Inventory turnover is a ratio showing how many times a company has sold and replaced inventory during a certain period. A higher turnover indicates effectiveness in managing stock, with more sales from less inventory. It’s calculated by dividing the cost of goods sold by the average inventory.
1. How do you calculate the Inventory Turnover ratio?
Divide the ‘Cost of Goods Sold’ (COGS) by the ‘Average Inventory’. Average Inventory can be obtained by adding the beginning and ending inventory for a period then dividing it by two. COGS is found in the income statement.
2. What does a low Inventory Turnover ratio mean?
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A low turnover ratio implies weak sales and possibly excess inventory, which could be an unfavorable sign. It means a company may not be managing its inventory well.
3. Is a high Inventory Turnover ratio always better?
Not necessarily. While a high inventory turnover often indicates strong sales, it may also suggest low purchasing power, scarcity of inventory, and the potential for lost sales.
4. How can a company improve its Inventory Turnover ratio?
A business can improve this ratio by increasing sales, reducing production costs, improving inventory management, or a combination of these practices.
5. What is a good Inventory Turnover ratio?
Acceptable ratios vary by industry. However, as a rule of thumb, companies should aim for a ratio that’s neither too high nor too low, taking their respective industry standards into account.