Rate of inventory turnover (times)
6.1 Calculation and Understanding of Accounting Ratios
Rate of Inventory Turnover (times)
The inventory turnover ratio tells you how many times a company sells and replaces its inventory during a period. Think of it like a coffee shop that sells cups of coffee: the more cups sold in a day, the faster the shop is turning over its inventory of coffee beans.
The formula is:
$ \displaystyle \text{Inventory Turnover} = \frac{\text{Cost of Goods Sold (COGS)}}{\text{Average Inventory}} $
Where Average Inventory = $\frac{\text{Opening Inventory} + \text{Closing Inventory}}{2}$
- Find the Cost of Goods Sold for the period.
- Calculate the Average Inventory using opening and closing balances.
- Divide COGS by Average Inventory to get the turnover ratio.
| Item | Amount (£) |
|---|---|
| Opening Inventory | $12,000 |
| Closing Inventory | $8,000 |
| Cost of Goods Sold (COGS) | $48,000 |
Calculation Example 🚀
Average Inventory = $\frac{12,000 + 8,000}{2} = 10,000$
Inventory Turnover = $\frac{48,000}{10,000} = 4.8$ times.
Interpretation: The company sells and replaces its inventory about 5 times a year.
A higher ratio usually indicates efficient inventory management, but if it’s too high it might mean the company is not keeping enough stock to meet demand.
Practice Question 📚
A retailer had an opening inventory of £9,000 and a closing inventory of £7,000. The COGS for the year was £36,000. What is the inventory turnover ratio?
Answer 🔍
Average Inventory = $\frac{9,000 + 7,000}{2} = 8,000$
Inventory Turnover = $\frac{36,000}{8,000} = 4.5$ times.
Revision
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