Those who finally make it in business would have mastered the art of quickly converting their inventory or services into money. One mustn’t be happy seeing volumes of stocks in the warehouse, getting busy counting it at the end of the week, month or year as closing stock. That’s not how it must be. Stocks must just come and go.
The number of times stock is converted into cash within a trading period determines the level of business the organisation is experiencing. The slower the stock is converted into cash the lesser the sales. The principle of inventory turnover is exactly what we are driving at.
What is Inventory Turnover?
Inventory turnover, or the inventory turnover ratio, is the number of times a business sells and replaces its stock of goods during a given period. It considers the cost of goods sold, relative to its average inventory for a year or in any set period of time.
A high inventory turnover generally means that goods are sold faster and a low turnover rate indicates weak sales and excess inventories, which may be challenging for a business.
Inventory turnover can be compared to historical turnover ratios, planned ratios, and industry averages to assess competitiveness and intra-industry performance. Inventory turns can vary significantly by industry.
Success in business is partly determined by the number of times you turn the stocks that you have within a month. It doesn’t make any business sense to have a stock value of US$200,000 per month when your monthly sales are only US$20,000. This means you’re carrying 10 months’ worth of stocks. You would rather invest elsewhere than tying your money in inventory that you cannot push within reasonable time.
Inventory turnover can be calculated by dividing your Cost of Goods Sold (COGS) by Average Inventory Value of inventory. As mentioned earlier on that a high turnover means the business is more effective in converting stocks into cash and a lower one means the company is overstocked compared to its potential to sell.