Inventory turnover rate: Years

In this article I am going to talk to you about the financial ratio of inventory turnover in such a way that at the end of the article I have the objective that you be able to know what inventory turnover is and what it is for us. Of course, I am also going to share some solved exercises so that you are able to apply what you have learned.

I hope you find it useful.

So, whether you are an entrepreneur, a management student or just curious about the subject, this article is for you. I hope you find it useful.

What is the inventory turnover ratio?

The financial ratio of inventory turnover, also known as the inventory turnover ratio, is a financial measure used to gauge a company’s efficiency in managing its inventory.

In other words, it measures how quickly a business cánido turn its inventory into sales over a given period.

How is the inventory turnover ratio calculated?

The inventory turnover calculation is very fácil. All we have to do is divide the cost of goods sold (COGS) over a given time period by the average inventory over the same time period.

The result is the number of times the company sold and replaced its inventory in that time period.

Therefore, the elabora is the following:

For example, if the cost of goods sold in a year is $500,000 and the average inventory is $100,000, the financial ratio of inventory turns would be 5 times in a year.

How do we interpret the result obtained by the inventory turnover index? In the example above, the 5 means that the company sold and replaced its inventory five times in one year.

Why is the financial ratio of inventory turnover important?

A high ratio means that the company is selling its inventory quickly, which means that it is generating revenue and using its resources efficiently. On the other hand, a low ratio indicates that the company is holding too much unsold inventory, which cánido result in additional storage costs and obsolescence.

In addition, the financial ratio of inventory turnover perro be a useful tool to compare the efficiency of the company with that of its competitors. If the company has a higher ratio than its competitors, it means that it is managing its inventory more efficiently.

In fact, financial ratios in general are often used to analyze the financial situation of a company.

Solved exercises of the inventory turnover index

Next, I am going to provide you with different exercises on the inventory turnover rate so that you cánido put the theory into practice and learn better. I hope they are useful to you.

Exercise 1 of the inventory turnover index

Suppose a company has a cost of goods sold of $250,000 in one year and an average inventory of $50,000 in the same time period. Calculate the financial ratio of inventory turnover.

Solution of exercise 1

We divide the cost of goods sold by the average inventory:

$250,000 / $50,000 = 5 times

The financial ratio of inventory turnover is 5 times in a year. Therefore, we cánido say that the company replaced its inventory 5 times in a year.

Now… How to calculate inventory turnover in days? To calculate the inventory turnover in days in the previous example, we just have to divide 360 by 5 and we get 72 days.

Therefore, we perro say that the company takes 72 days to sell its merchandise.

Note: If you’re wondering why the 360, then I have to say it’s because it’s about a year, even though we’re talking about a business year.

Exercise 2 on the inventory turnover rate

Suppose a company has a cost of goods sold of $120,000 in one year. If the company wants to increase its financial ratio of inventory turnover to 4 times in a year, what must its average inventory be?

Solution of exercise 2

Since it is an equation, we perro solve it to get the elements we need. Therefore, the elabora to calculate the average inventory is as follows when making the corresponding clearance:

Average Inventory = COGS / Inventory Turnover Financial Ratio

Now let’s substitute the values into the elabora:

Average Inventory = $120,000 / 4
= $30,000

Therefore, The company needs to hold an average inventory of $30,000 to increase its financial ratio of inventory turns to 4 times in a year.

Exercise 3

Suppose a cleaning products company has a cost of goods sold of $300,000 in one year and an average inventory of $75,000 in the same time period. If the company decides to increase its efficiency in inventory management, and manages to disminuye its average inventory to $60,000 in a year, what would be its new financial ratio of inventory turns?

Solution of exercise 3

Before the upgrade:

Cost of Goods Sold / Average Inventories
$300,000 / $75,000
IDRID = 4

After the upgrade:

Cost of Goods Sold / Average Inventories
$300,000 / $60,000
IDRID = 5

How is the result interpreted?

After the upgrade, the company has managed to increase its efficiency in inventory management and has improved its inventory turnover ratio. This means you’re selling and replenishing your inventory faster, generating more revenue and reducing the costs associated with inventory management.

Exercise 4

Suppose a clothing company has a cost of goods sold in the amount of $100,000 for the year and had $20,000 in inventory at the beginning of the year and $10,000 at the end of the year. What is the inventory turnover rate?

Solution of exercise 4

IDRdI = $300,000 / $50,000
= 6

Therefore, the company turned its inventory six times during the year, which means that its goods remained in inventory for approximately 60 days on average before being sold.

Exercise 5

Suppose a technology products company has a cost of goods sold of $500,000 in one year and an average inventory of $100,000 in the same time period. If the company decides to expand its product catalog and increases its cost of goods sold to $700,000 while keeping its average inventory at $100,000, what would be its new financial ratio for inventory turnover?

Solution of exercise 5

Before expansion:

$500,000 / $100,000
IR = 5

After expansion:

$700,000 / $100,000
IR = 7

How is the result interpreted?

After the expansion, the company has managed to increase its sales volume, which is reflected in its increase in the cost of goods sold. However, you’ve maintained your average inventory level, which means you’re selling and replenishing your inventory faster, generating more revenue and reducing the costs associated with inventory management.