Inventory turnover ratio

Inventory turnover ratio (ITR) is an activity ratio and is a tool to evaluate the liquidity of company’s inventory. It measures how many times a company has sold and replaced its inventory during a certain period of time.

Formula:

Inventory turnover ratio is computed by dividing the cost of goods sold by average inventory at cost. The formula/equation is given below:

inventory-turnover-ratio-img1

Two components of the formula of inventory turnover ratio are cost of goods sold and average inventory at cost. Cost of goods sold is equal to cost of goods manufactured (purchases for trading company) plus opening inventory less closing inventory. Average inventory is equal to opening balance of inventory plus closing balance of inventory divided by two.

Note for students: If cost of goods sold is unknown, the net sales figure can be used as numerator and if the opening balance of inventory is unknown, closing balance can be used as denominator. For example if both cost of goods sold and opening inventory are not given in the problem, the formula would be written as follows:

Inventory turnover ratio = Sales / Inventory

Example 1:

Compute the inventory turnover ratio and average selling period from the following data of a trading company:

  • Sales: $75,000
  • Gross profit: $35,000
  • Opening inventory: $9,000
  • Closing inventory: $7,000

Solution:

$40,000* / $8,000**

5 times

Computation of cost of goods sold and average inventory:

*$75,000 – $35,000 = $40,000
**($9,000 + $7,000) / 2

Average selling period is computed by dividing 365 by inventory turnover ratio:

365 days / 5 times

73 days

The company will take 73 days to sell average inventory.

Significance and Interpretation:

Inventory turnover ratio vary significantly among industries. A high ratio indicates fast moving inventories and a low ratio, on the other hand, indicates slow moving or obsolete inventories in stock. A low ratio may also be the result of maintaining excessive inventories needlessly. Maintaining excessive inventories unnecessarily indicates poor inventory management because it involves tiding up funds that could have been used in other business operations.

Users must also observe various factors that can effect inventory turnover ratio (ITR) before interpreting or making any decision. For example, companies using FIFO cost flow assumption may have a higher ITR in the days of inflation because the latest inventory purchased at higher prices remain in the stock under FIFO. On the other hand, companies using LIFO cost flow assumption may have comparatively lower ITR than others because the oldest inventory purchased at comparatively lower prices remain in the stock under LIFO.

Another factor that could influence this ratio is the use of just-in-time inventory method. Companies using just in time system of inventory management usually have high inventory turnover ratio as compared to others in the industry.

Example 2

The ITM trading company provides you the following data for the year 2016:

  • Inventory turnover ratio: 12 times
  • Opening inventory at cost: $36,000
  • Closing inventory at cost: $54,000

Calculate cost of goods sold for the year 2016.

Solution

Inventory turnover ratio = Cost of goods sold/Average inventory at cost

12 times = Cost of goods sold/$45,000*

Cost of goods sold = $45,000 × 12 times

= $540,000

*($36,000 + $54,000)/2

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22 Thoughts on Inventory turnover ratio

  1. Fawad

    I have difficulty and need your help in solving the following problem:

    A company earned a net profit of $212,000 before interest and tax. Total operating expenses for the year were $12,000. The opening stock was $12,000 and the closing stock was $4,000 higher than the opening stock. The goods are sold to make a gross profit of 50% on original cost.

    Required:

    (1). Calculate the amount of total goods purchased during the period.
    (2). Calculate stock/inventory turnover ratio of the company.
    (3). Calculate average selling period. Assume 360 days in a year.

  2. Accounting For Management

    You need to compute cost of goods sold and average stock first. These figures can be computed as follows:

    Gross profit
    = Net profit before interest and tax + Operating expenses
    = $212,000 + $12,000
    = $224,000

    Since the company sells goods at 50% above their original cost, the cost of goods sold can be computed as follows:

    Sales
    = $224,000 / 0.5
    = $448,000

    Cost of goods sold
    = $448,000 – $224,000
    = $224,000

    Average stock or inventory:
    = ($12,000 + $16,000)/2 = $14,000

    (1). Purchases made during the year:
    = (Cost of goods sold + closing stock) – Opening stock
    = ($224,000 + $16,000) – $12,000
    = $228,000

    (2). inventory turnover ratio (ITR):
    = $224,000 / $14,000
    = 16 times

    (3). Average selling period:
    = No. of days in a year / ITR
    = 360/16
    = 22.50 days

  3. May

    pls. compute…and help….
    quantity=12
    unit cost=18.00
    total cost=?
    selling price (x15%)
    NO. OF ITEMS SOLD=8
    TOTAL COST PRICE=?
    TOTAL SALES=?
    PROFIT=?
    ITEMS LEFT=?
    PLS…ANSWER…THANKS

  4. Accounting For Management

    Sorry May but the information you have provided is not complete. For example, quantity = 12, what quantity is it? Is it quantity purchased during the period?

