While strong sales are good for business, insufficient inventory is not. A high ratio can imply strong sales, but also insufficient inventory. This could be due to a problem with the goods being sold, insufficient marketing, or overproduction. The purpose of calculating the inventory turnover rate is to help companies make informed decisions about pricing, manufacturing, marketing, and purchasing new inventory.Ī low ratio can imply weak sales and/or possible excess inventory, also called overstocking. Together, these components provide a comprehensive perspective on the company's sales in relation to its inventory.įor example, a company with $20,000 in average inventory with a COGS of $200,000 will have an ITR of 10. On the other hand, COGS, or Cost of Goods Sold, pertains to the total cost associated with producing the goods sold by a company during a specific timeframe. This formula gives a clear picture of how effectively a company's inventory is being utilized in relation to its sales.Īverage Inventory is the mean value of the inventory during a specific period, typically calculated by adding the beginning and ending inventory for a period and dividing by two. The formula for calculating the inventory turnover rate is as follows: The longer an item is held, the higher its holding cost will be, and so companies that move inventory relatively quickly tend to be the best performers in an industry. The speed at which a company is able to sell its inventory is a crucial measurement of business performance. Define Inventory Turnover Rate in Simple Terms Monitoring the ITR is pivotal for businesses to ensure they are neither understocking nor overstocking items.Ī well-maintained ITR can lead to reduced storage costs, minimized obsolescence, and enhanced cash flow. It quantifies how often a business can sell its entire inventory in a given period, often annually.īy gauging the speed at which goods move from stock to sales, companies can make informed decisions regarding purchasing, production, and sales strategies. If the figure is high, it will generally be an indicator of the fact that the company is encountering problems selling its inventory.Inventory turnover rate (ITR) is a ratio measuring how quickly a company sells and replaces inventory during a given period. Companies are aiming to keep their days in inventory figures low. What is Days in Inventory?ĭays in inventory is a measure of how many days, on average, a company takes to convert inventory to sales, which gives a good indication of company financial performance. Inventory Turnover (IT) = COGS / ĮI represents the ending inventory. The following formula is used to calculate inventory turnover: Should a company be cyclical, the best way of assessing its operations is to calculate the average on a monthly or quarterly basis. We calculate the average inventory by adding our starting and finishing inventories together and dividing by two. We calculate inventory turnover by dividing the value of sold goods by the average inventory. The ratio can show us the number of times and inventory has been sold over a particular period, e.g., 12 months. Inventory turnover is a very useful way of seeing how efficient a firm is at converting its inventory into sales.
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