![]() Mel’s Furniture Company sells home furniture in California. For example, the apparel industry has one of the highest turn averages among all industries. Now, inventory turns vary from one industry to the next. Banks want to know that this inventory will be easy to sell for cash. Creditors are usually interested in this because inventory can be put up as collateral for loans. This metric is also important to creditors. This measurement shows how easily a company can turn its inventory into cash, which is important for an investor thinking about investing in your business. If this inventory can’t be sold, the inventory is worthless to that company. Inventory is one of the biggest assets a retailer reports on a balance sheet. If you’re looking for investors, they’ll want to see that retail metric. There’s another big factor that this measurement shows, that is how liquid a company’s inventory is. It would also show that the company can effectively sell what inventory it buys. Now, since inventory turnover measures how efficiently a company can control its merchandise, it’s vital to have “high turn.” This would indicate that the company doesn’t overspend buying its inventory or wastes resources by storing non-salable inventory. Suggested for you Beauty Pulling Its Weight With Retail Spending & Recovery An Important Retail Metric To Many The inventory turnover ratio is calculated by dividing the cost of goods sold for a period by the average inventory for that period. This is exactly why your purchasing and sales departments have to work in conjunction. If you can’t match it, inventory will not turn effectively. Sales: You want your sales to match inventory purchases. This will lead to more storage costs and holding costs, both you want to avoid. If the company can’t sell these greater amounts of inventory, turnover will be negative. Purchasing Stock: If large amounts of inventory are purchased during the year, the company must sell greater amounts of inventory to improve turnover. Why is your inventory turnover ratio important? Well, it’s a performance indicator that focuses on 2 core components. Quick Example: A company with $1,000 of average inventory and sales of $20,000 effectively sold it at 20 times over. In short, it measures how many times a company sold its total average inventory dollar amount during the year. This metric measures the amount of times average inventory is “turned” or sold during a period. Using the sales value instead will give a misleading result, because the average inventory in the same formula is taken at cost value, and not at retail value.The inventory turnover ratio is an efficiency ratio that shows you how effectively inventory is being managed by comparing cost of goods sold with average inventory for a period. When you calculate the inventory turnover you do not use sales in the formula, but rather the COGS ( cost of goods sold). The beginning and ending inventory is taken at cost value. To calculate the average inventory use the below formulaĪverage Inventory = (Beginning Inventory + Ending Inventory ) ÷ 2 To calculate IT you will need the COGS for that period and the average inventory for the same period.Īverage inventory is used because typically the level of inventory varies throughout the year, depending on seasonality and events. Inventory Turnover (IT) = COGS ÷ Average Inventory It gives an idea about how efficiently a company is managing its inventory. Inventory turnover ratio (IT) measures how many times a company turns its inventory during a certain period of time. ![]()
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