How to Get Inventory Turnover Ratio

Inventory turnover is a way to measure the number of times a business sells its inventory during a given period. Enterprises use inventory turnover to evaluate the competitiveness, profitability of projects, and the overall assessment of enterprises in the industry. Unlike employee turnover, a high inventory turnover ratio would be considered a positive factor, because it indicates that goods are sold relatively quickly before they are likely to be damaged. . In general, inventory turnover is calculated using the formula Turnover = Cost of Goods (COGS)/Average Value of Inventory . ^{[1] X Research Source}

Table of Contents

Find Inventory Turnover Ratio

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Select a specific time period to calculate. Inventory turnover is always calculated for a specific period — so you can choose any period from a day to a financial year — even the entire life of the business. However, the inventory turnover ratio cannot immediately describe a business’s performance. Although it is possible to define the value of a business’s inventory at any particular point in time, cost of goods is not an instantaneous value, so a specific time period must be selected for calculate.

In this article, we will use the example below to illustrate and calculate. Let’s say we own a coffee wholesaler. In this case, the selected period is one year of company operation. In the next step, we will find the inventory turnover ratio for this one-year period.

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Find the cost of goods for the selected period. After determining the time period, the first step to take is to find the cost of goods (also known as “COGS”) for this period. COGS is the direct cost of making the good. Typically, this includes the cost of producing the good plus any labor costs directly related to the production of the good. ^{[2] X Research Source}

COGS does not include costs such as shipping and distribution costs that are not directly related to the production of the goods.
In the example above, we had a pretty high yield year, and spent $3 million on seeds, pesticides and other costs associated with growing the coffee and $2 million on labor. for planting seeds. In this case, we can say our COGS is $3 million + $2 million = $5 million .

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Divide COGS by average inventory value. Next, divide the COGS by the average inventory value for the time period you’re analyzing. Average inventory value is the average financial value of all the goods you hold in stock and on store shelves that have not been sold over a given period of time. The simplest way to find this value is to take the value of the selected beginning inventory plus the ending inventory and divide it by two. However, the use of additional midterm data points may result in more accurate averages. If using more than two data points, add all the values together, then divide by the number of data points to find the average.

In our example, let’s say at the beginning of the year we have $0.5 million worth of coffee beans stored as inventory. At the end of the year, we have 0.3 million USD of seeds. Thus, the average inventory value is (0.5 million + 0.3 million)/2 = 0.4 million USD .
Next, divide the COGS by the average inventory value to find the inventory turnover ratio. In our example, COGS is $5 million and average inventory value is $0.4 million, so our inventory turnover for one year is $5 million/$0.4 million= 12.5 . The coefficient found is a ratio excluding units.

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You can quickly estimate the inventory turnover ratio using the formula Inventory Turnover = Sales/Inventory. If you don’t have time to follow the standard equation described above, this formula can help you calculate an approximate value of your inventory turnover ratio. However, most businesses avoid using this method because the results obtained can be inaccurate. Because sales are charged at the price offered to consumers but inventory is charged at a lower wholesale price, formulating can make your inventory turnover higher than it actually is. economic. As a general rule, this equation should only be used for quick estimates — for more important calculations, you should use the equation above.

For the same example as above, let’s say we had sales of $6 million in the past year. To find the inventory turnover ratio with the alternative equation above, we’ll divide this sales value by the final inventory value listed above of $0.30. The result is 6 million USD/$0.3 million USD = 20 . The result found is significantly higher than the value of 12.5 we calculated using the standard equation.

Increased accuracy in calculations

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Use different inventory data points for more accurate results. As noted above, finding the average inventory value from the beginning and ending inventory values can give you an approximate average inventory value, but this value will not account for stock fluctuations. inventory for the period you selected. Using additional data points will make your values more accurate.

When selecting a data point, you must ensure that the data point is evenly distributed over the selected time period. For example, if you are looking for the average inventory value for a year, you should not use twelve points from the same month of January, but instead use one point from the first day of each month.
Assume that the beginning inventory for one year of our business is $20,000 and the ending value is $30,000. Using the basic method above, we should get an average value of $25,000. However, by simply adding a new data point, we get a different picture. For example, let’s say we also use a data point from the middle of the year with a value of $40,000. In this case, our average inventory value is ($20,000 + $30,000 + $40,000)/3 = $30,000 — slightly higher (and more representative of average inventory value). troops) than the previous value.

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Use the Time = 365 days/inventory turnover formula to find your average time to sell your inventory. This step will tell you how long it takes on average to sell your entire inventory. First, find the annual inventory turnover ratio as usual. Then divide 365 days by the inventory turnover ratio. The result will be the number of days you have to sell your entire inventory.

For example, let’s say we have an inventory turnover ratio of 8.5 for a given year. By dividing 365 days by 8.5, we get 42.9 days . In other words, on average, we sell our entire inventory about once every 43 days.
If your inventory turnover ratio is for a period other than a year, simply replace 365 days with the number of days in the period selected into the formula. For example, if you have an inventory turnover ratio of 2.5 for September, then the average time to sell all your inventory is calculated as 30 days/2.5 = 12 days .

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Use the inventory turnover ratio as an approximate measure of operating efficiency. Often (though not always) businesses want to sell inventory quickly, rather than slowly. As a result, a business’s inventory turnover ratio can be used to find clues about how well that business is doing, especially compared to its competitors. However, it’s important to remember that context comparisons are important. Low inventory turnover is not always bad, and high inventory turnover is not always good.

For example, high-end sports cars often don’t sell quickly because the market for this product is quite small. As a result, you can expect a fairly low inventory turnover ratio for an auto dealership that imports sports cars — they may not even sell all of their inventory in a year. On the other hand, if the same dealer’s inventory turnover ratio suddenly increases, this can be a very good thing, but it can also be a bad thing, depending on the context — for example, this could indicates product shortages, and can lead to lost sales. ^{[3] X Research Sources}

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Compare your inventory turnover ratio with the industry average. A useful way to gauge a business’s performance is to compare its inventory turnover ratio with the averages of businesses in the same industry. A number of financial publications (both print and online) have an industry average inventory turnover rating, which you can use as a benchmark against which to measure your company’s performance. company. You can find such rankings here. However, as a reminder, it’s important to note that these values represent industry averages and that in some cases, inventory turnover ratios are significantly lower or higher than value. Statistical can be a good thing.

Another useful tool for comparing a business’s inventory turnover ratio with the industry average is the BDC approximation inventory turnover calculator. This tool allows you to select an industry, then find a hypothetical inventory turnover ratio by entering the company’s COGS and average inventory value and then comparing it to the average. average of your chosen industry.

Advice

View industry-specific statistics to see how your inventory turnover compares to your competitors and similar businesses. The company’s accountants recommend that you choose as many similar cases as possible to really gauge how successful your company’s inventory turnover ratio is in that area. how.
Guaranteed cost of goods sold and average inventory value based on the same valuation. For example, if your business is a multinational, you must make sure to use the same currency for these two values. Since both of these numbers will be in the form of total values, they will be correlated and produce exact results.

Steps

Find Inventory Turnover Ratio

Increased accuracy in calculations

Advice

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