Inventory turnover, also known as inventory turnover ratio, is an efficiency ratio that measures how efficiently inventory is managed. Let's find out with Giaiphapdonggoi.net what is inventory turnover!
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1. What is inventory turnover?
What is inventory turnover?
Inventory turnover or inventory turnover ratio is a financial ratio that shows the number of times a company has sold and replaced its inventory during a given period. A company can then divide the days in the period by the inventory turnover formula to calculate the number of days it needs to sell its inventory.
Inventory turnover can help a company understand a number of specifics, including:
Product prices should be adjusted.
Purchase schedules are subject to change.
Production volumes will vary.
Promotion is necessary to sell excess inventory.
It looks at cost of goods sold compared to its average inventory for a year or for a given period.
A high inventory turnover generally means that goods are sold faster, and a low turnover indicates weak sales and excess inventory, which can be challenging for a business.
Inventory turnover can be compared with historical turnover rates, planning ratios, and industry averages to gauge the competitiveness and performance of intra-industry operations. Inventory turnover can vary significantly by industry.
2. Factors affecting inventory turnover
Inventory turnover is driven by a number of factors, including:
Factors affecting inventory turnover
Length of distribution channel: If suppliers are far away, companies tend to stock more safety stock.
Fulfillment Policy: If management wants to fulfill most customer orders at once, this requires keeping a larger stock on hand.
Materials management systems: A push system, such as material requirements planning, tends to require more inventory than a pull system, such as a just-in-time system.
Consignment: Some companies keep title to their goods at pick-up locations, which increases the amount invested in inventory.
Purchasing Policy: A company may purchase raw materials in bulk to obtain a lower bulk rate, although this increases the company's inventory investment.
Product versions: If there are multiple versions of a product, each version is usually kept in stock, which increases inventory levels.
Drop shipping: Sellers can arrange with their suppliers to ship directly to the customer. By using such a reduced shipping arrangement, the seller maintains no inventory levels at all.
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3. Formula to calculate inventory turnover
Formula to calculate inventory turnover
Inventory turnover ratio = (Cost of goods sold) / (Average inventory)
Inside:
Cost of goods sold is the cost incurred by a company to produce goods that are sold during a given period. A company's cost of goods sold can be found on the company's income statement.
Average inventory is the average value of inventory for a given period. Note: Analysts may use average or ending inventory values.
Companies can also calculate inventory turnover by:
Average inventory calculation is done by dividing the sum of beginning inventory and ending inventory by two.
Divide sales by average inventory.
As you can see above, there are two main methods for calculating inventory turnover: one using cost of goods sold (COGS) and the other using sales. Analysts divide cost of goods sold by average inventory, rather than sales, for greater accuracy in calculating inventory turnover because sales include a spread. compared to cost. Dividing sales by average inventory will increase inventory turnover. In both cases, average inventory is used to help eliminate the effects of seasonality.
Eg:
Company ABC has a cost of goods sold of $5 million for the current year. The company's opening inventory cost is $600,000 and the ending inventory cost is $400,000. With the inventory balance, the average cost of inventory for the year is calculated as $500,000. As a result, inventory turnover is assessed at 10 times a year.
4. Importance of Inventory Turnover to a Business
Importance of inventory turnover for a business
One way to gauge business performance is to know how quickly inventory sells, how efficiently it meets market demand, and how well it sells.
How does it compare to similar products? Businesses rely on inventory turnover to evaluate the effectiveness of products, because this is the main source of revenue for the business.
Inventory turnover is a measure of how quickly a company sells its inventory. Low turnover means weak sales and possibly excess inventory, also known as overstock. It could indicate a problem with the merchandise being offered or be the result of too little marketing. On the other hand, a high ratio means high sales or insufficient inventory. The former is desirable while the latter can lead to losing business.
The speed at which a company can sell its inventory is an important metric for evaluating business performance. Retailers that move inventory faster tend to perform better. The longer an item is kept, the higher its holding costs will be and the less reason consumers will return to the store to purchase new items.
A typical example can be seen in the fast fashion business. Companies like H&M and Zara often limit stock runs and replace rapidly depleting inventories with new items. Slow-selling items equate to higher holding costs than faster-selling inventory. In addition, there is the opportunity cost of low inventory turnover, an item that takes a long time to sell that prevents the layout of newer items that can be sold more easily.
Higher inventories are favorable because they imply marketability of the product and reduce holding costs, such as rent, utilities, insurance, theft, and other costs of maintaining inventory. goods in stock.
Another purpose of the inventory turnover test is to compare a business with other businesses in the same industry. Companies measure their performance based on whether their inventory turnover is at or above the average benchmark set by industry standards.
Above is some information to answer your questions about what is inventory turnover that Giaiphapdonggoi.net has provided. This financial indicator plays an important role in evaluating the performance of the business. Depending on the actual situation, the company needs to take measures to adjust the coefficient to ensure the level of production and distribution.
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