Inventory turnover

In accounting, the Inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year. The equation for inventory turnover equals the cost of goods sold or net sales divided by the average inventory. Inventory turnover is also known as inventory turns, merchandise turnover, stockturn, stock turns, turns, and stock turnover.

Inventory Turnover Formulas

The formula for inventory turnover:

\mbox{Inventory Turnover}=\frac{\mbox{Net Sales}}{\mbox{Average Inventory}}

or

\mbox{Inventory Turnover}=\frac{\mbox{Cost of Goods Sold}}{\mbox{Average Inventory}}

or

\mbox{Inventory Turnover}=\frac{\mbox{Cost of Material − Change in inventories (of 1/2 and 1/1 goods)}}{\mbox{Inventories}}

The most basic formula for average inventory:

\mbox{Average Inventory}=\frac{\mbox{Beginning inventory+Ending inventory}}{\mbox{2}}

or just

\mbox{Average Inventory}=\mbox{Ending inventory}


The average days to sell the inventory is calculated as follows:[1]

\mbox{Average days to sell the inventory}=\frac{\mbox{365 days}}{\mbox{Inventory Turnover Ratio}}

Application in Business

A low turnover rate may point to overstocking,[2] obsolescence, or deficiencies in the product line or marketing effort. However, in some instances a low rate may be appropriate, such as where higher inventory levels occur in anticipation of rapidly rising prices or expected market shortages.

Conversely a high turnover rate may indicate inadequate inventory levels, which may lead to a loss in business as the inventory is too low. This often can result in stock shortages.

Some compilers of industry data (e.g., Dun & Bradstreet) use sales as the numerator instead of cost of sales. Cost of sales yields a more realistic turnover ratio, but it is often necessary to use sales for purposes of comparative analysis. Cost of sales is considered to be more realistic because of the difference in which sales and the cost of sales are recorded. Sales are generally recorded at market value, i.e. the value at which the marketplace paid for the good or service provided by the firm. In the event that the firm had an exceptional year and the market paid a premium for the firm's goods and services then the numerator may be an inaccurate measure. However, cost of sales is recorded by the firm at what the firm actually paid for the materials available for sale. Additionally, firms may reduce prices to generate sales in an effort to cycle inventory. In this article, the terms "cost of sales" and "cost of goods sold" are synonymous.

An item whose inventory is sold (turns over) once a year has higher holding cost than one that turns over twice, or three times, or more in that time. Stock turnover also indicates the briskness of the business. The purpose of increasing inventory turns is to reduce inventory for three reasons.

Note

Some computer programs measure the stock turns of an item using the actual number sold.

\mbox{Inventory Turn} = \frac{\text{Number of Units Sold (Over a given period)}}{\text{Average Number of Units (For the period)}}

The important issue is that any organization should be consistent in the formula that it uses.

See also

References

  1. ↑ Weygandt, J. J., Kieso, D. E., & Kell, W. G. (1996). Accounting Principles (4th ed.). New York, Chichester, Brisbane, Toronto, Singapore: John Wiley & Sons, Inc. p. 802.
  2. ↑ Commercial Loan Analysis: principles and techniques for credit analysts and lenders By Kenneth R. Pirok ISBN 1-55738-716-8

Further reading


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