Stock calculations and analysis can be used to measure the overall efficiency of a company. In general, higher inventory revenue indicates better performance and lower revenue indicates inefficiency.
High inventory turnover shows that you don’t spend too much by buying too much and wasting resources on storage costs. It also shows that you are effectively selling the stock you buy and quickly replenishing your liquidity. Alternatively, a low inventory turnover rate could be caused by overstocking or inefficiencies in the product line or by sales and marketing efforts.
It is usually a bad sign, as products tend to age [obsolete] when they are in a warehouse, at a cost. Plus, excess inventory holds a company’s money and leaves you vulnerable to market declines. But there are nuances and exceptions to those general principles. An exceptionally high turnover rate can indicate strong sales or ineffective purchases, which can ultimately lead to a loss of sales because the stock is too low. This can lead to inventory shortages and ultimately lower sales.
Stock turnover is a measure of the number of times the stock has been sold and replaced in a given period. This ratio is calculated by dividing Sales by Inventory. The time period is usually one year, but can be shorter. Analyzing inventory turnover helps a company plan at all levels of its income statement. It enables an organization to better predict what liquidity is likely to be reinvested in inventory in the coming months based on past performance.
It allows an organization to identify underperforming sales lines and products so that those products can be moved more quickly, either through specials or by focusing on those products that have previously been neglected. This in turn will free up cash flow and shelf space for larger volumes or better performing products. It can also improve inventory logistics and supplier relationships. Transport costs can be reduced if sufficient attention is paid to this ratio, and finally, account can be taken of inventory storage capacity requirements as the company grows.
Stay in control of your inventory
- Regularly check purchase prices with suppliers and ask for discounts when requesting a quote or placing orders.
- Define inventory groups in a way that is useful to your business so that you are better able to analyze, understand and respond to inventory that should theoretically work in a similar way.
- Get an understanding of your best-selling products and the inventory you are selling.
- Improve forecast accuracy by grouping inventory and tracking trends.
- Encourage customers to pre-order products so your company can plan inventory purchases.
- View and remove stagnant inventory to prevent it from taking up valuable warehouse space.
Inventory depreciation represents inventory that no longer has value in the company (as opposed to depreciation, where the inventory value is reduced). Inventory can be written off due to technological obsolescence, theft or damage. Inventory depreciation is simply the value of the inventory to be depreciated. It can be assigned to the Cost of Goods Sold account, but this will disrupt the gross margin percentage. I prefer to isolate it by assigning it to a debit account.
The Inventory Depreciation value reflects how much inventory depreciation costs the company. If the level is significant, it is necessary to investigate further why depreciation is necessary and corrective action to be taken. Every growing business should have a process of identifying slow-moving or non-salable products and considering scrapping or writing off some of those items to make room for more profitable products. It is important to have a process to do this periodically. The last thing you want is to find out in the future that your inventory is not the value that is on the balance sheet, which means you have to undergo a significant write-off in the income statement. Companies can and have gone bankrupt.
There are different types of inventory costs. A few are ordering costs, holding costs and storage costs. Once you understand where each of these costs applies to your business, the next step is to determine the best way to value your inventory. A valuation method is used to determine the profit of your company.
Storage costs are costs incurred when storing and maintaining inventory. This could include insurance, costs related to the space in which the inventory is housed, security and associated equipment, and labor costs. An example of a holding cost could be a forklift needed to move inventory in the warehouse. Holding costs are simply the cumulative value of these various costs. They are usually accounted for separately, but they can be grouped together when reporting.
Average inventory is the median value of the inventory over a period of time. The average inventory ratio equalizes seasonal fluctuations, effectively normalizing data. It is an indicator of how quickly inventory sells and the average volume at hand. A fluctuation can reveal problems with purchase or sale.
Average number of days to sell inventory
The average days to sell inventory is a measure of how long it takes a company to buy or make inventory and make a sale from it. Average number of days to sell inventory is calculated as (inventory divided by selling costs) multiplied by the number of days in the year.
There is a simple formula to calculate the ratio of the stock formula.
- Determine the total cost of goods sold from your annual income statement.
- Calculate the cost of an average inventory by adding the initial inventory and the closing inventory for one month and dividing by two.
- Finally, divide the cost of goods sold by average inventory
Inventory turnover ratio: cost of goods sold / ([start inventory + closing stock] / 2)
Inventory turnover period: 365 / inventory turnover ratio
cost of sold goods: 137 457, –
average inventory: 15273, –
inventory turnover ratio: 137457/15273 = 9
Inventory turnover period: 365/9 = 40.5
Monthly stock resale: 40.5 / 12 = 3,375 months.
The inventory turnover ratio is critical because total sales depend on two fundamental performance components. The first is the share buyback. If large amounts of inventory are purchased during the year, your business needs to sell larger amounts of inventory to improve sales. If you can’t, you will be charged storage and other retention fees. The second part is sales. Sales must match inventory purchases or inventory will not run effectively. Therefore, the purchasing and sales departments must be coordinated.
A car dealer buys a car to show in the yard. The cost of the car is € 20,000. The company’s capital costs are 6%. Therefore, for every month that the car is in the yard, the company has an alternative cost of 6% × 20,000 ÷ 12 = € 100.
If the average time it takes the company to sell each car is 180 days, the company should investigate whether the car can sell faster if the sales price is lowered. If the car sold 30 days faster once the price was $ 100 less, the company would be indifferent, but if the car sold 30 days faster once the price was $ 90 less, the company would in fact be ahead of $ 10 financially. The case is even more convincing when the sales price is considered instead of the item cost.
Benchmark your sales
A company’s inventory turnover varies greatly by industry. Fashion retailers average between 4 and 6. Auto parts can go up to 40. Supermarkets are around 14 and car dealers are often as low as 2 to 3.
In short, low-margin industries generally have higher inventory conversion rates than high-margin industries, because low-margin industries have to offset lower unit profits with higher unit sales volume.
In addition, it is important to understand that the timing of inventory purchases – especially those made in preparation for special promotions or new product introductions – can change the ratio suddenly and somewhat artificially.