Inventory turnover ratio is used to calculate how many times total inventory get sold out in the company. It is calculated by dividing cost of goods sold figure by inventory amount. The outcome comes in times. That is why; we say number of times total inventory sold out in a year.
Inventory turnover ratio = COGS ÷ Inventory
Here Sales is the total of credit sales and cash sales. Inventory is calculated by adding the opening balance & closing and divided by 2. This is also called average inventory.
Average inventory/ stock = (Opening balance + closing balance) ÷ 2
Note: Sometimes, it is not possible to calculate COGS figure. Under this case, you may simply use sales figure.
Example 1: Cost of Goods Sold (COGS) = $10,000/-, Average Stock = $5,000/-. Calculate
Stock turnover ratio.
Solution:
As we know,
Stock Turnover ratio = COGS ÷ Average Stock
= 10,000 ÷ 5,000
= 2
Example 2: A complex situation may arise where you have to find COGS figure from available data. For example, calculate inventory turnover ratio from following data:
Sales figure is $120,000 and Gross Profit is 10{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} over sale.
Opening Stock = $15,000
Closing Stock = $10,000
Solution:
Average Stock/ Inventory = (Opening Stock + Closing Stock) ÷ 2
Average Stock/ Inventory = (15,000 + 10,000) ÷ 2
Average Stock/ Inventory = 12,500
COGS = Sales – Sales x Gross Profit {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}
COGS = 120,000 – 120,000 x 10{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}
COGS = 120,000 – 12,000
COGS = 108,000/-
Now, we will calculate Inventory Turnover Ratio below:
Inventory turnover ratio = COGS ÷ Average Stock
Inventory turnover ratio = 108,000 ÷ 12,500
Inventory turnover ratio = 8.64
Inventory Turnover ratio is very effective in comparing companies in the same industry. Alternatively, you can analyze the trends of inventory over the periods to judge its performance. In a FMCG (Fast moving consumer goods) industry, the inventory turnover ratio used to be quite higher as inventory quickly comes and sold out to the customers.