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Bank Promotion Exams |
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Inventory Turnover Ratio The inventory turnover ratio is an efficiency ratio that shows how effectively inventory is managed by comparing cost of goods sold with average inventory for a period. This measures how many times average inventory is "turned" or sold during a period. In other words, it measures how many times a company sold its total average inventory dollar amount during the year. This ratio is important because total turnover depends on two main components of performance. The first component is stock purchasing. If larger amounts of inventory are purchased during the year, the company will have to sell greater amounts of inventory to improve its turnover. If the company can't sell these greater amounts of inventory, it will incur storage costs and other holding costs. The second component is sales. Sales have to match inventory purchases otherwise the inventory will not turn effectively. That's why the purchasing and sales departments must be in tune with each other. The inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period. Formula Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory Example Govind's Furniture Company sells industrial furniture for office buildings. During the current year, Govind reported cost of goods sold on its income statement of 10,00,000. Govind's beginning inventory was 30,00,000 and its ending inventory was 40,00,000. Govind's turnover is ...... Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory = 1000000 / ((3000000+4000000)/2) This means that Govind only sold roughly a third of its inventory during the year. It also implies that it would take Govind approximately 3 years to sell his entire inventory or complete one turn. In other words, Govind does not have very good inventory control. ................................. |