Inventory turnover ratio is a financial metric that helps businesses to evaluate their efficiency in managing their inventory. It measures how many times a company sells and replaces its inventory during a specific period. Here are the steps to calculate the inventory turnover ratio:
Determine the time period: Decide on the time frame for which you want to calculate the inventory turnover ratio. Usually, it’s calculated on an annual basis, but it can also be calculated on a quarterly or monthly basis.
Calculate the cost of goods sold (COGS): COGS is the cost of the products that have been sold during the specific time period. It can be calculated using the following formula:
COGS = Beginning Inventory + Purchases – Ending Inventory
Beginning inventory is the value of inventory at the beginning of the period, and ending inventory is the value of inventory at the end of the period. Purchases are the total value of inventory purchases made during the period.
Determine the average inventory: Average inventory is the average value of inventory held during the specific time period. It can be calculated using the following formula:
Average Inventory = (Beginning Inventory + Ending Inventory) / 2
Calculate the inventory turnover ratio: Once you have the COGS and average inventory, you can calculate the inventory turnover ratio using the following formula:
Inventory Turnover Ratio = COGS / Average Inventory
The resulting number will be the number of times the company has sold and replaced its inventory during the specific time period.
Note that a high inventory turnover ratio indicates that the company is selling its inventory quickly, while a low ratio suggests that the company is not selling its inventory quickly enough. The ideal inventory turnover ratio varies by industry, so it’s important to compare the ratio with other businesses in the same industry.