What is the Inventory Turnover Formula?
Inventory turnover refers to the number of times an enterprise sells any particular stock of goods and replaces it in a given period of time. The inventory turnover formula helps you determine how effectively an e-commerce business manages its inventory.
Significance of Inventory Turnover Formula
The inventory turnover ratio formula is instrumental for e-commerce businesses in the following ways:
- The formula for inventory turnover ratio can be used to understand how quickly an enterprise is selling out its inventory.
- It helps in making pricing decisions. For instance, if your inventory turnover is too low, you can lower your pricing in order to generate more sales.
- It also helps companies optimize their manufacturing and marketing strategies. Therefore, if a company has low inventory turnover, it can change re-evaluate its marketing strategy or lower its manufacturing or purchasing quantities.
Application of Inventory Turnover Ratio Formula
The inventory turnover formula is applied to:
- Calculate liquidity, which is the amount of cash any enterprise possesses.
- Warehouse and inventory management, since it gives precise data on the number of times an inventory is replaced.
Inventory Turnover Formula
The formula to calculate inventory turnover is:
Inventory Turnover =
Cost of goods sold / Average inventory
Definition of Each Element in the Inventory Turnover Formula
The two elements in the inventory turnover formula are described below:
- Cost of Goods Sold: It refers to the direct cost involved in producing goods.
Cost of goods sold =
Beginning inventory + purchases – Ending inventory
- Average Inventory: Average inventory refers to the average cost of goods during specified periods. It is calculated by:
Average Inventory =
[ Beginning inventory + Ending inventory] / 2
How To Use Inventory Turnover Formula: An Example
Take, for example, your cost of sales for the year 2022 is ₱10,000. Additionally, your beginning and ending inventories were ₱100 and ₱400, respectively. Therefore, your inventory turnover ratio would be:
This indicates your inventory has been replaced 40 times in a given period.
How To Interpret Results Obtained From Inventory Turnover Formula?
A higher inventory turnover ratio points to greater sales or inadequate inventory stocking. Conversely, a lower turnover ratio means lower sales or excess inventory stocking. The ideal inventory turnover ratio for most businesses is between 5-10.