The inventory turnover calculator is a financial efficiency ratio calculator that uses the inventory turnover formula and inventory days formula to determine how quickly a company’s inventory is sold in a given time. It can demonstrate to investors whether management methods are boosting the efficiency of their production, manufacturing, or selling process if they are tracked on a trend basis.
What exactly is inventory?
Inventory, by definition, relates to raw materials for production, items in the manufacturing process, and finished commodities that are ready for sale. As a result, it encompasses all material process transformations.
Some companies may purchase produced goods from various vendors and resell them to their customers, such as clothing stores; in the meantime, other companies may purchase pig iron and coke in order to begin steel production.
Both will keep track of such items as inventory, thus the possibilities are endless; yet, because inventory control is so important to the business, defining techniques for inventory control becomes necessary.
Inventory is treated as a current asset on the balance sheet in accounting terms. It has a high liquidity level, which means we expect it to be turned into cash in a short period of time (less than one year).
Once the finished product is sold, the company’s costs for manufacturing it must be recorded on the income statement as Cost of Goods Sold, or COGS as it’s commonly known. COGS could be more or lower depending on your accounting technique. See FIFO and LIFO for more information.
Inventory is considered a component of current assets.
Keeping track of inventory levels as part of current assets is critical for investors since it helps them to track total company liquidity. This means that a company’s inventory sell cash can cover whatever short-term debt it may have. Check out our current ratio and quick ratio calculator if you want to learn more about liquidity, how to measure it, and other financial ratios.
Inventory turnover as a measure of financial efficiency
A company’s operations necessitate cash. It must be sponsored from the start by lenders and investors. Cash for sustaining operations is obtained from the sale of items (cash inflow) and short-term obligations from financial institutions or suppliers once the company is up and running (cash outflow)
Inventory turnover is required to keep this chain (also known as the Cash conversion cycle) from breaking. The more efficient and faster this occurs, the more cash a company receives, making it more resilient in the face of market volatility. It’s important to remember that the higher the number recorded as Cost of Goods Sold, the more inventory the company sells over time.
Inventory turnover indicates how many times the inventory was sold and recorded as such on an average basis during the time period under consideration. Inventory days, on the other hand, indicate to the investor how long it takes to sell the typical amount of inventory.
Let’s say Company A has a 14 percent inventory turnover ratio, which means the company sells its product 14 times per year. Then, by dividing 365 days by 14, we can deduce that the corporation takes 26 days to sell its whole average amount of inventory. The next paragraphs go through the inventory turnover ratio calculation in further depth.
EBIT and free cash flow are two more numbers to consider as significant additional tools for determining a company’s profitability.
How can you figure out inventory turnover and days on hand?
Before we look at the inventory turnover formula, we need to think about the time frame of the study. The most frequent time periods are 365 days for the entire fiscal year and 90 days for quarter computations. In this piece, we’ll choose the first period because it includes any seasonality effects that may occur throughout the year.
Find out how much inventory you have at the start and end of the fiscal year. If we look at the annual balance sheets for 2018 and 2019, we can get this value for the Beginning and Ending Inventory, respectively. After that, we take both inventory data and average them:
Average inventory = (Beginning inventory + Ending inventory) / 2
To check, we extract the Cost of Goods Sold (COGS) from the year’s income statement, and then calculate the turnover ratio:
Inventory turnover = COGS / Average inventory
Furthermore, once we obtain the ratio, we can use the inventory days calculation to determine how many days the average amount of inventory is turned over:
Inventory days = 365 / Inventory turnover
Of course, because you have our beloved Omni inventory turnover calculator on your left, you won’t have to memorize these calculations as you would in school.
What can investors learn from inventory turnover?
To begin, we’ll discuss what we don’t have to do when looking at the ratio and the days, which is to examine it independently. When regarded in this light, they are merely numbers.
The significance of these values is determined by the trend. Then, after collecting data for three to five years, we can determine if efficiency improves or declines.
The higher the figure, the better in terms of inventory turnover. A high turnover value indicates that the inventory was sold multiple times on average to generate the whole amount of value recorded as the Cost of Goods Sold. A low figure, on the other hand, implies that the company processes its inventory only a few times per year.
The lower the number of inventory days is, the better. A high inventory days figure indicates that the company spends a lot of time rotating its items, which implies it takes longer to convert them into cash to keep operations running. In contrast, if a company can get rid of its inventory in fewer days, it will be in a stronger financial position since cash inflows would be more consistent.
As a result, as an investor, you want to observe an upward trend in inventory turnover ratio over time and a downward trend in inventory days.
There are three reasons why a company’s inventory turnover can be improved.
The following are the top three reasons why a corporation could be able to improve inventory management:
The company is working to improve its purchasing procedures. It’s possible that the corporation has found superior suppliers, making raw material acquisition easier and speedier.
The company’s production method may have been enhanced, allowing things to be ready for sale in less time.
The business is growing at a quicker rate. After researching customers, developing marketing methods, or gaining market share, a corporation may be able to produce exactly what customers want, resulting in the sale of the majority of its items in a shorter period of time.
Inventory ratios that are worsening, on the other hand, may indicate that a company’s growth is stagnating. This could be due to issues with suppliers, manufacturing methods, or competition.
In cyclical firms like automakers or commodity-based enterprises like Steelmakers, this deterioration is critical. If the corporation is accumulating more and more stock quarter after quarter, there is clearly a problem developing, and if you own shares in such a company, you should consider selling and taking profits.