What is Inventory Turnover Ratio?
A measurement of efficiency that provides solid data on how well a company is managing and moving inventory.
Inventory turnover ratio is one of the most important measurements of a company’s efficiencies. Together with the broader asset turnover ratio, inventory turnover ratios provide a detailed picture of a company’s ability to move inventory and the amount of investment it takes to make revenue. The exact definition of inventory turnover ratio is the company’s sales divided by the companies average inventory over that same period.
‘The exact definition of inventory turnover ratio is the company’s sales divided by the companies average inventory over that same period.”
Why do inventory turnover ratios matter.
As we stated above, inventory turnover ratios allow companies to measure their efficiencies and track their ability to generate revenue. This is an important metric as it prevents a company from over leveraging their credit, either from a bank or an internal budget, to buy more inventory than is necessary for the period. Too much inventory on hand can also lead to unnecessary insurance, storage, and losses due to damage or obsolescence.
Similarly, accurate stockpile and inventory data allows our clients to lower their risk of under leveraging credit and running short on inventory, causing lost sales. This level of data analysis empowers companies to have the right amount of inventory and mitigates risk.
How inventory turnover ratios are calculated.
The formula in the short answer above dictates that ITR=Sales/Average Inventory.
Now we will take a deeper look at how we get those figures from raw inputs. Ideally, companies looking to track turnover ratios will have a sales account that records Inventory Sales. According to Chron, when a sale occurs accountants should debit the accounts receivables and credit inventory sales or revenue.
Lets assume a company records $100,000 in sales in July on 15,000 cubic yards of sales. Our company had 60,000 Cubic yards on hand and now believe they have a two months of inventory left on hand.
What about shrinkage? Shrinkage is the loss of inventory due to damage, theft, or obsolesce. It can be very difficult to measure shrinkage, especially for aggregate, mining, and fill dirt suppliers. Overfilled trucks, heavy loads, weather erosion of stockpiles, and mishandling can reduce the amount of usable inventory.
Florida Aerial Survey Technologies provides stockpile calculations and asset turn over measurement products that allow our customers to observe the actual amount of inventory on hand and compare to the previous period. This gives our clients an actual, factual, insured report on what volume of material has been moved. Using this method, your inventory data will have a volume tolerance of roughly 2-5%. For our example, lets assume Florida Aerial Survey Technologies shows 20,000 cubic yards of inventory movement during July. Assuming a 2% tolerance, the company actually has much less inventory available than they thought!
So far, we have dealt with shrinkage, we have learned how to accurately record sales data and inventory levels.
Next we need to calculate our Average Inventory. First we take our inventory at the beginning of the period in question and the inventory at the end and add them together. After that we divide by two to get our Average Inventory. Finally, we calculate our Inventory Turnover Ratio, taking our total sales on inventory and dividing by average inventory of the period.
Ultimately, our company has an inventory turnover ratio as follows: 100,000/20,000 = 5.0
What about Efficiency?
In our example above, we calculated our turnover ratio and we learned that we are turning over at a rate of 5.0.
Dissecting the data
Great! Now what does that mean? Well, that depends on the exact industry, company, and the goals an organization sets for itself. A quick Google search can help find information on an industry’s typical ratio. We can easily find for example that a mining company should be seeing an inventory turnover ratio of about 10-20 with the industry averaging 15.51.
Consider that our company’s ITR was well below 15.51. This is not good.. However, lower than expected turnover ratios are common when a writer makes up a company to provide a simple example!
What else can we learn from our collected data?
Well, we can see what our shrinkage was for the period. Remember, our company recorded 15,000 cubic yards of sales but actual volume moved was proved to be 20,000 cubic yards. This shows our shrinkage at roughly 33%! Again, industry periodicals can better shed light on whether or not that number is alarming or normal.
How to choose a Period.
We have talked extensively about calculating and interpreting your stockpile and inventory data. Next lets discuss how to choose the period. At Florida Aerial Survey Technologies, our average customer ultimately chooses a quarterly or monthly period.
An extensive list of options can be found below.
- Bi-monthy (every other month)
- Bi-annually (twice a year)
- Custom Schedule
Essentially, the more frequently you take inventory, the more accurate your data is. Take note, your team needs to be prepared to use this data.
We have developed software in house to help with this and our InterMaptive Viewer software allows easy analysis of inventory levels. The downside that it costs more. Our company provides discounts for clients that regularly survey their sites to help lighten the burden on your budget.
Less frequent inventory analysis leaves holes in the data and reduces accuracy. The benefit here is mainly cost, however, if you use a company other than FAST, another benefit arises. Because other companies still deliver only a PDF deliverable, the amount of data parsing is reduced.
Our deliverable is a PDF report and an interactive map called our InterMaptive Viewer. This was developed in house and overlays your site and stockpiles on Google maps. Then it renders a layer to show the bounds of each stockpile. Clicking a stockpile shows the PDF of the whole site and gives you the volume number of the highlighted pile. To take a test drive of the software, contact us.
Scheduling a survey
If you are looking to accurately calculate your company’s inventory turnover ratio, our company provides highly accurate stockpile volume analysis. We provide this data in a number of easy to use formats and we believe in empowering our clients to quickly and efficiently get the data they need to run their business effectively.
To schedule a survey contact us by using the button below.