Inventory Turnover Ratio – Formula, Analysis, Limitations

The inventory turnover ratio is a common measure of the firm’s operational efficiency in the management of its assets. Preferably the stock turnover ratio would be determined as systems sold divided by systems on hand.

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Stock Turnover Ratio

Inventory turnover is an indication of the variety of times inventory is sold or utilized throughout a specific time period such as one year. It is an excellent measurement to evaluate the frequency of motion of inventory towards production and thus it is a better indicator to take a look at the up and downs in sales.

Solution:

Stock turnover ratio = Cost of products sold/ Average stock.

Typical stock =1/2( opening stock closing stock).

Expense of goods sold = opening stock inventory purchased throughout the year– closing stock.

Need To Read– Accounting Requirement 10

Analysis:

• When compared to the market’s ideal ratio the greater the ratio of stock turnover, the much better the efficiency of an entity’s overall stock is, which indicates movement of stock indicates much better production hence there are sound sales.And the business is practicing an effective stock management process.
• As said in my previous posts on monetary ratios, there must be the harmony in the services being carried on by the companies whose inventory ratios you want to compare.

  Should Check Out– Accounting Standard 16

  Limitations:

  1. The stock turnover ratio is not a perfect monetary ratio.Like sensible other monetary ratios this is likewise depends on many presumptions.

  2. Even in case of higher inventory turnover ratio, Carrying insufficient quantity of stock might lead to loss of sales, as products that customers need might not be easily offered on time.

  Must Read– Accounting Standard 15

  3. A high turnover ratio might provide an impression that the business is having effective inventory management and excellent demand for its items in the market, but does not inform you whether inventories were too low and there is danger that existing customers may switch over to replacement products in the market due to the backorder that takes place as an outcome of non accessibility of inventory at peak periods.

  4. The opening and closing stock levels for the period may be misleading.

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