How to Calculate Inventory Turnover

Calculation of inventory turnover ratio is absolutely essential to ensure that the operations of the company as systematic and flawless. Any expert would be able to judge the efficiency in operations and compare it with the efficiency in operations of other firms by knowing the inventory turnover ratio. For the inventory turnover to be as per expectations, proper management skills are required for managers and core team of the company. Before we know how to calculate inventory turnover rate, let us first understand the importance of calculating rate of inventory turnover in the next paragraph.

Overview of the Concept Inventory Turnover

Inventory turnover is nothing but a measure of the number of times a company uses its inventory in a specific period of time. Generally, a period of one entire financial year is taken into consideration for calculating the inventory turnover. As per the analysis of many accounting professionals and financial experts, the higher the inventory turnover ratio, more is the efficiency and utilization ability of the firm. Inventory turnover is a measure of how many times the inventory is put to use in industries and its calculation involves three to four basic steps.

Those calculating inventory turnover believe that the faster it is sold, the lesser is the risk for companies owning the inventory. A huge amount of cash is invested in the inventories and hence if it takes time to dispose it off, losses will naturally increase. We all know that losses in inventories will be reducing the profit levels substantially, and this would not be good for the financial health of the company. Before we move over to the inventory turnover formula, let us understand this concept with the help of a simple example. Let us assume that two firms A and B have around two million dollars of inventory and A takes thirty days to sell it off completely, whereas B takes forty five days to sell that same inventory. Then, in this case, the firm A will be able to minimize its losses and maximize its profits whereas the firm B stands at a risk of large losses, affecting its margins. Efficient inventory management is the success of large product manufacturing companies.

Calculating Inventory Turnover
The first step in this would be to find out the cost of goods. This can be calculated by simply multiplying the cost of each good or product with the number of products. Then, the second step is to find out the average value of inventory. Finally, in the third step, when you divide the cost of goods by the average inventory value, you will be getting the inventory turnover ratio. So, note the inventory turnover formula given below.

Inventory Turnover Ratio = Total cost of sold goods / Average inventory of the period.

Precise calculation of the average inventory is also a must to use this formula correctly in the computation of inventory turnover ratio. The average inventory of the period can be calculating by adding the inventory at the beginning with the inventory at the end, and dividing the sum by two. So, go through the formula for average inventory given below.

Average Inventory = (Inventory in the beginning + Inventory at the end) / 2.

The formula and explanation given in this article will help you to understand how to calculate the inventory turnover ratio. With exact details, you will be able to calculate this ratio yourself. Good luck and do the math correctly!