Inventory Turnover

It shows the number of times inventory is being replaced after sales. It is also defined as the ratio of the sales to the inventory.

Inventory turnover=Goods sold/ Inventory

Or

Inventory turnover=Cost of goods sold / Average inventory.

Inventory turnover must be compared with the industry average; if the ratio is lesser than the industry average then the performance of the company is not good. In other words the sales done by the company is not up to the industrial standard.  If the ratio is higher than the industrial ratio then the organization is performing better than the industrial performance. If the ratio is low it is a cause of concern for both the investor as well to the managers of the company. Managers of the company must worry that they cannot convert the inventory into sales. Increase in inventory increases the inventory cost as well. Inventory cost is nothing but the cost that the company has to bear for keeping the inventory inside the company.

There are some special cases in the inventory ratio analysis they are,

• In some cases the inventory turnover ratio will be low but that might be a good situation. If in case if there may be extra ordinary sales how ever the inventory is too low which implies that the company is in no position to increases its production and match the demand in the future.
• In other case the inventory turnover ratio will be very high how ever that might not be a good position to the company because the company might not produce more and hence the sales may be low as well.

It is therefore important for the managers to maintain Inventory control based on the market nee. Inventory cannot be excess as well as it cannot be very low. Excess inventory will increase the cost of production, whereas lesser inventory will slow the things and thereby reducing the efficiency of production. It is therefore always important for the production manager to strike a balance in inventory maintenance. It is important to understand the condition prevailing in the company before making use of the inventory turnover method. Inventory turnover method cannot be used in service oriented companies.

Question

•   What are the various special cases that must be taken care before using inventory control method?
• What is inventory cost?