What is inventory turnover?
Inventory turnover is the ratio that indicates the number of times the company has sold and replaced inventory in a given period. The company can then divide the days of the period by the inventory turnover formula to calculate the number of days it needs to sell inventory. Calculating inventory turnover can help businesses make better decisions about prices, production, marketing, and purchasing new inventory.
Formula of inventory turnover
Inventory turnover = Cost of Goods Sold / Average inventory
Average inventory = (Beginning inventory + Ending inventory) / 2
What inventory turnover can tell you
Inventory Turnover measures how quickly a company sells inventory and how analysts compare it to the industry average. Low sales mean weak sales and possible excess inventory, also known as over-stocking. It could indicate a problem with the merchandise being offered for sale or the result of too little marketing.
A high ratio means high sales or insufficient inventory.
The speed at which a company is able to sell inventory is a key measure of business performance. Retailers that move inventory faster tend to perform better. The longer an item is kept, the higher its cost of storing, and the fewer reasons consumers will return to the store to buy new items.
One can see a good example in the fast fashion business (H&M, Zara). Such companies typically limit the number of times and quickly replace inventories with new items. Items that sell slowly equates to a higher cost of holding than inventory that sells faster. There is also a low inventory turnover opportunity cost; an item that takes a long time to sell prevents it from making it easier to arrange newer items for sale.
Difference between inventory turnover and Days sales in inventory
Inventory turnover shows how quickly a company can sell its inventory. Meanwhile, Days sales in inventory considers the average time a company can turn its inventory into sales. DSI is essentially the inverse of the inventory turnover for a given time period - calculated as (Inventory / Cost of goods sold) * 365. Days sales in inventory is the number of days it takes to convert inventory into sales. sales, while inventory cycles determine the number of times a year inventory is sold or used.
Limitations of the use of inventory turnover
When comparing or forecasting inventory turnover, one must compare similar products and businesses. For example, car sales at an auto dealership can be much slower than FMCG sales sold by a supermarket. Trying to manipulate inventory sales with discounts or closures is another consideration, as it can significantly reduce your return on investment and return on investment.
- Inventory Turnover shows the number of times a company has sold and replaced inventory over a given period of time.
- This helps businesses make better decisions about pricing, production, marketing, and buying new inventory.
- Low turnover means weak sales and possible excess inventory, while that ratio means strong sales or insufficient inventory.
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