The inventory turnover ratio is a ratio that shows how many times the inventory has gone on sale throughout the year. In other words, the inventory turnover ratio is the ratio which measures the number of times a company sells its inventory during the year.
In a manufacturing firm, there is a need for maintaining inventories to accommodate unexpected fluctuations in demand and supply. So basically there is a formula for calculating the inventory turnover ratio, so with the help of cost of goods sold then beginning stock in inventory and cost one is ending stock in inventory. So formula,
Inventory turnover ratio = cost of goods sold/ average inventory.
We are supposing that the cost of goods sold is 800and the beginning inventory is 1000 and the ending inventory is 200 so after we calculate our inventory turnover ratio is 1.35. So basically inventory turnover ratio shows how effectively your inventory is managed. The Inventory turnover ratio is a measure how many times your inventory is sold in a certain period of time. Inventory turnover ratio helps us in finding a balance sheet that shows the company is making profit in their business or not. The most basic formula for calculating Inventory turnover ratio = Net sales/Inventory, the net sales is directly taken from the profit and loss statement of any company and inventory is mentioned in the balance sheet as well.
Two main components of inventory turnover ratio
Suppose you purchase a high amount of inventory during a year so the company will try to sell a high amount of inventory to the customer during a year.
In other, You have to match the sale of inventory with the purchase of inventory because both are complementary to each other and depend on each other because the more you purchase, the more you have to take its outcome. That’s they are interlinking to each other.
Every company needs a high inventory turnover ratio so that the company can control its business. It basically shows the company doesn’t buy inventory more because of maintaining sales. You know what, inventory is the highest asset which is recorded in the balance sheet. Suppose you are a manager of a purchase department and you have purchased an inventory but you can’t sell those inventory so it will have a bad impact on the company’s income and be worthless to the company. So companies have to convert these inventory into cash. These inventories are used as collateral for loans because banks or other lenders know these inventories will be easy to sell.
How inventory is important for manufacturers?
Suppose you are a manager of manufacturing industry and your industry manufactures bakery biscuits so for manufacture, companies need maida flour so flour is the inventory and when this inventory you will buy, so you will have expectation to sell these biscuits more at a high rate. Inventory used to finishing a product.
Every manufacturer has a dream of effective inventory because inventory has a direct effect on revenue or profit. If inventory sales increase, profit increases also and if inventory sales low, profit decreases. You know what, inventory calculates through cost of goods sold, cost of goods sold subtracted from sales to calculate gross profit and it is done by the manufacturer. Even calculate the net income, deduct all the operating expenses from gross profit so it is important for manufacturers to record the cost of goods sold.
Every business has demand for inventory so for manufacturers, inventory needs more than enough to fulfill this demand so that they earn more profit. Manufacturer only orders not too much inventory, they order according to the demand of supply, in this case, they have more chances to face risk and losing money. They ordered according to customer demand.