Inventory Turnover Ratio Formula

Inventory Turnover Ratio Formula (Table of Contents)

• Inventory Turnover Ratio Formula
• Inventory Turnover Ratio Calculator
• Inventory Turnover Ratio Formula in Excel (With Excel Template)

Inventory Turnover Ratio

Inventory is one of the major important factors for tracking the manufacturing company. Movement in inventory gives a clear picture of a company’s ability to turn raw material into a finished product. In order to track this movement, inventory turnover ratio or days in inventory are used.

Inventory Turnover Ratio Formula

Inventory Turnover Ratio Formula helps you in finding a balance that is right for your business which will lead to making a profit in business.

Inventory turnover ratio is important, as well as an efficient ratio formula. It shows how fast a company can replaces a current period batch of inventories and transforms it into sales to find a balance that is right for your business.

Inventory turnover ratio is a ratio that shows how many times a company has replaced and sold inventory during a period, say one year, five years, or ten years.

The inventory turnover ratio is a simple ratio that helps to show how effectively inventory can be managed by comparing average inventory and the cost of goods sold for a particular period. This helps you to measure how many times the average inventory ratio is sold or turned during a particular period.

In simple words, it shows how many times a company can be sold the company’s total average inventory amount during one year. A company with $2,000 of average inventory and sales of $40,000 effectively sold its 20 times over.

The company can be able to divide the number of days in the period by the inventory turnover formula to calculate the days it takes to sell the inventory on hand. It can be calculated as sales divided by average inventory. For a one-year period following formula can be used.

Examples

Luxurious Company sells industrial furniture for office buildings Infrastructure During the current year; Luxurious Company reported the cost of goods sold on its income statement of $1,000,000. Luxurious’s beginning inventory was $3,000,000, and its ending inventory was $4,000,000.

Luxurious’s turnover can be calculated like the following:

First, we calculate Average Inventories,

• Average Inventories = Beginning Inventories + Ending Inventories) / 2
• Average Inventories = ($3,000,000 + $4,000,000)/2
• Average Inventories = $3500000

Then, we calculate Inventory Turnover Ratio using the Formula.

• Inventory Turnover Ratio = Cost of Goods Sold/ Average Inventory
• Inventory Turnover Ratio = $1,000,000 / $3500000
• Inventory Turnover Ratio = 0.29

As you can see, Luxurious Furniture Company’s turnover is .29. This means that Luxurious Furniture Company only sold roughly a third of its inventory during the current year. It also states that it would take Luxurious Furniture Company approximately 3 years to sell its entire inventory or complete one turn. In simple words, Luxurious Furniture Company does not have very good inventory control, so Luxurious Furniture Company has to Improve Inventory Control.

The same can be observed from the below formula:

• Days in Inventory = 365 / Inventory Turnover Ratio
• Days in Inventory = 365 / 0.29
• Days in Inventory = 1278 days

Another Example of Inventory Turnover Ratio Formula:

Calculation of inventory turnover and days inventories outstanding for XYZ, Inc. based on the information provided below:

Opening inventories	$15,000
Closing inventories	$30,000
Cost of goods manufactured	$250,000

The cost of goods sold can be calculated below:

• Cost of goods sold = Beginning Inventories + Cost of Goods Manufactured in a company – Ending Inventories
• Cost of goods sold = $15,000 + $250,000 – $30,000
• Cost of goods sold = $235,000

First, we calculate Average Inventories,

• Average Inventories = Beginning Inventories + Ending Inventories) / 2
• Average inventories = ($15,000 + $30,000) ÷ 2
• Average inventories = $22,500

Then, we calculate Inventory Turnover Ratio using the Formula.

• Inventory Turnover Ratio = Cost of Goods Sold/ Average Inventory
• Inventory turnover ratio = $235,000 ÷ $22,500
• Inventory turnover ratio = 10.44

after Inventory Turnover Ratio, we calculate Days in Inventory.

• Days in Inventory = 365 / Inventory Turnover Ratio
• Days inventories outstanding = 365 ÷ 10.44
• Days inventories outstanding = 34.96

Explanation of Inventory Turnover Ratio Formula

The inventory turnover ratio can be calculated by dividing the cost of goods sold for a particular period by the average inventory for the same period of time.

Cost of goods sold = Beginning Inventories + Cost of Goods Manufactured in a company – Ending Inventories

Average Inventories = Beginning Inventories + Ending Inventories) / 2

It is always a good method to use average inventory instead of taking only ending inventory because many companies’ inventory fluctuates greatly throughout the year. For instance, a company might purchase a large number of quantities of inventory on January 1 and sell that for the rest of the whole year. By December, almost the entire inventory is sold, and the ending balance does not accurately reflect the company’s actual inventory during that year. Average inventory can be calculated by adding the beginning and ending inventories of a company and dividing it by two. The cost of goods sold is reported on the profit & loss statement of a company.

Significance and Use

Inventory Turnover Ratio plays a very important role because total turnover depends on two main components of performance that is stock purchasing and sales. The first main component is stock purchasing. If a large number of amounts of inventories are purchased during the year, the company will have to sell its greater amounts of inventory to improve its turnover. If the company is failed to sell these greater amounts of inventory, it will incur storage costs and other holding costs as well.

The second component is sales. Sales must have to be matched with inventory purchases; otherwise, the inventory will not turn effectively, which will make Inventory void. That’s why the sales and Purchasing departments must be in touch with each other. So, it is relevant to know the importance of Stock Purchasing and sales.

Inventory Turnover Ratio is the ratio of Cost of Goods Sold / Average Inventory during the same time period. The higher the Inventory Turnover Ratio, the more likely it is that a business is carrying too much inventory. Overstocking means that cash is tied up in inventory assets for a prolonged period.

Use of Inventory Turnover Ratio Formula

Inventory Turnover Ratio can be used if you are in an inventory-based business company; managing your inventory efficiently is conclusive to your business profit and success. Too much and too little stock can drag down your bottom line. Then you may be wondering what a solution to this is.

To this Firstly, You need to decide your company’s inventory turnover ratio. This ratio helps you find the effective spots between having so much product it becomes Antediluvian and having enough so it does not hinder sales. It will surely help your inventory to flow smoothly and effectively through your supply chain, keeping your customers happy and increasing your margins and forecasting as well.

Inventory Turnover Ratio Calculator

You can use the following Inventory Turnover Ratio Calculator

Inventory Turnover Ratio Formula in Excel (with excel template)

Here we will do the same example of the Inventory Turnover Ratio formula in Excel. It is very easy and simple. You need to provide the two inputs i.e. Average Inventories and Cost of goods sold

You can easily calculate the Inventory Turnover Ratio using the Formula in the template provided.

In the first example,

First, we calculate Average Inventories,

Then, we calculate Inventory Turnover Ratio using the Formula.

After Inventory Turnover Ratio, we calculate Days in Inventory.

In the second example,

The cost of goods sold can be calculated below.

First, we calculate Average Inventories.

Then, we calculate Inventory Turnover Ratio using the Formula:

After Inventory Turnover Ratio, we calculate the Days in Inventory.

Recommended Articles

This is a guide to Inventory Turnover Ratio formula. Here we discuss its uses along with practical examples. We also provide you with the Inventory Turnover Ratio Calculator with a downloadable excel template. You may also look at the following articles to learn more –

1. Ratio Analysis
2. Equity Multiplier Formula
3. Calculate Gross Profit Margin
4. Accounts Receivables Turnover