It’s also useful for anyone looking to invest in or buy a business. Inventory turnover ratio is a basic metric used to help retailers and other businesses manage inventory. Keep in mind that reasonable inventory turnover ratios vary by industry. Retailers often do inventory turnover ratio calculations on individual product lines or items to help identify fast-selling products. It suggests the business is neither buying too much inventory nor risking being out of stock too often. $200,000 sales / $50,000 average inventory = 4 inventory turnover ratioĪn inventory turnover ratio of 4 is within the desirable range for many retailers. Here’s how the formula looks for this example: Now applying the inventory turnover ratio, divide annual sales of $200,000 by the average inventory of $50,000 to get 4. Dividing by two gives $50,000 as the average inventory. To calculate average inventory, add the $45,000 beginning inventory to the $55,000 ending inventory. At the end of the year, it had $55,000 inventory. At the beginning of the year, it had $45,000 in inventory. Inventory turnover ratio = Sales / Average inventoryįor example, consider a picture framing shop that sold $200,000 worth of picture frames during the year. Now to calculate inventory turnover ratio divide the sales figure by the average inventory. Add the two figures together and divide by two. To do this, obtain the dollar value of inventory at the beginning of the period and at the end of the period. This should be available from the most recent income statement. Start with the total sales, or revenue, figure for the period. Retailers manage inventory turnover ratio by buying more or less inventory, using price discounts on slow-moving merchandise, initiating marketing promotions and other means. This means the retailer is selling off and replacing its inventory from two to four times a year. A startup, for example, might expect – at least initially – a lower inventory turnover as it introduces a new product.Īn annual inventory turn ratio of 2 to 4 is typically considered good for many retailers. Different types of retailers have different benchmarks for efficient inventory turns. Rather than trying to make inventory turns higher or lower, retailers generally seek to strike a happy medium. That’s not necessarily bad, since it means customers are less likely to find the items they want aren’t available. Lower inventory turns mean stock is moving more slowly. ![]() That means the business is spending less on holding costs. In addition to guiding business managers, inventory turn ratios may be scrutinized by lenders when a business uses inventory as collateral for a loan.Ī higher inventory number means stock is selling faster and spending less time in storage or on store shelves. ![]() It helps retailers avoid being either out of stock on popular items or having too many items sitting unsold on shelves. Being out of stock on an item when a customer is looking for it means a retailer has missed out on a sale. Being overstocked means the retailer is tying up money used to purchase inventory on slow-moving items. Overstocks also cost retailers money by occupying warehouse space. Inventory turnover ratio is an important tool for two main tasks of inventory management. ![]() Couple shopping for a new car at an auto dealership
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