The inventory turnover ratio is a ratio of cost of goods sold to its average inventory. It is measured in times with respect to the cost of goods sold in a year normally.
Where, average inventory is the average of ending inventory balances of current year and last year. Cost of goods sold is obtained from income statement of the current year.
Merchandise inventory is any type of goods that are held for reselling purposes but not yet sold. Any business showing on balance sheet an item of merchandise inventory means that the items of inventory are not yet sold at the balance sheet date. It is reported as a current asset.
The formula for finding ending inventory is
Ending inventory= (Opening inventory + Purchases) - Cost of Goods Sold
This is an important ratio to assess the operational efficiency of a business. Generally it is a good sign for a business to have its inventory sold quickly. A high inventory turnover ratio shows that the inventory is sold more times in a period, which means that the goods are of good quality, the production department and sales departments are putting good efforts to fuel up the speedy sales. On the other hand a lower inventory turnover means that the inventory is not selling with as much frequency as it should be. This could point out different causes of slow inventory sales like the inventory production process is slower and it takes a long time to get ready for sales.
This ratio measures the average time the inventory takes to sell. This is measured in days.
Suppose the opening and ending inventory of a business is $45,000 and $35,000 respectively and cost of goods sold is $235,000. The business operated 365 days a year. Calculate the inventory turnover ratio and inventory conversion period for the business.
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