Inventory Turnover Ratio Formula | Free Cost Accounting Articles
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Inventory Turnover Ratio Formula
Inventory Turnover Ratio
There are several items in the stores which are issued to the production after a long gap from the date of purchases. There are several other items that are never issued to the production as they have become outdated which need to be disposed of. These items need to be identified so that management can avoid the capital locked up in such items. It is necessary to compute the inventory turnover ratio for finding these items.
This ratio indicates not only the replacement of stock during the year but the efficiency or inefficiency with inventories are maintained in the organization. This ratio measures how quick sales of inventories is done. It is the test of efficient inventory management. A higher inventory turnover ratio indicates good inventory management. A low inventory turnover ratio may adversely affect the ability of an organization to meet consumers’ demands and not cope up with requirements.
Inventory Turnover Ratio Formula
This ratio measures the relationship between the cost of goods sold and the inventory level. The Inventory turnover ratio is calculated as follows :
Inventory turnover ratio = Cost of goods sold or material consumed / Average Inventory or Stock
Where,
Cost of material consumed = opening stock + purchases − closing stock
Average Inventory = (Opening stock+Closing stock) / 2
This ratio can also be calculated in days as follows :
Inventory turnover ratio (in days) = Number of days in a year / Inventory Turnover Ratio
= …………………. Number of days
However serious limitation of this approach is that detailed data may not be available in respect of inventory level and cost of goods. In order to overcome this difficulty, another approach for the computation of inventory turnover Ratio is used which is based on the relationship between sales and closing inventory. Alternatively,
Inventory turnover Ratio = Sales / Closing Inventory
In short, of the two approaches of calculating inventory turnover ratio, the first relates to the cost of goods sold to an average inventory, and theoretically, it is superior whereas the advantage of second approach is that it is free from practical problems of computations.
Solved Problem
The following data are available in respect of material ‘Y’ for the year ended 31st March 2015.
| Particulars | Rs |
| Opening Stock | 1,10,000 |
| Closing Stock | 1,50,000 |
| Purchases during the year | 3,20,000 |
Calculate:
i) Inventory turnover ratio.
ii) Number of days for which average inventory is held.
Solution:
Cost of material consumed
= opening stock + purchases − closing stock
= 1,10,000 + 3,20,000 – 1,50,000
= 2,80,000
Average Inventory
= (Opening stock+Closing stock) / 2
= (1,10,000 + 1,50,000) / 2
= 1,30,000
i) Inventory Turnover Ratio
= Cost of goods sold or material consumed / Average Inventory or Stock
= 2,80,000 / 1,30,000
= 2.15 times
ii) Number of days for which average inventory is held
= Number days in a year / Inventory turn over ratio
= 365 / 2.15
=169. 76 days OR 170 days
