What is inventory turnover? Meaning of Inventory turnover

Inventory turnover is a financial indicator commonly used in the production and business sector. This coefficient is present in the financial statements to help assess the general situation and development trend of the business. Let’s explore in details what Inventory turnover means.

What is inventory turnover?

One of the indicators of great interest in the financial statements of the business is the Inventory turnover. The term is known as the inventory turnover rate or the inventory turnover ratio.

So what is inventory turnover actually? Inventory turnover is a financial indicator that helps analysts evaluate whether a business is operating effectively or not.

inventory-turnover

Especially in companies, Inventory turnover is evaluated quite similar to Sale. How quickly inventory turnover will be in stock is sold or shipped to the buyer. To put it simply, this financial indicator represents the average number of times inventories are carried over for the accounting period.

Inventory turnover is the most commonly used inventory turnover in the production and business sector.

See also: What is EBITDA? Simple EBITDA Formula

Inventory turnover calculation

Inventory turnover shows whether the business has good or poor inventory management. This index is calculated using the following formula:

Inventory Turnover = Cost of goods sold / Average Inventory

Inside:

  • Inventory Turnover: Inventory turnover ratio
  • Cost of goods sold: Cost of goods sold
  • Average Inventory: Average inventory value
  • Inventory turnover shows whether the business has good or poor inventory management

inventory-turnover-ratio-formula

This can be calculated by replacing cost of goods sold with sales. Note, however, that the values ​​used must be taken within the same accounting period. At the same time, the average value of inventories should be calculated using the following formula:

Average value of inventories = (value of inventory at the beginning of the period + value of inventories at the end of the period) / 2.

You can also calculate inventory turnover using the same formula for the last 4 quarters. Specifically:

Inventory turnover ratio of the last 4 quarters = Total cost of goods sold in the last 4 quarters / Average inventory value.

See also: What is IRR? The Fundamental Role of IRR in business investment

What is the meaning of Inventory turnover?

Inventory turnover is considered one of the important financial indicators. So what is the meaning of inventory turnover – what is inventory turnover? This coefficient helps analysts of financial statements identify the development trend of the business. At the same time, the investors also check the current financial situation of the company.

Inventory turnover ratio represents the average number of inventory turns in a period. If this index is high, it means that the time when businesses can sell their products quickly, their inventories are not much stagnant. Therefore, in the financial statements, the inventory item decreases over the years, the risk of the business is minimized.

However, when this index is too high, it also shows that the company has a small amount of inventory in stock. This becomes detrimental for the company if there is a sudden increase in demand. Businesses will face the risk of business market shares in the industry being dominated by competitors.

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Inventory turnover is considered one of the important financial indicators

In addition, too high inventory turnover ratio is also a sign for the inadequate reserve of raw materials for production. This situation can lead to a chain stall. Therefore, businesses need to control this index at a moderate level, ensuring production capabilities and customer needs.

what-is-inventory-turnover

Based on the specific characteristics of each industry, in each period, this index requires a high or moderate level. The inventory turnover ratio may be low when the enterprise buys raw materials aggressively at a time when the price falls sharply. In the near future, the company will gain a large profit thanks to the high difference between revenue and expenses.

Above is information that answers the meaning of what is inventory turnover. This financial index contributes significantly to the evaluation of business performance. Depending on the actual situation, the company should have measures to adjust the coefficient to ensure production and distribution.

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