What is Inventory Turnover?
Inventory Turnover simply means the number of times inventory is used and then replaced for a given period. Some companies may opt for computing this ration on a quarterly, semi-annual, or annual basis depending on their needs. This ratio is one measure of business health as it gives reference to the actual movement of goods.
Inventory Turnover may be computed in two ways. The first formula puts sales figures for a given period and divides this with the actual inventory for the same period. The result is now your ratio or inventory turnover. This computation is the most commonly used among companies from different industries. The second computation involves actual cost of sold goods over the average inventory. This is so because most inventories are recorded in books with the actual cost and not the selling price. Average Inventory is also used for a given period instead of the actual inventory to come up with a more realistic result for a given period. This formula will then take out the seasonal factors affecting sales and inventory.
Using either computation, a low ratio means you have too much inventory because of low sales. A high ratio indicates high sales figures. But this may also indicate ineffective buying, so ratios should also be compared with averages in your particular industry.
In computing your own company’s inventory turnover rate, many suggest that figures you put for cost of goods sold include stock mobilization expenses, like costs in transferring goods from one shop to another. Goods used for other purposes like testing and internal use should also be added into the figure. And for inventory fluctuations within a particular period, many prefer to use an average figure instead of the usual month-end, quarter-end, or year-end figures, as these may not represent the actual sales-inventory picture.
Monitoring your company’s inventory ratio is a very important tool to help you achieve your business goals. In times of crisis, this may help you make adjustments on areas you need to improve on to effectively manage your stocks and generate better sales.