Inventory Turnover Ratio Analysis, Formula and How to Calculate It?

We do know about the inventory, which is the stocks we hold in an organization. Now comes to the Inventory turnover ratio, which used to calculate the ratio of goods sold and purchased during a financial year.

Inventory turnover ratio is important because it focuses on two main components of an organisation, and the first one is how many times a company purchases the stock and the second one is how many stocks company sold. Apart from this, It often used to calculate the actual financial condition of the company as if the company purchases more stocks and could not able to clear it. Then it may be a loss for the company.

Inventory Turnover Ratio Analysis:

inventory-turn-over-ratio-formula

We know that inventory is the biggest asset that the company holds. Inventory turnover ratio used to analyze the actual condition of the company, whether the company is appropriately using its resources and is it efficient for selling the stocks.

It also affects the investors as it shows how liquid the company is. Meanwhile, investors like to invest in those companies who have a higher inventory turnover ratio.

Apart from this, Creditors like banks are also interested in providing loans to these stock holding companies as they know if the company fails to clear the debts, then they can cover it by selling the stocks.

Inventory Turnover Ratio Formula:

The formula used to calculate the inventory turnover ratio. The method simplifies by dividing the cost of goods sold into average inventory.

Mathematical Formula:

Inventory Turnover Ratio = cost of goods sold/average inventory

Average inventory is preferred to use instead of ending inventory because the businesses fluctuate whole year. Therefore, It is recommended to use Average inventory instead of ending inventory.

How To Calculate?

The calculation is damn easy. You need to collect a few things before starting the calculation, and we will show you the calculation by presenting an example. We calculate the inventory turnover ratio to know about the exact details of goods sold during a year and goods purchased during a year.

Example:

Granny’s Furniture Company sells industrial furniture for office buildings. During the current year, Granny reported the cost of goods sold on its income statement of $1,000,000. Granny’s beginning inventory was $3,000,000, and its ending inventory was $4,000,000. Granny’s turnover calculated like this:

Formula:

Inventory Turnover Ratio = cost of goods sold/average inventory

Inventory Turnover Ratio = 1000000/3000000+4000000

Inventory Turnover Ratio = 0.29 Times

We can see that the inventory turnover ratio of granny is 0.29 Times it means she roughly sold one-third of her stocks during the period. It also shows that it would take around three full years to sell off this entire inventory. Meanwhile, Granny didn’t make a good score in Inventory turnover ratio.

Conclusion:

Inventory turnover ratio used to analyze the position of any company. To know about the ratio of the company for selling goods and purchasing goods. It often prefers by the banks and the investors as well. It shows us the precise data of the company about its capability of selling products.