Inventory Turnover Ratio
Inventory turnover is the rate at which a company converts its inventory into sales. It is the number of times a company makes sale of its inventory in a period. Where inventory is the total of all goods in its stock which includes Raw material, Brought out parts, Work in progress and Finished goods.
It is better to maintain inventory turnover to be higher. A higher inventory turnover means more and quick sale. But lower inventory turnover indicates fewer sale and less demand for the products.
How to calculate Inventory turnover Ratio?
Inventory turnover ratio formula is the Cost of Goods Sold divided by Average inventory.
Inventory Turnover Ratio = Cost of goods sold / Average inventory
- Average inventory is the average of start inventory and end inventory in a year. Average inventory can be calculated by adding start and end inventory and dividing by 2.
- Average inventory = (Start inventory + End inventory) / 2
- 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 sale of goods.
Monthly Inventory Turnover Ratio :
If we need to calculate Inventory Turnover Ratio in a month, then we calculate 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 start and end inventory in a month.
Number of days inventory:
It means how many days it takes for inventory to convert (turn) in to sale. It is the inverse of inventory turnover ratio.
Nos of days inventory = (Average inventory / Cost of goods sold ) X 365
Number of days should be less to convert inventory into sale.
Inventory Turnover Ratio example:
If a company sale is 60 crore in a year and average inventory of the company is 3 crores. Then what will be the Inventory turnover ratio and Nos of days inventory?
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 average inventory of the company turn (sold) 20 times in a year. Average inventory in the company is for 18 days. So target should be to increase the inventory turnover and reduce number of days inventory.
Inventory management is a critical part of a company. Because excess inventory is also a waste. But there is risk in less inventory of delivery failure to customer. We should balance the inventory of the company so that to achieve maximum turnover while fulfilling customer demand as well. Inventory turnover ratio is the main quality objective of the store department in a company. So it the responsibility of store in charge to balance the inventory.