Your competitor has 13 inventory turns per year. We can conduct the same exercise for the other years for both companies, and we will build the following graph. QUESTION 6 You have learned that your company has 8 inventory turns per year. On the other hand, inventory days show the investor how many days it took to sell the average amount of its inventory.įor example, let's say Company A has an inventory turnover ratio of 14 \small \rm Inventory days = 54.1 Inventory turnover shows how many times the inventory, on an average basis, was sold and registered as such during the analyzed period. It is worth remembering that if the company sells more inventory through the period, the bigger the value declared as the cost of goods sold. The more efficient and the faster this happens, the more cash a company will receive, making it more robust against any face-off with the market. Such short term focused order cycles make forecasts very accurate, much more accurate than competitors who may order every two weeks or every month. Stores place orders twice a week and this drives factory scheduling. In order not to break this chain (also known as Cash conversion cycle), inventories have to turnover. Zara has 12 inventory turns per year compared to 3 4 per year for competitors. Once the company is running, cash for sustaining operations is obtained from the products sold (cash inflow) and from short-term liabilities from financial institutions or suppliers ( cash outflow). At the very beginning, it has to be financed by lenders and investors. You can also run this calculation using sales ÷ inventory. In other words, your stock rotates a little more than once a year. The inventory turnover ratio formula is calculated by dividing the cost of goods sold for a period by the average inventory for that period. This would mean that your inventory turns ratio is slightly over 1:1. Note that depending on your accounting method, COGS could be higher or lower. Using the same examples as before, your inventory turnover formula looks like this: 145,000 ÷ 105,000 1.38. ![]() Once we sell the finished product, the company's costs for producing the goods have to be recorded on the income statement under the name of cost of goods sold or COGS as it's usually referred to. It has a high degree of liquidity, meaning that we expect it to be converted into cash in a short period of time (less than one year). ![]() On the Accounting side, we consider inventory as a current asset recorded on the balance sheet. Some companies might buy manufactured products from different suppliers and sell them to their clients, like clothes retailers meanwhile, other companies could buy pig iron and coke to start steel production.īoth of them will record such items as inventory, so the possibilities are limitless however, because it is part of the business's core, defining methods for inventory control becomes essential. Therefore, it includes all the material process transformation. As per its definition, inventory is a term that refers to raw materials for production, products under the manufacturing process, and finished goods ready for selling.
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