Inventory Turnover Ratio is one of the most important figures which is used for the evaluation of the efficiency of a business organization which sells the manufactured product. Even though there are some limitations for this Stock Turnover Ratio is used by many organizations for evaluation purpose.
Calculation of Inventory Turnover Ratio
Inventory Turnover Ratio is defined as the ratio which is equal to the cost of goods being sold within a time frame and the average inventory during the time frame. The average inventory is calculated by the difference between beginning inventory and the inventory available at the end of the period for which inventory turnover ratio is calculated.
Interpretation of Inventory Turnover Ratio
If we assume that the average inventory turnover ratio is x then the amount of inventory in stock during a year is either renewed or turned over x times during the time period. Inventory Turnover ratio is an average figure and in the case of hot selling items the stock has been depleted and renewed by a considerable amount. There is also a chance of keeping products which are not successful during the time period.
Importance of Inventory Turnover Ratio
It is generally believed that the higher the inventory turnover ratio more efficiency can be expected from the organization. This means that the business concern is holding a lower level of inventory with respect to sales. In effect, the ore inventory kept in stock the more will be the money kept for stocking goods. As in most cases, the money borrowed is from financial institutions having the interest to be paid higher stock can lead to blocking of money.