Knowing how to calculate inventory turnover will help you find the rate at which your company replaces inventory within a specific period concerning sales. Suppose you intend to learn and implement inventory turnover calculations for your business. In that case, you will be able to state better pricing and look out for better marketing, purchasing, and manufacturing decisions.
When you look out to implement a well-managed inventory, you will eventually showcase your company sales to be at an optimal level. The inventory turnover ratio gives a verdict upon how a company generates sales from the inventory. In this article, you will learn about the proper steps to calculate the inventory turnover ratio.
What is Inventory Turnover?
Inventory turnover is a calculation used to measure how fast a company sells through its inventory. It is calculated by dividing the cost of goods sold by the average inventory on hand. This calculation gives you the number of times per year that a company sells through its entire inventory.
Therefore, knowing the proper process of calculating it over time will help a company thrive in many ways. The inventory turnover ratio matters because:
- A high inventory turnover ratio indicates that the company has a better sales record of selling the goods quickly for refilling the stock.
- Inventory turnover calculation will give insight into how proficiently the company is managing its stock or inventory.
- Inventory Turnover indicates whether the purchasing and sales department of a company is functioning in sync.
The inventory turnover ratio is important because it will give insight to the business owners about how effectively the sales rate matches the inventory purchases. In case they don't check, the company has to modify its measures to improve business sales. It is essential to keep the inventory purchases and sales aspects on the right track and keep them in tune with one another.
How to Calculate Inventory Turnover
The inventory turnover ratio indicates the amount of inventory sold over a specific period. For calculating it, you need to follow certain steps, which are as follows:
Step 1: Collect all the Important Data
In the first step, you need to collect all the critical data such as:
- Cost of goods sold
- Beginning inventory
- Ending inventory
- Average inventory
You can determine the total cost of goods sold (COGS) from the annual income statement of your company.
Related article: How to Calculate Beginning Inventory
Step 2: Find Average Inventory
In the second step, you need to implement the method for calculating the average inventory. For that, you need to obtain the beginning inventory data and the ending inventory data as per the period you have decided. Now, add them up to find the sum and divide the result by 2. Hence, this will give you the average inventory.
Step 3: Apply the Formula for Calculating Inventory Turnover
The formula for calculating inventory turnover ratio is "Cost of Sold Goods/Average Inventory." So, determine the cost of sold goods and divide it with the average inventory you obtained in Step 2. The result will be your inventory turnover ratio.
Tips & Reminders for Inventory Turnover
If you are unsatisfied with the obtained ratio, then here are some of the tips that you can implement to improve your inventory turnover:
- Compare the numbers you obtain with the industry benchmark that you have set long back.
- You need to forecast the need of your business and act accordingly.
- For improving sales, you need to work on implementing effective marketing measures.
- For better results, you can prefer to automate the inventory for effective management.
- It is better to restock small quantities over time than keep more extensive stocks on hold for high-selling items.
- Find ways to replace the older inventory, as storing them will affect your inventory turnover ratio. Therefore, consider replacing them with newer ones over time.
- Negotiate with the distributors and suppliers to get the goods at the best prices. It will help put an impact on your overall ratio.
- Use the perfect strategies and tools to determine the correct pricing point for the inventory goods. Compare your prices with the prices of competing products. Keep a constant check upon pricing and consider evaluating it to maintain a high level of sales.
This article elaborated on calculating the inventory turnover ratio and emphasized the tips that will help you improve it. So, make sure that you keep a constant track of your inventory turnover ratio to determine whether your business sales are on the right way or not.
If your company involves an inventory where you stock the finished or unfinished goods, then you need the formula to calculate the turnover ratio on priority. So, keep the procedure in mind, and be aware of your company's sales insight.