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When examining an income statement, the value for the costs of goods sold includes all of the items that have been transferred out of inventories during any fiscal reporting period. This means there is a relationship between the cost of goods sold and the inventories maintained throughout the year. The Inventory Turnover Ratio is an indication of how many times inventories are replaced each year.
The calculation of inventory turnover is as follows:
Cost of Goods Sold / Average Inventory
A high value for inventory turnover usually accompanies a low gross profit figure. A high ratio means that a company needs to sell a lot of items to maintain an adequate return on the capital invested in the company. If inventory turnover is too high, it may be an indication the company is losing sales due to inadequate inventories. |
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