How To Calculate Your Inventory Turnover Ratio
You need to know your inventory turnover. You have investors or creditors wanting to know. Are you trying to figure it out? Great! There is actually an inventory turnover ratio you can use to calculate it. We are going to walk you through the steps. Using your inventory turnover ratio shows how effective you are at managing your inventory, so let’s figure it out. Fulfillment companies, use this metric to track how well you are doing.
The quicker you move product the better. Measuring your inventory turnover ratio shows how quickly you move merchandise. As a matter of fact, you want to have a high inventory turnover rate. Also, it will show if you are purchasing too much product. By purchasing too much product you must to sell larger amounts of inventory to improve turnover. If your product isn’t moving, you are likely liable for additional holding and storage cost. This is exactly why your sales and purchasing teams must be on the same page.
Calculating Your Inventory Turnover Ratio
To calculate your inventory turnover ratio you will need your cost of goods sold and average inventory for a specific period of time. You use these to measure how many times average inventory is “turned” or sold during a specific date range.
Simply put, it measures how many times did you sell your total average inventory dollar amount during the specified time period.
Let’s use the calculator to the left. If your company has $2,000 of average inventory and sales of $20,000 of inventory sold, your inventory turnover ratio would equal 10 times.
Use your average inventory versus ending inventory. Using average inventory is more accurate because a businesses’ products constantly change throughout the year. Your company may purchase larger quantities of product in November and December for the holidays versus what you would buy in January or February.
Calculate your average by adding the beginning and ending inventory for the year and divide it by two. Use the cost of goods sold reported in the income statement.
Let’s take it a step further and look at Sarah’s business. We’ll say Sarah is selling soaps and candles. During the year, Sarah reports her costs of goods sold on her income statement of $2,000,000. Sarah’s beginning inventory is $3,000,000 and her ending inventory is $1,500,000.
In this example, Sarah is turning over (0.89) of her inventory. This means Sarah is selling nearly 9/10 of her inventory during the year. This means it would take Sarah just over 13 months to sell all her inventory. That’s calculating average inventory turnover ratio.
Who looks at Inventory Turnover Ratio?
You need to know your inventory turnover ratio for investors. Liquid inventory is an important metric you need to know as well. Inventory is one of the biggest assets for reporting on your balance sheet. Knowing how much inventory is in stock, ordered or being sold is required for a firm or individual to consider investing in your company .
Additionally, investors want to know if your inventory is not being sold. If your inventory is sitting in stock but not selling, that inventory is considered worthless. Essentially, the inventory turnover ratio shows how quickly and how easily you can turn your inventory into cash.
Equally important, banks and creditors want this information from you too. Can you easily convert your inventory into cash, banks and creditors will want to know. Knowing your inventory turnover ratio so your inventory can be put up as collateral for loans is important. Inventory turn can differ widely depending on the industry you’re in. To give you an example, clothing is going to have a higher inventory turn versus luxury jewelry.
Know your Inventory Turnover Ratio
To sum up, know your inventory turnover ratio. It is an important metric for your business. Make sure you bookmark this page so you have easy access to the formula.