A company sells products to its costumers in hopes of turning a profit, this is business 101. However, what if the rate at which a company sells inventory gave analysts a better idea of future earnings? Inventory turnover is a good predictor a company’s success.
What Is Inventory Turnover?
By definition, inventory turnover shows how many times a company sells inventory, then replaces it. Also, a few different ways of calculating this ratio exist. Some express inventory turnover in term of sales, others cost of goods sold. The most basic calculation shows average inventory = (beginning inventory + ending inventory)/2
Furthermore, the aforementioned ratios are displayed below:
In terms of net sales: Net Sales / Average Inventory
In terms of cost of goods sold: Cost of Goods Sold/ Average Inventory
Additionally, companies track how long it to sell the inventory by the following : Average Days to Sell = 365 days / Inventory Turnover Ratio.
Inventory Turnover In Practice
Companies never want excess inventory sitting on their shelves. This is potential profits that the company either reinvests or returns to shareholders. This measurement is industry specific. Additionally, industry benchmarks exist to compare against.
Analysts use inventory turnover when measuring the strength of sales. Low inventory ratio leaves a company cash strapped and insolvent. Furthermore, this ratio relates to the company’s return on assets (ROA). Shareholders watch this ratio as it explains how efficiently a company utilizes its assets. Like other ratios, different industries scrutinize the measure with different importance. For example, a retail analyst shows great interest in the ratio, whereas a service company analyst values it less.
Finally, the advent of quick shipping methods brought new focus on inventory turnover ratios. Consumers showed their willingness to purchase any and all products online, creating a new dynamic for sellers. This brought about a tremendous demand for supply chain analysts whose main objective is streamlining inventory turnover and creating the most efficient operation possible.