Inventory Turnover Ratio Calculator

What is Inventory Turnover Ratio?

Inventory Turnover Ratio is a ratio that shows how many times an average inventory of a company is sold or replaced during a period, for example, a year. It compares two things, viz., the cost of goods sold and average inventory.

Formula for Calculating Inventory Turnover Ratio

The formula used for calculating the inventory turnover ratio is as follows:

Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory

Where average inventory = (Opening Stock + Closing Stock)/2

Components of Inventory Turnover Ratio

Let’s understand the components of the ratio of inventory turnover.

Cost of Goods Sold

The cost of goods sold here includes the cost of all the materials, labor costs, and overheads that have occurred to produce the goods or services. We may understand that selling and distribution costs and finance costs are not made part of it.

Average Inventory

For the purpose of this ratio, we take an average of opening and closing inventory. Why? We know that inventory is a moving asset and not a fixed asset. Therefore, the levels of inventory keep changing with each transaction; whether it is a sale or purchase, inventory moved to waste, etc. With the advent of sophisticated inventory management software, it is possible to find out the real weighted average inventory it had held during a year.

Interpretation of Inventory Turnover Ratio

The most important thing after calculating this ratio is to interpret and analyze it.

Low Inventory Turnover Ratio

Apparently, the higher this ratio, the better it is. Lower ratios signify a lack of sufficient sales or higher levels of stock. Some smart businessmen purposely keep high ratios, foreseeing a demand rise in their industry or a rise in prices of the stock. This normally is a temporary phenomenon. The best way to judge whether a ratio is up to the mark or not is to compare it with the industry averages.

High Inventory Turnover Ratio

It implies either strong sales and better inventory management, and also better liquidity. But it can also indicate a shortage or inadequate inventory levels, which may lead to a loss in business.

Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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