For instance, a company might purchase a large quantity of merchandise January 1 and sell that for the rest of the year. The inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period.Īverage inventory is used instead of ending inventory because many companies’ merchandise fluctuates greatly throughout the year. That’s why the purchasing and sales departments must be in tune with each other. Sales have to match inventory purchases otherwise the inventory will not turn effectively. If the company can’t sell these greater amounts of inventory, it will incur storage costs and other holding costs. If larger amounts of inventory are purchased during the year, the company will have to sell greater amounts of inventory to improve its turnover. This ratio is important because total turnover depends on two main components of performance. A company with $1,000 of average inventory and sales of $10,000 effectively sold its 10 times over. In other words, it measures how many times a company sold its total average inventory dollar amount during the year. This measures how many times average inventory is “turned” or sold during a period. So it is the responsibility of the store in charge to balance the inventory.The inventory turnover ratio is an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. 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. But there is risk in less inventory of delivery failure to customer. Because excess inventory is also a waste. Inventory management is a critical part of a company. So the target should be to increase the inventory turnover and reduce the number of days in inventory. The average inventory in the company is for 18 days. Nos of days inventory = (Average inventory / Cost of goods sold ) X 360įrom the above example, it is clear that the average inventory of the company turn (sold) 20 times in a year. Inventory Turnover Ratio = Sale / Average inventory = 60 / 3 = 20 Then what will be the Inventory turnover ratio and Nos of days inventory? If a company’s sale is 60 crores in a year and the average inventory of the company is 3 crores. The number of days should be less to convert inventory into sales. Nos of days inventory = (Average inventory / Cost of goods sold ) X 365 It is the inverse of the inventory turnover ratio. It means how many days it takes for inventory to convert (turn) into a sale. Where average inventory is the average of start and end inventory in a month. Inventory Turnover Ratio = (Cost of goods sold in a month X 12) / Average inventory in a month If we need to calculate Inventory Turnover Ratio in a month, then we calculate as below: It means it will be equal to the sale of goods. The cost of goods sold is the production cost of goods which includes Raw material cost, Labor cost and company overheads.Average inventory = (Start inventory + End inventory) / 2.Average inventory can be calculated by adding start and end inventory and dividing by 2.
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