Inventory Turnover Ratios
Inventory has a holding cost associated with it. The
holding cost is either the company’s borrowing cost rate, or its cost of
capital rate. The faster inventory turns over and is converted into
receivables, and then cash, the more efficient management is in deploying
its resources. The inventory turnover ratio measures this efficiency, and is
easily compared with competitors’ results.
The “inventory turnover ratio” is calculated by
dividing annualized cost of goods sold by average inventory.
Another way to look at the efficiency of inventory
management is to calculate “day’s sales in ending inventory.” This is
computed by dividing the inventory turnover ratio into the number of days in
the year, and is the inverse relationship of the inventory turnover ratio,
expressed as number of days. This discloses the number of days it takes to
sell your inventory. Either calculation should detect slow moving and
possibly obsolete inventory. The faster the inventory turns over, the lower
the holding cost.
There have also been major advances in the accuracy
of audited inventories, as well as in identifying and reducing the amount of
shrinkage in stores. Inventories may be bar coded; the counting/auditing
companies, like RGIS, do a fantastic job of verifying inventories,
especially in retail and grocery stores. The values reported on the balance
sheet to investors have been greatly improved over the years, because of
these inventory-auditing companies.
continuing trend towards outsourcing production capabilities is disturbing.
Investors should be concerned if an organization can maintain its profit
margins, if it can’t manufacture the products it sells.
Click here for information on:
-Focus on the Profit Margins
-Perpetual vs. Periodic Inventory
-Inventory Accounting Calculation
-Inventory Costing Methods
-Lower of Cost or Market