory of $35,000 Following this, you can calculate your inventory turnover ratio of 14 by dividing the cost of goods sold ($500,000) by the average inventory ($35,000). 29.
How to Calculate Inventory Turnover
FAQ
What is inventory turnover example?
Inventory turnover is calculated as COGS divided by average inventory value. For instance, if your average inventory value was $50,000 and your COGS for the previous year were $200,000 in goods, your inventory turnover ratio would be 4.
How is inventory turnover calculated and what does it measure?
Inventory turnover is a ratio that counts how many times inventory is sold or used up in a certain amount of time. The inventory turnover formula is calculated by dividing the cost of goods sold (COGS) by average inventory, also known as inventory turns, stock turn, and stock turnover.
What is the formula for calculating inventory?
Beginning inventory plus net purchases minus COGS equals ending inventory is the basic formula. Your beginning inventory is the last period’s ending inventory. The items you purchased and added to your inventory count are the net purchases.
