![]() When making comparison between firms, it's important to take note of the industry, or the comparison will be distorted. This is a major concern in fashion industries. Items that turn over more quickly increase responsiveness to changes in customer requirements while allowing the replacement of obsolete items.Reducing holding cost increases net income and profitability as long as the revenue from selling the item remains constant.The organization spends less money on rent, utilities, insurance, theft, and other costs of maintaining a stock of good to be sold. Increasing inventory turns reduces holding cost.The purpose of increasing inventory turns is to reduce inventory for three reasons. Stock turnover also indicates the briskness of the business. In this article, the terms "cost of sales" and "cost of goods sold" are synonymous.Īn item whose inventory is sold (turns over) once a year has a higher holding cost than one that turns over twice, or three times, or more in that time. Additionally, firms may reduce prices to generate sales in an effort to cycle inventory. However, cost of sales is recorded by the firm at what the firm actually paid for the materials available for sale. 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. 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). Cost of sales is considered to be more realistic because of the difference in which sales and the cost of sales are recorded. Cost of sales yields a more realistic turnover ratio, but it is often necessary to use sales for purposes of comparative analysis. Some compilers of industry data (e.g., Dun & Bradstreet) use sales as the numerator instead of cost of sales. This often can result in stock shortages. 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.Ī low turnover rate may point to overstocking, obsolescence, or deficiencies in the product line or marketing effort.Ĭonversely, a high turnover rate may indicate inadequate inventory levels, which may lead to a loss in business as the inventory is too low. The average days to sell the inventory is calculated as follows:Īverage days to sell the inventory = 365 days / Inventory turnover ratioĪ low turnover rate may point to overstocking, obsolescence, or deficiencies in the product line or marketing effort.Inventory turnover = Cost of goods sold/Average inventoryĪverage inventory = (Beginning inventory + Ending inventory)/2 Inventory turnover is also known as inventory turns, stockturn, stock turns, turns, and stock turnover. The equation for inventory turnover equals the cost of goods sold divided by the average inventory. It can provide them with a number of insights regarding their inventory management, specifically in relation to how efficiently it is being managed.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. This average can then be used as a baseline for future analyses.Īn inventory turnover ratio is a useful calculation for businesses to refer to. However, it is important to first compare inventory turnover ratios of other similar firms in a given sector to determine what the average is. Higher ratios can be a positive indication of a business's performance. A higher ratio would match the increased speed at which such products are intended to be sold. This result can still be considered reasonably good for a sizable organization with a breadth of products across multiple niches.ĪBC Company’s inventory turnover ratio would not be as acceptable for a company that offers products meant for immediate consumption. By implication, the company's products remain in stock for a longer amount of time before being sold. In this example, ABC Company’s inventory turnover ratio is fairly low. This yields a result of 0.71, meaning that ABC Company sold 71% of its product inventory in the year.
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