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Inventory Turnover (Times)

Inventory Turnover (Times) – an activity ratio measuring the efficiency of the company's inventory management. It shows how many times a firm usually turns its inventory into sales per year. It can be computed by dividing the cost of goods sold by the company's average inventory.

The efficient inventory management means that the current level of the production supplies, goods in process and finished goods allows the continuous production and sales process, but at the same time minimum of financial resources is being used to finance the inventory. If the operational process is continuous but the inventory level is significant, the firm's expenses will grow. The necessity to pay the warehouse rent and the interest for the funds involved for the additional inventory purchase - all this increases expenses of the enterprise.

Normative values for the inventory turnover (times) highly depend on the industry and can be seen in the table below:

Indicator Agricultural production Oil and Gas Extraction Electric Power Generation, Transmission and Distribution Construction of Buildings Miscellaneous Store Retailers Religious, Grantmaking, Civic and Professional Organizations
Inventory Turnover (Times) >= 4,7 >= 31,9 >= 21,8 >= 5,3 >= 4,7 >= 40,9

Source: Almanac of Business and Industrial Financial Ratios

When making conclusions on the company's inventory management efficiency, it should be taken into account that even for a certain industry this indicator values may vary. That's why it is necessary to compare the values with main competitors. The dynamics of the inventory turnover should also be analyzed. An increasing trend of its values witnesses the continuous improvement of the company's inventory management efficiency.

Resolving the problems with the inventory turnover exceeding the normative range:

Briefly, the inventory management policy must ensure the continuous process of production and sales. On this purpose, the inventory stock is being formed, which will guarantee the continuity of the production process in between the supply periods. Also, the emergency inventory stock is being formed. Technological inventory stock should be taken into account if the company cannot use the inventory for the production process without their preliminary preparation. Finally, the attention should be paid to the seasonality. Considering all the above-mentioned factors, an optimal inventory stock is being formed. If the current inventory stock is higher than optimal, it should be decreased in order to release a part of the financial resources. If it is lower than optimal, a risk of production and sales process collapse exists due to the lack of resources.

Formula(s):

Inventory turnover (Times) = Cost of Goods Sold ÷ Average Inventory

Inventory Turnover (Times) = 360 ÷ Inventory turnover (Days)

Example:

Inventory Turnover (Times) (Year 1) = 3351÷ 314 = 10,6

Inventory Turnover (Times) (Year 2) = 3854 ÷ 428 = 9,0

In year 1 a firm was able to turn its inventory into sales 10,6 times. In year 2 this value has declined to 9,0, indicating the deterioration of company’s working capital. One of the reasons might be the lack of resources, which leads to interruptions in the operating process. To make more accurate conclusions more detailed research should be made.

Conclusion:

Inventory turnover measures how efficient is the company's process of the inventory management. Depending on whether it is higher or lower than normative, it can indicate either a possibility of releasing additional financial resources through decreasing the inventory stock, or a risk of the production and sales process collapse due to the lack of resources.

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