Inventory Turnover Ratio

NickyW

Please can someone help? I don't understand what this ratio is telling me!
Also sometimes it is calculated using the cost of sales and then other times the sales figures!!!!
Any help would be greatly appreciated.
Nicky

jay cutler

Inventories/Cost of Sales x 365 = Inventory Turnover days

This tells you how many days the company hold on to their inventories before replinishing their inventories. A market trader would be expected to have an invetory turnover of a day or two as most of their stock on the stall would be gone before they bother to buy more invetories (I'm thinking of a fruit and vegetable stall here). A big jewelly shop (with lots of jewellery) however would have a long long invertory turnover - like 60 or 90 days - to sell their goods before they replenish their invertories.

The smaller the inventory turnover the more efficient the company is at selling their stock before buying more. Hope this helps.

NickyW

That really helps.
Thankyou!

SandyHood

Please allow me to add a small condition

Remember that inventory is made up of:

1. Raw materials
2. Work in progress
3. Finished goods

Inventory (or Ave Inventory) x 365
Cost of Sales........................................ is fine for finished goods,
but if you are looking at a j-i-t production facility, there shouldn't be any finished goods. So if you want to know the inventory days you really want to know how long raw materials are in stock before being turned into products and sold.
Cost of sales includes purchases, and the conversion costs.

Using the formula above you would get a misleading figure because of the conversion costs, so it would be better to use purchase costs only.

Inventory (or Ave Inventory) x 365
Material purchases

jay cutler

Sandy that is a brilliant explanation. I've printed it off for my DFS & PEV notes. Thank you.

NickyW

Thank you , Sandy. This really helps!!
Nicky

NickyW

Really sorry but confused again - why does my text book have the ratio as cost of sales divided by inventories?? - in the above replies it is the other way round?

SandyHood

It is measuring the number of times the stock that stock will turnover (or be fully replaced) each year.
If you have a stock holding period of 1 month, the stock will turnover 12 times per year.

NickyW

Sandy
Thank you for this. I completely get that inventories/cost of sales x 365 days gives you the average number of days it takes to turn over inventories.
I also get that cost of sales/inventories gives you the amount of times the stock will turnover.
What I still dont get is my text book has inventory turnover period as cost of sales/inventories x 365 days - this is different from the above 2 formula. Is it a misprint?
I hope I am making sense - and thank you for replying to my threads!
Nicky

SandyHood

We would like our terminology to be precise:

1. Inventory Turnover (often times per year)
2. Inventory Holding Period (often in days)

Your point about the confusing use of the terminology in your text book could also apply to some exam questions.

I tend to find the holding period the most useful, so turnover period can genuinly be interpreted as holding period.

In terms of the formula, I agree that the book has an error. It should either miss off the x 365 or have inventory divided by cost of sales.

I think I addressed the use of the "cost of sales" part before - it would be most useful in relation to finished goods.

Oly

I undertand exactly what your saying Nicky I am confused with exactly the same ratio and in the text book and on other websites i've been on the stock turnover ratio is:

Cost of sales/inventories, the complete opposite of the ratio above.

The other thing that is confusing me is:
The Dec 08 PEV past paper question 2:1 (a) (vii) raw material stock turnover in days
How do they get the answers as 40.56 days and 73 days?

SandyHood

Oly

For the raw material question you asked, see if this helps.
Raw material holding period

As far as your other point is concerned, remember cost of sales/stock gives the number of times the stock turns over in a year, whereas stock/cost of sales x 365 shows the ave number of days stock is held

Oly

Just recalculated the past paper question using the ratio you supplied in the link Sandy, at last it makes sense.

Thanks Alot