Inventory Turnover Ratio: Simple Formula & How to Compute

Inventory Turnover Ratio: What It Means For Your Business

In any market, inventory management is an integral business operation. For one, understanding your stock turnover directly affects sales, business costs, and financial projections. It enables you to price your products properly, make production more efficient and streamline warehouse operations.

On the other hand, a company that remains on top of inventory management is more effective in the future due to the trust established with its clients and the ability to make smarter decisions based on clear insights. In summary, it’s vital to the health of your company.

Do you know how to calculate inventory turnover ratio for your company? If you do not, there is a good deal of potential information you might be missing on stock turnover. We have created a guide that will help you identify what you will need to know about the overall issue and how to carry out this vital calculation.

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What’s Inventory Turnover Ratio?

To understand this term we will first go in the definition of”stock” and”inventory turnover.”

Inventory consists of all of the goods a business offers for sale. This might be finished goods which were purchased in wholesale and resold at a profit like clothing or food products, or raw products.

Manufacturing firms’ inventory consists mainly of raw products and other completed items that function as product elements. By way of instance, a handbag manufacturer would have leather, pleather, or other substances as raw products, together with completed items such as emblems or packaging. All of these are considered inventory.

The sum of this inventory or inventory sold in a particular period of time constitutes the inventory turnover. Most firms express this as a ratio. Therefore, inventory turnover ratio is a measure of how often a company has sold and replaced its stock during a particular period of time.

It is used as a tool to assess the liquidity of a corporation’s inventory and is a significant accounting formula for many businesses because it measures the efficiency of the company in handling and selling its stock.

Low inventory turnover could indicate that its products aren’t selling, or they’re either overstocking or restocking their merchandise slowly. On the other hand, a business with a high stock ratio reveals demand for goods is high and there’s a profitable balance between sales and inventory turns. This is among the reasons why monitoring this metric is so vital for a business.

How To Compute Inventory Turnover

Prior to starting, you’ll have to identify the information you will need to perform this calculation. The factors of a stock turnover formula include:

  • Time interval : This ratio is measured over a particular interval
  • Sales: The dollar amount for all your earnings in 1 year. So as to compute the ratio, use the figure for net earnings or cost of goods sold in the organization’s income statement and stock from its balance sheet. This includes the value of the inventory that you have sold within that period but has not received payment for yet.
  • Cost of goods sold (COGS): This is how much you sold your product for, the price, but is often termed as”cost” of merchandise to include the cost of raw materials, direct labour, or direct factory overheads used to generate the merchandise for sale.
  • Typical Inventory Formula: Arrived at by adding the dollar amount of the beginning inventory (beginning of this year in this case) with the completing inventory (year-end) and dividing by 2.
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With these figures in hand, you will find two unique techniques for calculating inventory turnover ratio. The first stock turnover calculator is where earnings are divided by average inventory

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-Net Sales / Average Inventory # of instances turned over

The next stock turns formula divides the cost of goods sold (COGS) by your typical stock:

-Cost of Goods Sold / Average Inventory = # of times turned over

Analysts think that using the next formula where the COGS is divided by average inventory rather than the first formula is more precise. This is because earnings include a markup over costs, and this inflates the stock turnover ratio.

What is the ideal inventory turnover ratio? It depends upon the industry. By way of instance, a grocery store would have a greater ratio than an automobile dealer. This does not mean that the supermarket is doing better in terms of gains, they simply happen to inventory faster-moving goods.

The Advantages of Calculating Inventory Turnover

Business owners may fail to calculate their company turnover ratio when they believe they have a hand on things, but there is a reason analysts insist on this calculation. Your inventory turnover ratio is important for the following reasons:

1. It tells you how fast your company is selling stock

As stated before, a high stock ratio generally indicates that a business is efficiently managing its stock and selling their goods. Faster sales mean more money since cash isn’t tied up in stock, and most likely a gain has been achieved.

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But too high a ratio means products are selling out too quickly and the company may wind up missing out on sales and disappointing customers. The silver lining is that high need presents an opportunity for the company to boost the price of a product.

On the other hand, a very low stock turnover ratio is a sign of a slow-moving item. A business might even be holding obsolete inventory. This ties up the provider’s funds and eats into profits.

There are a number of instances where a business could be holding on to its inventory like in preparation for the holiday season or a special occasion. Or maybe they have received word of a providers’ attack in the near future–Business predictions are important to business efficiency.

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2. It provides a contrast to others in your industry

With a precise comparison to industry averages through numbers is essential for measuring your organization’s performance. If your turnover ratio is significantly lower than other comparable companies in your area, it might highlight inefficiencies in your manufacturing or any chances on the market that you’re not benefiting from.

3. Gives you insight into the workings of Your Organization

In precisely the exact same manner that comparing with others may emphasize several things, calculating your stock turnover provides you clear insight into your own operations. Your ratio will tell you how well you’re managing your inventory, sales performance, cost inefficiencies, and other valuable insights.

Does this provide a photo of whether products are in demand or obsolete, but in addition, it gives a very clear picture of management and business culture.

How To Enhance Your Inventory Turnover Ratio

Here are some strategies that will assist you improve your stock turnover.

1. Improve your Marketing

The heart of your small business success lies in its advertising. A successful marketing strategy will involve many tasks, including advertising, promotions, and public relations. Reaching new customers and attaining a competitive advantage will increase sales and so improve inventory turnover. You don’t know, maybe your merchandise is slow on the shelves since the marketplace doesn’t understand how amazing it is!

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2. Stock Inventory That Sells

This may appear obvious, but a good deal of business owners buy stock on misconceptions and lack of market understanding. This contributes to stocking products that don’t do well on the market. For those who have an idea for a new item, test out reception by clients first by stocking a small quantity. This may help you avoid headaches where you thought you had a excellent product but uptake was disappointing.

3. Ensure Efficient Restocking

Where you’ve popular products which are flying off the shelves, adjust your stock to make sure they remain in stock. The best way to do this is by increasing the speed at which you stock the item, as opposed to purchasing large amounts at one time. Overstocking not only ties up your small business capital, it might also lead to getting dead stock if the product go out of popularity or season dies down suddenly.

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4. Push Old Stock

Stay away from old stock becoming dead inventory by providing sales, special discounts, and promotions, applying specific marketing strategies, and much more. Any business should avoid getting old inventory as all costs because it ties up funds thus burdening the business.

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5. Make Use of Business Forecasting

Various times of the year include unique requirements: Holidays, back-to-school intervals, and needless to say, weather seasons. All this will have a large effect on your stock and any wise business owner should have stock strategies to expect not only this but crises like supply interruptions.

6. Use Smart Pricing Plans

As opposed to use a single pricing plan for all your inventory, consider custom pricing for an assortment of products. Variable these on seasons, transport needs, cost of production, shelf life, and such.

7. Review Purchase Rates Often

Keep your ear to the ground on what is happening in your business. Has there been a surplus of raw products which should reduce prices, have your providers applied a more efficient process? Knowing all this info can help you negotiate lower prices for your inventory, which translates into lower prices for your clients thus higher demand.

8. Invest in Automation Software

You can’t manage all facets of your organization, and even if possible, a computer can likely do it ten times better. Purchasing things that help your company automate tasks such as a retail POS system, inventory management platform, or marketing automation won’t only increase efficiency, it is going to free up much-needed time to concentrate on other facets of the company.

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