Inventory Turnover Ratios
Inventory is a valuable resource for any company. It is the store of raw materials, work in progress and finished goods that can be sold in the future. The faster inventory turns over, the better it is for business. So it is important to know the Inventory Turnover Ratio of your business to plan the cashflows, How much outstanding credit and how fast you roll over the money from Purchase to Sales and Collections.
The Inventory Turnover Ratio is calculated by dividing cost of goods sold by average inventory for a period. This ratio can help companies understand how efficiently they are using their resources to generate revenue. This ratio shows how many times a company’s inventory is sold per year.
For example, if we divide cost of goods sold by average inventory for the period, the result would be $4 million divided by $10 million, which equals 40% in terms of turnover ratio. The higher the number, the better.
The higher the ratio, the better it is for a business because it means that there is less money tied up in inventories and more money available to grow or reinvest in other areas.
How to find a Product Age based on the receipt of item?
Below are two methods that can be used to find the Product Age based on a receipt of the item. Finding the age of a product is most commonly done by looking at the date on the receipt. However, many items like clothing, footwear and makeup have limited or no date stamps.
In manufacturing there are multiple ways to track and identify an items Age.
- Batch and Serial numbers gives an idea on when the Part was produced.
- Few Chemicals and Medicines have Batch with Expiry dates.
- Few items are tracked from the date of Purchase to Date of Consumption of the same. However without a batch number is little difficult.
How to Calculate Inventory Turnover Ratio
Inventory Turnover Ratio is a financial metric used to assess how efficiently a company manages its inventory. It measures the number of times inventory is sold and replaced during a specific period, typically a year. The formula for calculating Inventory Turnover Ratio is:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
To Inventory Turnover Ratio Calculation needs the below steps to be followed
Step 1: Calculate the Cost of Goods Sold (COGS)
COGS represents the direct costs associated with the production of goods sold by the company during a specific period. It includes the cost of raw materials, labor, and manufacturing overhead. The COGS value can be found on the company’s income statement.
Step 2: Determine the Average Inventory
To find the Average Inventory, add the beginning inventory and ending inventory for a specific period and divide the sum by 2.
Average Inventory = (Beginning Inventory + Ending Inventory) / 2
Step 3: Calculate Inventory Turnover Formula.
Divide the COGS (from Step 1) by the Average Inventory (from Step 2) to get the Inventory Turnover Ratio.
Inventory Turnover Ratio Formula = COGS / Average Inventory
The resulting ratio represents how many times the company’s inventory was sold and replaced during the period. A higher Inventory Turnover indicates that the company is efficiently managing its inventory and selling goods quickly, while a lower ratio suggests slower inventory turnover, which may imply excess inventory or inefficiencies in inventory management.
It’s essential to note that the interpretation of the Inventory Turnover Ratio may vary depending on the industry and business model. Comparing the ratio with industry benchmarks or the company’s historical data can provide valuable insights into its inventory management performance.
What is a Good Inventory Turnover ratio?
A good inventory turnover ratio is a value that indicates effective inventory management within a company. The ratio’s “goodness” can vary depending on the industry, business model, and specific circumstances of the company. Generally, a higher inventory turnover ratio is considered favorable, as it suggests that a company is efficiently selling its inventory and replenishing it at an appropriate pace.
A higher inventory turnover ratio typically signifies the following positive aspects:
- Efficient Sales: A high turnover ratio indicates that products are selling quickly, which can lead to increased revenue and reduced carrying costs.
- Effective Inventory Management: Companies with a high turnover ratio are often more adept at forecasting demand, optimizing stock levels, and avoiding excess inventory.
- Lower Holding Costs: By keeping lower inventory levels, companies can minimize storage costs, obsolescence risks, and the need for large warehouse spaces.
- Faster Cash Flow: A higher turnover ratio means that goods are sold more frequently, leading to quicker cash generation and improved liquidity.
FAQs about Inventory Turnover Ratio
What is the Inventory Turnover Ratio?
Inventory Turnover Ratio is a financial metric that measures the number of times inventory is sold or replaced within a specific period, indicating the efficiency of inventory management.
How is this Ratio calculated?
The Inventory Turnover is calculated by dividing the cost of goods sold (COGS) by the average inventory value. The formula is: Inventory Turnover Ratio = COGS / Average Inventory.
What is considered a good Inventory Turnover Ratio?
The ideal Inventory Turnover Ratio varies by industry. Generally, a higher ratio indicates efficient inventory management, while a lower ratio suggests slow-moving inventory or excess stock.
How can ERP software improve the Inventory Turnover Ratio?
ERP software provides accurate inventory data, demand forecasting, automated replenishment, and comprehensive reporting, enabling businesses to make informed decisions, reduce stockouts, and optimize inventory turnover.
Can ERP software integrate with existing systems?
Yes, modern ERP software is designed to integrate with existing systems such as Accounting, Sales, and Procurement, ensuring seamless data flow and efficient inventory management.
Conclusion:
Optimising your Turnover Ratio is vital for efficient inventory management and financial success. By leveraging the power of cloud-based ERP software, you can streamline inventory control, improve demand planning, reduce stockouts, and enhance supplier collaboration. Embrace our SaaS Cloud ERP Software today and unlock the benefits of an optimized inventory turnover ratio, empowering your Indian business to excel in the competitive market.