Wednesday, 18 January 2012

Inventory Turnover Ratio Analysis

Inventory Turnover Ratio Definition:
Inventory turnover ratio, defined as how many times the entire inventory of a company has been sold during an accounting period, is a major factor to success in any business that holds inventory. It shows how well a company manages its inventory levels and how frequently a company replenishes its inventory. In general, a higher inventory turnover is better because inventories are the least liquid form of asset. A useful tool in measuring and managing inventory turns is a Flash Report!

Inventory Turnover Ratio Explanation:
Inventory turnover ratio explanations occur very simply through an illustration of high and low turnover ratios. Despite this, many businesses do not survive due to issues with inventory.

A low inventory turnover ratio shows that a company may be overstocking or deficiencies in the product line or marketing effort. It is a sign of ineffective inventory management because inventory usually has a zero rate of return and high storage cost.

Higher inventory turnover ratios are considered a positive indicator of effective inventory management. However, a higher inventory turnover ratio does not always mean better performance. It sometimes may indicate inadequate inventory level, which may result in decrease in sales.

Inventory Turnover Ratio Formula:
The two main inventory turnover ratio formulas are listed below:

Inventory turnover = Sales / Inventory

Or Inventory Turnover = Cost of good sold / Average inventory

Inventory Turnover Ratio Calculation:
Inventory turnover ratio calculations may appear intimidating at first but are fairly easy once a person understands the key concepts of inventory turnover.

Example: assume annual credit sales are $10,000, and inventory is $5,000. The inventory turnover is: 10,000 / 5,000 = 2 times

Example: assume cost of goods sold during the period is $10,000 and average inventory is $5,000. Inventory turnover ratio: 10,000 / 5,000 = 2 times

This means that there would be 2 inventory turns per year. That is a company would take 6 months to sell and replace all inventories.

Inventory Turnover Ratio Example:
Derek owns a retail clothing store which sells the best designer attire. Derek, an avid fan of fashion, has worked in the apparel industry for quite a while and is well suited for the operations of his company.

Still, Derek has a little to learn about the business of retail clothing. He has been studying the subject with passion and wants to grow his business. From his study he has realized that inventory turnover is the key to his business.

Derek first talks to his accountant for inventory turnover ratio analysis. This requires somewhat of an expert because the matter is more complicated than the abilities simple, web-based inventory turnover ratio calculator. His accountant comes up with a figure which Derek would like to increase.

annual credit sales are $10,000 and inventory is $5,000

The inventory turnover is: 10,000 / 5,000 = 2 times

Derek decides, from this, that he needs to make some changes. He aligns a few strategies to move his products. First, he considers marking-down styles from the previous season as each season approaches. Similarly, he considers product give-aways with minimum transaction amounts. Derek considers the option of spreading contests and deals on social networking websites. He finishes his evaluation by finding ways to turn his extra inventory into a tax write-off.

Derek is pleased because he is applying his newly found skills and knowledge to better his business. Derek looks forward to the future.


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