Inventory turnover ratio

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and notes

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Inventory turnover ratio

Inventory turnover ratio =

Cost of Good sold

Average Inventory

INTERPRETATION

Inventory turnover ratio Measures how often average inventory is “turned” or sold during a period.

Business owners and managers use this ratio to evaluate how well they manage their inventory.

Note: expanded calculation

Dividing the cost of goods sold for a period by the average inventory for that period Average inventory = (beginning + ending inventory) /2

EXAMPLE

M&M reported a cost of goods sold on its income statement of $1,000,000. And their beginning inventory was $3,000,000, and their ending inventory was $4,000,000.

Inventory turnover ratio = $1,000,000 / (($3,000,000 + $4,000,000)/2) = .29

This means that M&M only sold roughly a third (29%) of its inventory during the year. It also implies that it would take them approximately 3 years (1 year / .29 = 3.44 years) to sell their entire inventory or complete one turn.

BENCHMARK: HA, PG, ROT

A “good” inventory turnover ratio varies by industry. A high turnover ratio usually indicates strong sales, while a low ratio might mean your business is stocking too much inventory or not selling enough.

Generally, companies that sell inexpensive products tend to have higher inventory turnover ratios than those that sell expensive items.

A high turnover ratio is a good indicator of effective inventory management but can also mean an inadequate inventory level.

Inventory turnover ratio:

ABBREVIATION KEY:

ROT: Rule of thumb
HA: Historical Average (organization’s historical average)
PG: Peer Group average
EB: Economic Benchmark

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