Read Inventory Valuation to know the different valuation methods and calculations with examples.The inventory turnover ratio measures the amount of times inventory is sold and replaced by a company during a specific period of time. High possibility of quality being deteriorated during storage because of the waiting period.Risk of a product being outdated or going out of fashion especially in the case of consumer goods industry.Piling up of stocks resulting in high maintenance and handling costs.Working capital blockage which could have been gainfully employed elsewhere.Low inventory turnover ratio puts your business into a disadvantage and potentially lead to some of the issues listed below: This indicates a lack of demand, outdated product or poor selling/ inventory policy etc. On the other hand, it’s also possible that a company may get adverse or low inventory turnover ratio. The higher ratio here is a positive sign for any business. It explains how successful you are in converting the stock into sales. Why Inventory Turnover Ratio is important?Ī high inventory turnover ratio implies that a company is following an efficient inventory control measures compounded with sound sales policies. 3 times the stock of finished goods is been converted into sales. The result implies that the stock velocity is 3 times i.e. So, the inventory turnover ratio will be = Rs. = (Opening inventory + closing inventory / 2) Let’s now calculate the average inventory. Inventory Turnover Ratio = Cost of goods sold / Average Inventory To calculate the inventory turnover ratio, let’s apply the formula we discussed. Now that we have understood the inventory turnover ratio formula, let’s calculate it by considering an example. So average inventory is 1,50,000 (1,25,000 + 1,75,00/2) Example of inventory turnover ratio 1,25,000 and value of inventory at the end of the period is Rs. Formula to calculate average inventoryĪverage inventory is calculated using the below formulaįor example, inventory at the beginning of the year is Rs. As the name suggests, it is calculated by arriving an average of stock at the beginning and end of the period. 1,20,000 Average inventory and its formula.Īverage inventory is an estimated amount of inventory that a business has on hand over a longer period. So the cost of goods sold in this case should be calculated as below.Ĭost of goods sold = Revenue from operations + Gross loss Let’ say finished goods worth of 1,20,000 was sold for Rs. Then, in that case, the cost of goods sold is derived by adding the gross loss to the cost of goods sold. There may also be a case where you may incur a loss on sale of inventory. Here, 1,00,000 (revenue – gross profit) is nothing but the cost of goods sold derived by unloading the profit margin from the sales. This is because net profit includes indirect expenses that cannot be attributed to an inventory.Ĭonsidering the above example, our revenue from operations is Rs. To simply put, reducing profit from sales. How to derive the value of Cost of goods sold?Ĭost of goods sold is derived simply by reducing the profit from the revenue generated. 1,00,000 is your cost of inventory or cost of goods sold. 1,20,000 is the revenue generated from the operations and Rs. So, the cost of sales is the actual value of inventory which has been converted into sales.įor example, finished goods worth Rs 1,00,000 was sold for Rs. Revenue from operations means your sales. Here, Cost of goods sold is nothing but the cost of revenue from operations. Inventory Turnover Ratio = Cost of goods sold / Average inventoryīefore we apply the above formula, let’s understand the cost of goods sold, average inventory and how to determine these. Formula to calculate inventory turnover ratio In simple words, the number of times the company sells its inventory during the period. Inventory turnover ratio explains how much of stock held by the business has been converted into sales. It is also called a stock turnover ratio. Inventory turnover ratio is an accounting ratio that establishes a relationship between the revenue cost, more commonly known as the cost of goods sold and average inventory carried during the period. Why inventory turnover ratio is important?.Formula to calculate inventory turnover ratio.
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