Inventory turnover ratio (ITR)



Inventory turnover ratio (ITR) and Stock turnover ratio are the same. This ratio shows how many times a company’s stock is sold and replaced over a phase of time. Every company has to preserve a certain level of stock of completed goods so as to be able to meet up the requirements of the company. But the level of stock should not reach too high or too low. It also looks at the average balance of stock against the total stock sales for a given period of time. This ratio indicates whether investment in inventory is within suitable boundary or not.





Stock turnover ratio manages warehousing needs, helps in adjusting pricing and promotions and gives a hand to supervise pricing. When this ratio is compared with industry averages, A low turnover suggests that there are poor sales hence there is excess inventory. A high ratio suggests higher sales or infective buying.

The formula for average inventory:

The average days to sell the inventory is


The stock turnover ratio is also a directory of profitability, where a high ratio signifies more profit; a low ratio signifies small profit. Sometimes, a high stock turnover ratio may not be accumulated by comparatively high profits. Likewise a high turnover ratio may be due to under-investment in stock. These norms may be different for different firms, it depends on the type of company and its nature of industry but the comparative analysis of stock turnover ratio is useful for financial analysis.
 
Example

The cost of goods sold is $100,000. The opening stock is $30,000 and the closing stock is $50,000 (at cost). Calculate inventory turnover ratio.
 
Calculation:
Inventory Turnover Ratio (ITR) = 100,000 / 40,000*
= 2.5 times
*= (30,000+50,000)/2
This shows that and average dollar invested in stock will turnover into 2.5 times in sales
Increasing stock turns reduces holding cost. The Company spends less money on rent, utilities, insurance, theft and other expenses of maintaining an inventory of goods to be sold. Stuff that turn over more quickly adds to openness to changes in customer necessities while allowing the substitute of out of date items. The vital concern is that any firm should be consistent in the formula that it uses.

Average stock and cost of goods sold are the two basics of this ratio. Average stock is calculated by adding up the inventory in the start and at the end of the period and dividing it by two. All the monthly balances are added and the sum is divided by the number of months, for which the average is calculated, In case of monthly balances of inventory.

A high turnover rate may point to insufficient stock levels, which may guide to a loss in business as the stock is too low for the company. This can result in stock shortages very often.
Minimizing the stock in-hand also means that the big storehouse may not be essential. You can use the capacity for another business enterprise, or move to a smaller facility.

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What is Stock Turnover Ratio ?




In order to understand stock turnover ratio we need to understand the term stock turnover. In terms of accounting stock turnover is referred to the number of times inventory of the firm is produced and used and sold in a specific time say one year. The term is also known as inventory turnover, stock turnover, stock turns and simply turns. Stock turnover is actually the measure of the ability of the firm of converting inventory r stocks into revenue. In some way it is similar to the asset turnover which is also a tool to measure the efficiency of a firm. Stock turnover value of the firm shows how intelligently a firm is making use the part of the working capital that has been invested in stocks. Stock turnover can also be termed as a ratio that shows the reoccurrence of the sales and replacement of the inventory of a firm or company. 

The low stock turnover of a firm is an indicator of its poor sales and shows that the firm has excess inventory at hand. However the higher number of stock turnover shows strong sales of a company and efficiency of the company in converting inventory into revenue by selling the goods. High level of inventory is undesirable for any firm in any industry because high level of inventory shows that company has invested its working capital in such an activity where the rate of return for the company is zero. High inventory leads a company towards trouble as company has to lower the price in order to sale the inventory and this step may incur loss for the company. 

Stock turnover and stock turnover ratio is a tool to measure the stock performance of a firm. The low rate of the stock turn over indicates that stock is taking a longer time to turnover and as a result funds are invested for a longer period of time in the stocks with no return and these circumstances result in a poor cash inflow for the company. One of the most important and the largest component of the working capital of a comopnay is its inventory. If the inventory is not turning over repetitively in a given period of time it means that company as frozen its cash in the form of assets and it would be difficult for a company to liquidate this asset in a short span of time.

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