Inventory turnover

Inventory turnover 

For many companies (retailers, distributors, and manufacturers), inventory is a need and is probably their biggest current asset. To satisfy the needs of the customers, there must be enough inventory. You lose sales and even consumers if you don’t have these things in stock.  

On the other hand, a company’s liquidity may be threatened by a surplus of inventory, and some inventory goods may even become outdated. 

The inventory turnover ratio, a type of financial metric, reveals how frequently a company’s stock is sold and replaced over a given time frame. The time it takes to sell the current inventory may then be determined using the inventory turnover formula and the number of days in the period. 

What is inventory turnover? 

The number of times a company sells and replaces its stock of items throughout a specific period is known as inventory turnover, or the inventory turnover ratio. It considers the cost of items sold, by looking at its average inventory over a year or another specified period. 

By dividing the average inventory value throughout the period by the cost of products sold, inventory turnover calculates how effectively a business utilises its inventory. Inventory turnover ratios are crucial for retailers because they can be used to compare similar companies.  

While a greater ratio implies good sales it may also indicate insufficient inventory stocking. A comparatively low ratio indicates either weak sales or excess inventory. Accounting practices, abrupt changes in costs, and seasonal considerations may skew comparisons of inventory turnover. 

Inventory turnover formula and calculations 

The Inventory Turnover Ratio can be calculated using the following formula: 

Inventory Turnover Ratio=Cost of Goods Sold/Average Inventory 

where, 

• The cost of goods sold is the cost associated with producing the commodities a business sells over a specific period. The income statement of a corporation contains the price of items sold by that company. 

• The mean inventory value during a given period is the average inventory. 

How inventory turnover works 

The speed at which a company’s inventory is sold is measured by inventory turnover. Speed can be used as a barometer for business performance. Retailers who shift their merchandise quickly typically perform better. Longer-term storage of inventory will result in higher holding costs. In this case, customers might decide not to visit the store again. 

Low turnover, lackluster sales, and excess inventory are all signs of overstocking. Such a circumstance may be brought on by the products sold or inadequate marketing. When the ratio is high, either there is not enough inventory, or there are strong sales.  

The latter could result in a decline in sales. Businesses must be cautious while moving inventory when working with perishable and time-sensitive items. The more time these products remain in inventory, the more money the company loses. 

Importance of inventory turnover for a business 

Knowing how quickly inventory sells, how well it satisfies customer demand, and how its sales compare to other products in its class category are all ways to evaluate business performance. Businesses rely on inventory turnover because it is their main income source to assess their products’ efficacy. 

The product’s marketability and lower holding costs, such as rent, electricity, insurance, theft, and other expenses associated with maintaining inventory, are implied by higher stock turns. Comparing a company to others in the same industry is another reason to examine inventory turnover. Inventory turnover is used by businesses to determine if their operational efficiency meets or exceeds the usual industry benchmark. 

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