Inventory Turnover Definition
An inventory turnover is a metric that measures the rate at which a company sells its inventory and replaces it in a given period. An inventory turnover calculates the days it takes a company to sell its inventory and the amount of time it takes to replenish the inventory.
This metric helps to measure the sales a company generates from its inventory. An inventory turnover ratio is calculated by dividing the number of goods or cost of goods sold by the average inventory. An inventory turnover ratio helps companies make sales and production decisions that will further enhance profitability and customers’ satisfaction.
A Little More on What is Inventory Turnover
A company will either have a high inventory turnover or low inventory turnover at a given period of time. Low inventory turnover is attributed to too much inventory, economic crisis and poor sales techniques. A high inventory turnover means that a company is able to convert an inventory into sales within a short period of time.
In cases of low turnovers, it is an indication that certain managerial decisions need to be revisited in terms of sales and marketing. When it comes to sales, how fast a company sell its products is crucial in measuring its performance. A slow-selling inventory requires holding and maintenance costs unlike its fast-selling counterpart.
Inventory Turnover and Profitability
When measuring the performance of a company, its inventory turnover ratio is important. Keeping a good inventory turnover helps a company maintain a good status quo and better performance. A company can outperform its competitors if it has a high inventory turnover. Also, the ability to sell inventory in a short period of time translate into higher profit margin for the company. A slow-selling inventory will cost a company more in terms of holding and maintaining it which will also reduce profit. Fast-selling inventory relieve a company of rent costs, holding and maintenance costs, among others.
Inventory Turnover and Dead Stock
Dead stocks are old stock that are removed from sale because of reduced quality and damages that have occurred to them. Time-sensitive goods have short life-span, they spoil easily and must be sold in a little period of time. A good inventory turnover is an important method that a company can use to sell products and goods before they become dead stock. A high turnover means a company sells its goods and the goods retain their freshness and quality.
Another factor that contribute to the availability of dead stock is excess inventory, getting too much products, especially slow-selling products can make them later become dead stocks.
Inventory Turnover Example
There are ways to calculate the inventory turnover of a company, the cost of goods sold (COGS) can be divided by the average inventory. An inventory can also be calculated as sales divided by average inventory The average inventory is calculated by adding the beginning inventory to the ending inventory and divide by 2; (beginning inventory + ending inventory)/2.
However, calculating the inventory turnover of a company as sales divided by average inventory is not an accurate method, this is because, there is a tendency for inflation in inventory turnover if the method is used. Dividing COGS by average inventory is a more accurate method.
Inventory Turnover Considerations
Oftentimes, people calculate inventory turnover and apply it in the interpretation of how companies run without paying attention to certain factors that need to be considered when applying inventory turnover.
When comparing turnovers of businesses, one must compare similar businesses and not two businesses from two distinct sectors. For example, comparing the inventory turnover of a gadgets store to a grocery store might amount to wrong conclusions being made.
Also, when drawing conclusions on inventory turnover, it is important to know that some companies might manipulate turnover using discounts which in turn adversely affect the profitability of the companies. More goods are sold but at lesser price, resulting in a reduction in ROI.
Inventory Turnover and Open-to Buy Systems
Open-to-buy systems are rampantly used in retail merchandise as a means to help inventory managers take orders, manage mad replace their inventories without getting into any trouble. OTB systems are softwares designed for budgeted purchase by retailers. This system help businesses manage and replace their inventories more efficiently. These OTB systems help businesses decide on how much inventory they can purchase that will not affect their operations. OTB systems are however designed for retail merchandise and not all categories of merchandise.
References for Inventory Turn over
- https://www.myaccountingcourse.com › Financial Ratio Analysis
- https://www.thebalancesmb.com › Industries › Retail Small Business › Inventory
- https://corporatefinanceinstitute.com › Resources › Knowledge › Finance
Research articles for “Inventory Turn over”
An econometric analysis of inventory turnover performance in retail services, Gaur, V., Fisher, M. L., & Raman, A. (2005). Management science, 51(2), 181-194.
The impact of lean practices on inventory turnover, Demeter, K., & Matyusz, Z. (2011). International Journal of Production Economics, 133(1), 154-163.
Evaluating inventory management performance using a turnover curve, Ballou, R. H. (2000). International Journal of Physical Distribution & Logistics Management, 30(1), 72-85.
The effects of firm size and sales growth rate on inventory turnover performance in the US retail sector, An examination of inventory turnover in the Fortune 500 industrial companies, Vergin, R. C. (1998). Production and Inventory Management Journal, 39(1), 51.
Expressing inventory control policy in the turnover curve, Ballou, R. H. (2005). Journal of Business Logistics, 26(2), 143-164.
An empirical analysis of inventory turnover behaviour in Greek retail sector: 2000–2005, Kolias, G. D., Dimelis, S. P., & Filios, V. P. (2011). International Journal of Production Economics, 133(1), 143-153.
The effect of inventory management on firm performance, Koumanakos, D. P. (2008). International journal of productivity and performance management, 57(5), 355-369.
System, method, and computer program product for increasing inventory turnover using targeted consumer offers, Juang, D., & Rane, R. R. (2012). U.S. Patent No. 8,335,720. Washington, DC: U.S. Patent and Trademark Office.
Inventory–turnover analysis: its importance for on-site food service, Reynolds, D. (1999). Cornell Hotel and Restaurant Administration Quarterly, 40(2), 54-58.