Overall, the inventory turnover ratio is an essential tool for any business looking to optimize its inventory management and ensure financial stability. By comparing one year’s inventory turnover ratio to that of the previous year, it can help business owners identify any areas where they need to improve efficiency, or identify any trends in their sales and purchasing patterns. The inventory turnover ratio can also be used to track the performance of a company over time. This also helps reduce their overall expenses, allowing them to re-invest any savings into other business areas that could help grow and expand it. When companies can accurately estimate the amount of inventory they need to purchase, it allows them to better manage cash flow and avoid raising additional capital or taking out loans. With an accurate inventory turnover ratio, companies can also ensure they don’t purchase too much raw material or overproduce finished goods that could go unsold. This includes the cost of renting storage space, insurance, and staffing to manage and move the goods. If a company can accurately calculate its inventory needs, it can reduce its costs. To avoid this, they can use the inventory turnover ratio to determine the amount of inventory to replace, instead of overstocking. If a business keeps too much inventory, it risks not having enough money to pay employees, bills, suppliers, and lenders if some items don’t sell. It can also benefit a company in several ways, such as: The inventory turnover ratio gives business owners insight into their day-to-day operations and can help them identify areas where they may need to improve efficiency. However, industries dealing with perishable products should aim for an even higher ratio to minimize losses due to spoilage. This indicates that the company sells and replenishes its stocks every one to two months. The recommended inventory turnover ratio for most industries is 5 to 10. The determining factors include the size of your organization, cash flow, and the speed at which you can sell your assets, as well as the kinds of products you sell. The ideal inventory turnover ratio varies, since each business has unique goals, objectives, and figures. On the other hand, a high inventory turnover ratio could also mean that a company was unable to meet the increased demand and therefore missed out on potential sales - so analysis and context are always important.Ĭonversely, a lower turnover ratio may indicate the company is having difficulty selling its goods or keeping its stock levels in check. (Beginning Inventory + Ending Inventory) / 2 = Average InventoryĪ higher inventory turnover ratio generally indicates better financial health, as it shows that the company has fewer unsold goods on hand and can more effectively move its product in and out of inventory. You can get this value by dividing the sum of your beginning and ending inventory by two. To get the inventory turnover ratio, the cost of goods sold (COGS) is divided by the average inventory:Ĭost of Goods Sold / Average Inventory = Inventory Turnover Ratioīefore calculating the inventory turnover ratio, though, you must first calculate the average inventory in a given period. To calculate the inventory turnover ratio, you need to divide the cost of goods sold during a given period by the average inventory for that same period.
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