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 to be higher. A higher inventory turnover means more and quick 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.
- 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
- 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.
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.
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 / Cost of goods sold ) X 365
The number of days should be less to convert inventory into sales.
Inventory Turnover Ratio example:
If a company’s sale 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 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 the average inventory of the company turn (sold) 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 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 to achieve maximum turnover while fulfilling customer demand as well. 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.