Inventory Turnover Ratio = COGS / Average Inventory Value Example 1Īn automotive parts store has a COGS of $500,000 with an average inventory of $10,000. The information for this equation is available on the income statement (COGS) and the balance sheet (average inventory). This equation will tell you how many times the inventory was turned over in the time period. The inventory turnover formula is also known as the inventory turnover ratio and the stock turnover ratio.Inventory turnover is calculated by dividing the cost of goods sold (COGS) by the average value of the inventory. The 5 turns figure is then divided into 365 days to arrive at 73 days of inventory on hand. Total inventory turnover is calculated as: The related information is $8,150,000 of cost of goods sold in the past year, and ending inventory of $1,630,000. The Hegemony Toy Company is reviewing its inventory levels.

If standard costing is used, the standard cost applied to an inventory item may diverge from its actual cost. The method for allocating overhead to inventory may change, such as from using direct labor hours as the basis of allocation to using machine hours used. For example, some items that were charged to expense as incurred are now allocated. The contents of the cost pools from which overhead costs are allocated to inventory may be altered. There are several ways in which the inventory turnover figure can be skewed. Problems with the Inventory Turnover Formula This is known as the inventory turnover period. Thus, a turnover rate of 4.0 becomes 91 days of inventory. You can also divide the result of the inventory turnover calculation into 365 days to arrive at days of inventory on hand, which may be a more understandable figure. The formula is:Īnnual cost of goods sold ÷ Inventory = Inventory turnoverĪ more refined measurement is to exclude direct labor and overhead from the annual cost of goods sold in the numerator of the formula, thereby concentrating attention on just the cost of materials. If the ending inventory figure is not a representative number, then use an average figure instead, such as the average of the beginning and ending inventory balances. To calculate inventory turnover, divide the ending inventory figure into the annualized cost of sales. The latter scenario is most likely when the amount of debt is unusually high and there are few cash reserves. However, it may also mean that a business does not have the cash reserves to maintain normal inventory levels, and so is turning away prospective sales. When there is a high rate of inventory turnover, this implies that the purchasing function is tightly managed. In both cases, there is a high risk of inventory aging, in which case it becomes obsolete and has little residual value. When there is a low rate of inventory turnover, this implies that a business may have a flawed purchasing system that bought too many goods, or that stocks were increased in anticipation of sales that did not occur. Doing so can substantially increase the investment in inventory. The purchasing manager may advocate purchasing in bulk to obtain volume purchase discounts.

A pull system that only manufactures on demand requires much less inventory than a 'push' system that manufactures based on estimated demand. The inventory accounting method used, combined with changes in prices paid for inventory, can result in significant swings in the reported amount of inventory.įlow method used. Some portion of the inventory may be out-of-date and so cannot be sold.Ĭost accounting. Inventory may be built up in advance of a seasonal selling season. The following issues can impact the amount of inventory turnover: It can be used to see if a business has an excessive inventory investment in comparison to its sales, which can indicate either unexpectedly low sales or poor inventory planning. The inventory turnover formula measures the rate at which inventory is used over a measurement period.

Inventories turnover ratio formula