Suppose a retail company has the following income statement and balance sheet data.įor 2021, the company’s inventory turnover ratio comes out to 2.0x, which indicates that the company has sold off its entire average inventory approximately 2.0 times across the period. Inventory Turnover Ratio Calculation Example We’ll now move on to a modeling exercise, which you can access by filling out the form below. The company’s inventory, if left unsold, might eventually need to be written down to reflect the true (lower) value on the balance sheet. Lower Inventory Turnover Ratio → There might be poor demand in the market and excess inventory accumulating (i.e.Higher Inventory Turnover Ratio → The company likely experiences strong demand in the market for its products, as confirmed by the high turnover and the frequent need for inventory replenishment.Since the inventory turnover ratio represents the number of times that a company clears out its entire inventory balance across a defined period, higher turnover ratios are preferred. Unique to days inventory outstanding (DIO), most companies strive to minimize the DIO, as that means inventory sits in their possession for a shorter period. The formula used to calculate a company’s inventory turnover ratio is as follows.ĭays Inventory Outstanding (DIO) = 365 Days ÷ Inventory Turnover Calculate Inventory Turnover Ratio → The inventory turnover ratio is determined by dividing the company’s cost of goods sold (COGS) in the current period by the average inventory.Compute Average Inventory → The average inventory is the beginning and ending inventory balance divided by two.Identify the Beginning and Ending Inventory Balances → The beginning of period and end of period inventory balances are recorded on the company’s balance sheet.The steps for calculating the inventory turnover ratio are the following: Thus, the inventory turnover rate determines how long it takes for a company to sell its entire inventory, creating the need to place more orders. The inventory turnover ratio is calculated by dividing the cost of goods sold (COGS) by the average inventory balance for the matching period. Simply put, the inventory turnover ratio measures the efficiency at which a company can convert its inventory purchases into revenue. The inventory turnover ratio is a financial metric that portrays the efficiency at which the inventory of a company is converted into finished goods and sold to customers. How to Calculate Inventory Turnover Ratio How to Interpret Inventory Turnover by Industry?.Inventory Turnover Ratio Calculation Example.What is a Good Inventory Turnover Ratio?.How to Calculate Inventory Turnover Ratio.
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