Inventory Ratio Interpretation

Inventory turnover ratio is the term used in the context of accounting ratios where it is used to calculate the period or number of times the products of company is sold and replaced during the year. Formula of inventory ratio is Cost of goods sold/Average stock (opening stock +closing stock/2), now let’s look at how it is interpreted or analyzed.

Higher the ratio better it is for the company because it implies that company is able to sell the product quickly and therefore it will lead to more profits as higher sales implies higher profits and also it implies higher efficiency on the part of the company. For example if company A is maintaining an average inventory of $5000 and its sales are $20000 then it implies that company is able to sell 4 times its average inventory. However a higher inventory ratio does not imply or give assurance that company is doing well because an inventory ratio can be high also when company is not buying at regular intervals or it is buying too little and if the inventory turnover ratio is high due to above reasons then it is not a good sign and therefore an individual analyzing should keep this factor in mind before judging the performance of company on the basis of inventory ratio. Inventory ratio is also known as stock turnover ratio.

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