What is Inventory Turnover Ratio? What Should be the Ideal Inventory Turnover Ratio for Companies?

Inventory Turnover Ratio and Inventory Days are some of the common ratios which an investor should look upon while investing in any stocks/companies, especially for goods-related companies. Hence, in this article, we will discuss in detail what is Inventory Turnover Ratio and Inventory Days, are and what should be the ideal ratio for a company. So, let’s get started.

What is Inventory Turnover Ratio?

The inventory turnover ratio is the number of times a company has sold and replenished its inventory over a specific amount of time. The formula can also be used to calculate the number of days it will take to sell the inventory on hand.
The turnover ratio is derived from a mathematical calculation, where the cost of goods sold is divided by the average inventory for the same period

How to Calculate Inventory Turnover Ratio:

A higher ratio tends to point to strong sales and a lower one too weak sales. Conversely, a higher ratio can indicate insufficient inventory on hand, and a lower one can indicate too much inventory in stock.

How are Inventory Days different from Inventory Turnover?

Another metric that is used to analyze the movement of inventory is inventory days. Inventory days are the average time that the company requires to turn its inventory into sales. This metric gives the same conclusion as the inventory turnover ratio.
Inventory Days can be calculated by dividing the number of days in a year (generally 365 days) by the Inventory Turnover Ratio.
For Example at Avenue Supermarts, the Inventory Days stand at 36.72 days which means Avenue Supermarts has 36 days of unsold inventory on an average as per FY21 numbers.
The higher the inventory turnover, the lower will be the inventory days and vice versa.

Is Low Inventory Turnover Ratio Always Bad?

The Answer is NO. It largely depends upon the industry in which the company operates.
For Example, KRBL Limited and LT Foods are 2 major Basmati Rice producers. As Basmati Rice is a product that is considered of better quality when it is quite older. So, the low inventory ratio for these companies cannot be termed as bad.

What Should Investors Do?

Inventory Days and Inventory Turnover Ratio are some common ratios that an investor should look upon. Ideally, the Inventory Turnover Ratio should be high, but as a matter of fact, one should also keep in the mind the industry wherein a particular company is operating, and hence sometimes a low inventory turnover ratio can also work well for the company.

Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.