Inventory Turnover & Turnover Ratio

In accountancy, inventory turnover is the measure of the number of times inventory is used or sold in a time period like in a year. The ratio most commonly used in analyzing the size of the inventory item is inventory turnover.

The formula for calculating inventory turnover is as follows:

Inventory turnover is equal to cost of goods sold divided by inventory (Inventory turnover = cost of goods sold/ inventory).

For example, if the cost of goods sold for a year is 1 million dollars and inventory is 250,000 dollars, then the inventory turnover is 4.0 times. This is equivalent to saying that the inventory turns over once every three months (quarter of a year). Some of the companies calculate this ratio on the basis of ending inventory, others on the basis of average inventory. The average inventory may be simply one-half the sum of beginning and ending inventories for the year, or it may be an average of monthly inventory levels. The end-of-period basis is more representative of the current state of inventory if volume is expected to continue at previous levels. The average basis is a better reflection of events that occurred during the period because it measures the amount of inventory that supported the sales activity of that period. Inventory turnover varies greatly with the nature of business.

Inventory Turnover Ratio

Turnover ratio divides sales by some assets: Sales/ Various assets. As the name implies, these ratios show how many times the particular asset is “turned over” during the year. Here is the inventory ratio:

Inventory turnover ratio is equal to sales divided by inventories (Inventory turnover ratio = sales / inventories).

Questionnaire:

• What is the inventory turnover?
• Give the formula to calculate Inventory turnover?
• What is Inventory turnover ratio and give the formula?