Turn Baby Turn – Why Inventory Turns Matter

Turn Baby Turn – Why Inventory Turns Matter

Be Sociable, Share! Tweet This is the third part of our series on ratios and what they mean to your business. Inventory turns are the amount of times in a fiscal year that you sell your complete inventory. The ratio is normally calculated by dividing sales by inventory on the year end balance sheet. As an example, if sales are $1,500,000 and inventory is 300,000 on the year end balance sheet, then: In this case the inventory turns five times per year. It can also be calculated by dividing cost of goods sold by average inventory. However, the sales/inventory is the more popular method. If you then divide the number of days in a year by the number of inventory turns, you get the inventory turnover period.  For example, using the 5 inventory turns from above, the inventory turnover period would be 73 days.   The reason this ratio is so important is that the more often the inventory turns the higher the profits. Profit is made each time inventory sells (or at least it better be!), so the quicker it sells the more profits you are bringing in.  A high turnover ratio implies that purchasing is managed well. Alternatively, it may mean that there is not enough cash to maintain normal inventory levels, and so the company is turning away possible sales. The second scenario is most likely when the amount of debt is unusually high and there are few cash reserves.   On the other hand, a low turnover ratio implies  implies that a business may have bought too many goods and their approach to purchasing is unsound. In this case, inventory aging may occur...
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