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An Inventory Turnover Ratio is the measurement of how many times inventory is sold or used in a given period, often calculated as cost of goods sold divided by average inventory.
Explanation: The Inventory Turnover Ratio is a financial metric that measures how efficiently a company manages its inventory. It indicates how many times a company has sold and replaced its inventory over a specific period, usually a year. This ratio helps businesses understand how well they are managing their stock levels and whether their sales and inventory management strategies are effective.
The Inventory Turnover Ratio is calculated using the following formula:
Inventory Turnover Ratio= Cost of Goods Sold (COGS)/ Average Inventor
Where:
Cost of Goods Sold (COGS) is the total cost of manufacturing or purchasing the products that a company has sold during a specific period.
Average Inventory is the average value of the inventory during the same period, usually calculated as the sum of the beginning and ending inventory for the period divided by two.
Importance of Inventory Turnover Ratio
A low inventory turnover ratio, on the other hand, may indicate overstocking, obsolescence, or weak sales, which can tie up capital and increase storage costs. Therefore, businesses aim to maintain a balanced inventory turnover ratio that aligns with their industry standards and operational goals.
