Guide to Understanding Inventory Turnover Show
Inventory Turnover is a ratio measuring the number of times that a company has replaced its inventory balance in a specific period. Table of Contents
How to Calculate Inventory TurnoverThe inventory turnover ratio portrays the efficiency at which the inventory of a company is turned into finished goods and sold to customers. In other words, the ratio measures how well a company can convert its inventory purchases into revenue. The ratio is calculated by dividing the cost of goods sold (COGS) by the average inventory balance for the matching period. Thus, the metric determines how long it takes for a company to sell its entire inventory (and need to place more orders). The steps for calculating the ratio are the following:
Inventory Turnover FormulaFormula Comparing a company’s ratio to its industry peer group can provide insights into how effective management is at inventory management. Practical Questions
How to Interpret Inventory TurnoverSince the turnover of inventory represents the number of times that a company clears out its entire inventory balance across a defined period, higher turnover ratios are preferred.
The company’s inventory, if left unsold, might eventually need to be written down to reflect the true (lower) value on the balance sheet. For companies with low turnover ratios, the duration between when the inventory is purchased, produced/manufactured into a finished good, and then sold is more prolonged (i.e. requires more time). That said, low turnover ratios suggest lackluster demand from customers and the build-up of excess inventory. Retailers are typically known for exhibiting high turnover ratios – in particular, “fast-fashion” retailers like Zara are highly regarded for their ability to research trends and clear out their inventory quickly. Caveat to High Turnover If a company’s inventory has an abnormally high turnover, it could also be a sign that management is ordering inadequate inventory as opposed to managing inventory well. In such cases, the amount of pent-up demand (i.e. back orders, delayed deliveries, and speed) must be evaluated to understand the reality of the circumstances, as well as if there is an adverse impact on revenue. Rather than being a positive sign, high turnover could mean that the company is missing out on potential sales due to insufficient inventory. Inventory Turnover Calculator – Excel Model TemplateWe’ll now move to a modeling exercise, which you can access by filling out the form below. Inventory Turnover Ratio Calculation ExampleSuppose a retail company has the following income statement and balance sheet data.
For 2021, the company’s inventory turnover ratio comes out to 2.0x, which indicates that the company has sold off its entire average inventory approximately 2.0 times across the period.
Inventory Turnover vs. Days Inventory Outstanding (DIO)The turnover of inventory ratio is closely tied to the days inventory outstanding (DIO) metric, which measures the number of days needed by a company to sell off its inventory in its entirety. The relationship between the two is as follows: Days Inventory Outstanding (DIO) Formula Unique to days inventory outstanding (DIO), most companies strive to minimize the DIO, as that means inventory sits in their possession for a shorter period of time. Step-by-Step Online Course Everything You Need To Master Financial ModelingEnroll in The Premium Package: Learn Financial Statement Modeling, DCF, M&A, LBO and Comps. The same training program used at top investment banks. Enroll Today How do you calculate inventory turnover?Inventory turnover is the rate that inventory stock is sold, or used, and replaced. The inventory turnover ratio is calculated by dividing the cost of goods by average inventory for the same period. A higher ratio tends to point to strong sales and a lower one to weak sales.
Which of the following formulas is used to calculate the inventory turnover ratio?Now that you have both average inventory and the cost of sales, you can determine your inventory turnover ratio. Inventory turnover ratio = Cost of goods sold / Average inventory.
What is the formula for the inventory turnover ratio quizlet?Measures the number of times that inventory is acquired and sold or used during a period; expressed as: Inventory Turnover = Cost of Goods Sold divided by Average Inventory.
What is an inventory turnover ratio example?Inventory turnover = COGS / Average Inventory Value
For example, if your COGS was $200,000 in goods last year, and your average inventory value was $50,000, your inventory turnover ratio would be 4.
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