They tend to look at inventory turnover to see if companies are draining their cash flow by investing too heavily in inventory. A higher ratio will ultimately generate profits.Ĭreditors simply want to make sure they will be repaid. A higher turnover ratio shows investors that the company is using a smaller amount of merchandise to generate a large amount of sales. Investors look at this ratio to estimate how well the company is performing in sales. Now, we can use this information to find the inventory turnover ratio using the formula: Inventory Turnover Ratio Cost of Goods Sold (COGS)/Average Inventory. In the (Internet) age of endlessly free information, checking our work is a critical part of checking our sources. Average Inventory (100,000 + 60,000)/2 80,000. On the other hand, they need enough to keep customer happy. Calculating Inventory Turns from a 10-k (Example) Now let’s pull up a company 10-k to show how we can check our work with the inventory turns formula presented in this article. On one hand, they don’t want to spend too much cash on inventory.
This is kind of a double-sided problem for the company. They also want to make sure that the current products are actually selling that they stock what customers want. They want to make sure they don’t purchase too much merchandise because idle inventory reduces cash flow. Managers are concerned with both indications.
Either way, a low turnover ratio indicates that the company is having problems. A lower ratio shows that either management is purchasing more merchandise than it can sell or that it is having trouble creating sales. Managers, investors, and creditors use this ratio to measure how well a company is a purchasing and selling its products. Since most companies don’t actually compute an average inventory number of a regular basis, you can compute the average of the accounting period by adding the beginning and ending totals and dividing by two. The inventory turnover ratio is calculated by dividing cost of goods sold by the average inventory for the period.