Inventory Turnover Ratio

Maximum profit extraction from your products

There are a number of different ways to compute the inventory turnover ratio. Before we get to that, lets think about products for a moment.

Most of the time when we think of products in a business, we are thinking about the sales side of things. How much of what is selling at what price to whom? We're trying to squeeze the most out of the situation.

That's fine as far as it goes, but doesn't take into account any of the associated costs of holding a product inventory. If you make your own products, then you also have to factor in the raw materials and work-in-progress elements of your product inventory too.

The goods and services used to keep that production line moving, or the warehousing required to hold those finished goods before they are sold all carry associated costs.

If you imagine that every day your goods are in the warehouse, you have to walk through and stick a brown envelope to them with the costs of storage for that particular day, you quite quickly come to the notion that it might be better if they weren't in there too long in the first place

This way of computing the stock turn ratio is most readily available when you are looking at a published set of accounts from a public company.

Inventory Turnover = Sales for year / (Average Inventory Held)

While straightforward, it doesn't relate as well as using something that links more exactly to goods made or acquired by the business. You may find it better to use:

Inventory Turnover = Cost of Sales / (Average Inventory Held)

The inventory turnover ratio is an accounting formula that will help you understand how many times a year you turn your average stock holding through your business.

The more times your inventory has turned, the more efficient your business is operating, and most likely, the less working capital you will have invested for a given $ Sales. That's a good thing because working capital costs money.

More Accounting Formulas

A little bit of Financial Ratio Analysis for enlightenment

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