    Please give us full information after then we will be able to solve it for you.

  5. Mariz Rose

    how will you compute the inventory turnover ratio if the inventory is unknown. There is no inventory account in the balance sheet. what does it mean. help please.

  6. najwa shaaban

    Please i need help to solve this..

    Inventory 1/1: 15000 units , $10 Per Unit
    Purchases:
    April 6: 14000 units , $12 Per Unit
    July 23: 11000 units , $14 Per Unit
    Oct 22: 10000 units , $15 Per Unit
    Sales during the year:
    May 15: 38000 units by 16 per unit

    Required :
    Using FIFO , LIFO and W.A methods.
    to Determine :
    – Cost of goods sold
    – Cost of inventory on hand at 31/12/2011
    – Profit/Loss Realized for 2011
    – Inventory Turnover and days in Inventory

  7. sandar

    Pls I need help to solve this.

    I want to know that can I replace the inventory turnover ratio: Cost of sale/Average Stock with Cost of sale Qty/Average Stock Qty or not. Thanks.

  8. ruchi patil

    How will the ratio be calculated if opening stock is not given …at that time total sales/closing stock would be the formula…but why?

  9. Ellie Monica

    Please help am stuck with these question below:
    (a) what are two methods for calculating inventory turnover?
    (b) using the two methods listed in 3.1 calculate inventory turnover for ABC company in 2013

    2012 2013
    Revenue $ 1000 000 $ 1500 000
    Costs of goods sold $ 500 000 $ 600 000
    Inventory $ 95 000 $ 100 000

    Thanks

  10. Accounting For Management

    ITR = 600,000/97,500*
    =6.15

    *(95000 + 100,000)/2

  11. Shashi

    Hi, if we do ,
    Inventory turnover= (average inventory/cost of good sold)
    Is ok or not?
    I want to find inventory turnover for the year so what is the equation ? Should I * by 365?

  12. Accounting For Management

    The basic equation is:
    Inventory turnover ratio (ITR) = Cost of goods sold/Average inventory at cost

    If you also want to calculate average selling period then divide 365 by ITR figure:
    Average selling period = 365/ITR

    hope this helps.

  13. decy

    the mraz inn and resort ask you to prepare an inventory report for the past transactionfor the anticipation of purchasing new inventories. these are the info.’s available in the resort book: 20 rooms are sold at P1500 per room; food and beverages sales is P15000; cost of rooms in P900 per room and P9000 for food and beverages. the beginning inventory is P4000 and the ending is P1000. compute for the stock turn at cost and stock turn at sales value.

  14. lilly

    during the year sales made were $400000.its gross profit ratio was 25% and net profit ratio was 10%.Ths stock turnover ratio was 10times.calculate gross profit, net profit. cost of goods sold and operating expenses.

    I have calculated gross profit as 25%*400000=100000. I don’t know if I did correctly please assist me with others.

    thank you in advance

  15. sidarth

    how can i solve this omega ltd. has authority to issue 1,00,000 shares of rs 100 each at premium 10% on allotment. it invited applications for 75000 shares but applications were received for rs 50000 shares only . money was as follow 25 % on app 25%on allotment 25% on first call 2nd and final call not to be made for the time being give journal enteries

  16. Naveen

    what is opening & closing stock, if i have salable stock & not salable stock? without any subtract value…
    For Exam:- salable stock = 0
    Not salable stock= 3000

  17. sony

    Please help me to solve this question

    Charlie’s Cycles Inc. has $150 million in sales. The company expects that its sales will increase 5% this year. Charlie’s CFO uses a simple linear regression to forecast the company’s inventory level for a given level of projected sales. On the basis of recent history, the estimated relationship between inventories and sales (in millions of dollars) is as follows:

    Inventories = 14 + 0.1010(Sales)

    Given the estimated sales forecast and the estimated relationship between inventories and sales, what are your forecasts of the company’s year-end inventory level and its inventory turnover ratio?

  18. Govind

    Pls. confirm that what should be the best inventory turnover ratio or stock-turn in Customized jobs production company?

  19. MEL

    How do I analyse inventory turnover ratio for ratio analysis

  20. Susanne

    Question: Should you use Inventory components (bottles, boxes, etc) in the Inventory Turn valuation or just Inventory Assemblies? It seems like it would just be finished goods or assembled items because the parts are not “saleable” until they are made into finished products.

  21. Brittney

    The following information was available for Blossom Company at December 31, 2017: beginning inventory $93000; ending inventory $146000; cost of goods sold $676000; and sales $824000. Blossom inventory turnover ratio (rounded) in 2017 was?

  22. WKV

    WHAT ARE THE USES OF STOCK TURNOVER RATIO

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