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How to calculate and the meaning of inventory turnover for businesses

Inventory turnover is one of the important indicators in corporate financial management that helps evaluate operating performance as well as optimize capital funds and increase profits. So what is inventory turnover ? Let's join 1C Vietnam to learn how to calculate and the meaning of inventory turnover , thereby better understanding the importance of this index in business management.

1. What is inventory turnover?

Inventory Turnover , also known as Inventory Turnover, is an important indicator in financial analysis, helping to measure the number of times a business sells out and re-stocks inventory in a specific period of time. The evaluation of this index reflects a business's ability to manage inventory. A high inventory turnover ratio shows that the business sells goods quickly and optimizes capital resources.

However, it should be noted that an inventory turnover that is too high can cause problems, such as the risk of losing customers, competition from competitors, etc. Therefore, maintaining a reasonable inventory turnover Management is extremely important to help ensure the stability and success of businesses in the market.

inventory turnover
Inventory turnover reflects a business's ability to manage inventory

2. Meaning of inventory turnover for businesses

Increased inventory turnover can indicate a business is selling more quickly and managing inventory more effectively. This may be the result of optimizing capital resources by reducing inventory. However, if turnover increases too quickly, businesses may not maintain enough inventory, causing shortages, affecting customers.

Meaning of inventory turnover
Increased inventory turnover shows that the business is selling quickly

Conversely, when inventory turnover decreases, this may indicate that the business is having difficulty selling or is ineffective in managing inventory. It's possible the business is keeping too much inventory in stock, leading to frozen capital and increased storage costs.

However, a low inventory turnover is not always a bad thing, especially if the business operates in an industry with long sales cycles intended to meet high customer demand.

3. How to calculate inventory turnover effectively

Inventory turnover is an important indicator in corporate financial analysis, calculated by dividing the sales value in a certain period of time by the average inventory value in the same period. The formula for calculating inventory turnover is shown as follows:

Inventory turnover = Sales value (Revenue)/ Average inventory value

inventory turnover
Formula to calculate inventory turnover

For example, suppose a company has the following financial information for the year:

  • Sales value: $4,000,000
  • Value of inventory at the beginning of the year: $800,000
  • Year-end inventory value: $500,000

First, businesses need to calculate the average value of inventory by taking the total value of inventory at the beginning and end of the year, then dividing it in half:

Average inventory value = ($800,000 + $500,000) / 2 = $650,000

Then apply the formula to calculate inventory turnover:

Inventory turnover = $4,000,000 / $650,000 = 6.15 times

For this example, the company's inventory turnover is 6.15 times for the year.

4. Factors affecting inventory turnover in warehouses

The following factors can directly or indirectly affect inventory turnover and should be considered for more accurate calculations. Specifically:

  • Customer demand: High product demand will increase inventory turnover rate, because businesses need to meet demand by selling more products, reducing inventory. Conversely, low demand will reduce inventory turnover ratio.
  • Product type: Products with a short shelf life such as food need a high inventory turnover rate to avoid quality deterioration or obsolescence.
  • Warehouse management methods: Ineffective warehouse management can lead to excess inventory and low inventory turnover rates.
  • Pricing strategy: Businesses that optimize the production process, providing products at lower prices can increase inventory turnover rates.
  • Marketing and sales strategy: Effective marketing and sales activities can also increase inventory turnover rates.
  • Economic conditions: An economic slowdown can reduce demand and reduce inventory turnover rates.
What is inventory turnover?
High product demand will increase inventory turnover ratio

5. Effective method of optimizing inventory turnover

To effectively optimize inventory turnover , businesses can apply the following methods:

  • Predict demand: Use sales figures, market research, and customer feedback to accurately predict demand and stock inventory.
  • Implement marketing strategy: Promote inventory turnover by increasing customer demand through promotions, PR and other marketing strategies.
  • Apply pricing strategy: Optimize warehouse management costs and negotiate prices with commodity suppliers to reduce raw material costs, thereby creating a competitive advantage in the market.
  • Implement Just in Time (JIT) inventory system: Control the amount of inventory supplied at the right time, helping to optimize inventory levels and improve inventory turnover.
  • Use specialized management software: Apply inventory management software to automate inventory management, orders and import-export activities, thereby improving performance and inventory turnover. .
inventory turnover
Boost inventory turnover by increasing customer purchasing demand

Above is an overview of the calculation and optimal method of inventory turnover for businesses. In today's era of digital transformation, managing inventory and warehouse systems with smart software will be a great solution that businesses cannot ignore. 1C:Company Management is proud to be a comprehensive business management software that stands out with warehouse management features, allowing for managing information, documents, setting up inventory, calculating cost of materials, etc. See more software information at 1C Vietnam website!

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