inventory turnover ratio

What is Inventory Turnover Ratio?

Inventory Turnover ratio is the ratio of cost of goods sold to inventory. Here, inventory is the average inventory that is sum of inventory at the beginning and inventory at the end of the year divided by 2.

Some organizations calculate the ratio on the basis of just ending inventory. However some prefer to take the average inventory while calculating inventory turnover. The end of the inventory is more accurate representation of the current state of the inventory if volume is expected to continue at previous levels.

On the other hand, the average basis is the better reflection of events that happens during the period. Because it measures the amount of inventory that supports the sales activity of that period.

Inventory turnover ratio varies with the nature of the business. A business which basically deals with perishable goods has higher turnover ratio. Whereas business such as jewelry or precious items have low inventory turnover. This is because in case of expensive items, they do not turn over their inventories as often as once in a year. While calculating, it one should also consider the seasonality of sales.

Inventory Turnover Formula

Inventory Turnover = Cost of Goods Sold/ Inventory

Here, Inventory = (Beginning inventory + Inventory at the end)/ 2

This turnover ratio basically indicates the velocity with which merchandise moves through a business. However the turnover may fall because stock has build up in anticipation of more sales or the sales volume has decline. Well, former is a favorable event, the second is unfavorable.

Example of Inventory Turnover Ratio

ABC is a garment manufacturing firm consisting of cost of goods sold for a year is 10,00,000. Inventory is 2,50,000. Calculate turnover ratio?

Inventory Turnover Ratio = 10,00,000/2,50,000

= 4 times

This implies that the inventory turns over once every three months that is quarter of a year.