Inventory Turnover Ratio is a type of Turnover Ratio that determines how many in a year the inventory has been turned/sold. In other words, this ratio tells how good a company is in getting off/selling the complete inventory. Inventory Turnover Ratio is also known as Stock Turnover Ratio.
$$Inventory\quad Turnover\quad Ratio=$$$$ \frac { Cost\quad of\quad Goods\quad Sold }{ Average\quad Inventory } \quad $$
Where,
Cost of Goods Sold = Inventory at the Beginning of Period + Purchase – Inventory at the End of Period
$$Average\quad Inventory=$$$$\frac { Opening\quad Inventory+Closing\quad Inventory }{ 2 } $$
⇨ 500000 + 500000 – 80000
⇨ Rs. 920000.00
$$Average\quad Inventory=$$$$\frac { Opening\quad Inventory+Closing\quad Inventory }{ 2 } $$
Average Inventory = (500000 + 80000) / 2
⇨ Rs. 290000.00
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
⇨ 920000 / 290000 = 3.17
$$Inventory\quad Turnover\quad Ratio=$$$$ \frac { Cost\quad of\quad Goods\quad Sold }{ Average\quad Inventory } \quad $$
Where,
Cost of Goods Sold = Inventory at the Beginning of Period + Purchase – Inventory at the End of Period
$$Average\quad Inventory=$$$$\frac { Opening\quad Inventory+Closing\quad Inventory }{ 2 } $$
Significance and Interpretation
Inventory Turnover Ratio tells the number of times the average inventory is sold in a period, it helps companies plan their productions.- High Inventory Turnover Ratio indicates either strong sales or insufficient inventory.
- Strong Sales are desirable for the business whereas insufficient inventory is a concern for the business.
- Low Inventory Turnover Ratio indicates that the company is having weak sales and/or excess inventory. One reason for the excess of inventory may be high production to meet upcoming demand, but it should not hold for too long as it has associated cost to it.
- It must be noted that while comparing two companies on the grounds of Inventory Turnover Ratio, they should be of the same industry.
Examples
Example 1:
Use the following data of ABC Ltd, to calculate its Inventory Turnover Ratio.- Total Purchase = Rs. 500000.00
- Inventory at the Beginning of FY = Rs 500000.00
- Inventory at the End of FY = Rs 80000.00
Solution:
Cost of Goods Sold = Inventory at the Beginning of Period + Purchase – Inventory at the End of Period⇨ 500000 + 500000 – 80000
⇨ Rs. 920000.00
Average Inventory = (500000 + 80000) / 2
⇨ Rs. 290000.00
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
⇨ 920000 / 290000 = 3.17
Hence, Inventory Turnover Ratio = 3.17
