Of the many metrics a business can use, one of the most important performance metrics for measuring how your business efficiently manages the quantity-side of their assets and sales equations on a balance sheet is the Inventory Turnover Ratio (IVR). The Inventory Turnover Ratio is derived by calculating the ratio of Cost of Goods Sold divided by the Average Inventory during the established time period (annum, quarter, season, etc.).
In short, the Inventory Turnover Ratio provides insight on how long capital is trapped in the cycle of being used to purchase finished product (or raw materials) for sale through to its sale. Particular Inventory Turnover Ratios differ from industry to industry. The higher your Inventory Turnover Ratio, the more likely it is that that company carries an excessive quantity of inventory. Cash that is tied up in stock and assets for a prolonged period is referred to as overstocking. Subsequently, the correlation between the company functioning in a cash-poor condition and an elevated Inventory Turnover Ratio is overwhelmingly high.
Depending on individual markets or circumstances, a company can improve its reporting when other performance metrics are graphed on a y-axis along with the Inventory Turnover Ratio over the period of one year (12 months increments). For instance, graphing one product’s gross product margin can give insight into the relationship between the pace at which that product is processed through the warehouse at selected price points. Graphs of monthly revenues generated by a specific product against the Inventory Turnover Ratio supply additional insight in the potential seasonality of an item and thus improve its buying patterns.
It is crucial that buyers, executives, and inventory managers analyze and review any Inventory Turnover Ratios. One of the most useful ways for reviewing IVRs is tracking the ratios at a SKU level – or item type level – then graph the ratio in monthly increments over a one year block of time. This resultant view will help the company to best understand any internal buying cycles or seasonality. One must always remember that the primary aim is to move stock with more speed and to continue the downward pattern in your Inventory Turnover Ratio.