What is the inventory turnover ratio and the number of days inventory

Inventory Turnover:

Inventory turnover is the rate at which a company converts its inventory into sales. It is the number of times a company makes the sale of its inventory in a period. Where inventory is the total of all goods in its stock, which includes Raw materials, bought-out parts, Work in progress and finished goods.

It is better to maintain inventory turnover at be higher level. A higher inventory turnover means more and quicker sales. But lower inventory turnover indicates fewer sales and less demand for the products.

How to Calculate Inventory Turnover Ratio?

The inventory turnover ratio formula is the Cost of Goods Sold divided by the Average inventory.

Where

• Average inventory is the average of the start inventory and the end inventory in a year. Average inventory can be calculated by adding the start and end inventory and dividing by 2.

• Average inventory = (Start inventory + End inventory) / 2

• The cost of goods sold is the production cost of goods, which includes Raw material cost, Labor cost and company overheads. It means it will be equal to the (Sale of goods – Profits) in a year.

Monthly Inventory Turnover Ratio :

If we need to calculate the Inventory Turnover Ratio in a month, then we calculate it as below:

Inventory Turnover Ratio = (Cost of goods sold in a month X 12) / Average inventory in a month

Where average inventory is the average of the start and end inventory in a month.

The number of days’ inventory:

It means how many days it takes for inventory to convert (turn) into a sale. It is the inverse of the inventory turnover ratio.

Nos of days inventory = (Average inventory x 365/ Cost of goods sold )

The number of days should be fewer to convert inventory into sales.

Note: In some industries total number of days is taken as 300 or the actual working days in a year.

Inventory Turnover Ratio example:

If a company’s cost of goods sold is 60 crores in a year and the average inventory of the company is 3 crores. Then what will be the Inventory turnover ratio and the number of days’ inventory?

Note: Here, the Cost of Goods Sold + Profit = Sales

Inventory Turnover Ratio = Sale / Average inventory = 60 / 3 = 20

Nos of days inventory = (Average inventory / Cost of goods sold ) X 360

= ( 3 / 60 ) x 360 = 18 days

From the above example, it is clear that the average inventory of the company turns (sells) 20 times in a year. The average inventory in the company is for 18 days. So the target should be to increase the inventory turnover and reduce the number of days in inventory.

Inventory Turnover Ratio analysis | Conclusion:

Inventory management is a critical part of a company. Because excess inventory is also a waste. But there is a risk in having less inventory of delivery failure to the customer. We should balance the inventory of the company to achieve maximum turnover while fulfilling customer demand as well.

The inventory turnover ratio is a financial measure that reflects how effectively a company manages and sells its inventory. A high ratio typically indicates efficient inventory management, quicker sales, and reduced holding costs. In contrast, a low ratio may suggest excess inventory or sluggish sales.

The inventory turnover ratio is the main quality objective of the store department in a company. So it is the responsibility of the store in charge to balance the inventory.