Managing inventory proves to be a challenging task for many managers and requires knowledge of inventory accounting basics. While the level of inventory varies from business to business, a reliable way to tell your inventory turnover rate is to utilize inventory turnover calculation measures.
The inventory turnover ratio tells you how liquid your inventory is- or how quickly your inventory can be converted into cash.
This ratio measures the number of times (on average) that your inventory is sold during a given period. It also measures how quickly your inventory can be converted into cash.
The inventory turnover ratio is calculated one of two ways. The most common way to calculate the ratio is:
The second and more accurate way to calculate the inventory turnover ratio is:
The second calculation is more accurate because "cost of goods sold" reflects your inventory's book value, and by averaging the inventory, you can reduce seasonal factors that influence the flow of inventory.
Generally, a high inventory turnover ratio means that your products are selling well. But before you get too excited about a high ratio, you need to compare it to the industry standards. If your ratio is higher than other companies in your industry, it could mean that your inventory management systems are ineffective.
Download "Inventory Turnover Ratio" white paper
Yes, knowing the entire financial health of your business is great, but there are times when all you want to know is your company's short term liquidity, and for that the quick ratio or acid-test ratio is where to look.
Here's what it looks like:
The quick ratio will tell you if your company is able to pay its short-term bills using your most liquid assets (cash, money in bank accounts, money market mutual funds, and US Treasury bills)
It's like the current ratio in the sense that it measures your ability to pay short-term debts, but it's more conservative of a measurement because it takes out inventory from your current assets. The inventory is subtracted from the current assets because some businesses can't quickly turn their inventory into cash. The current ratio can sometimes overestimate a company's ability to pay its short-term bills.
For example, if current assets equal $15,000 current inventory equals $6,000 and current liabilities equal $3,000, then quick ratio amounts to: ($15,000 - $6,000)/$3,000 = 3. Since we subtracted current inventory, it means that for every dollar of current liabilities there are three dollars of easily convertible assets.
Ideally, your company's quick ratio should be 1:1. The higher the ratio, the stronger your company is.
Learn more about inventory ratios. Download the Inventory Turnover Ratio white paper.
The market is down and unemployment is up. We all know this; we've been hearing it every day for the past year. Many people are becoming numb to the numbers thrown at us. It's not news anymore; it's becoming the new normal.
Some companies have decided to sit still and wait for the economy to turn around and others have started to recognize that things aren't going to change until someone makes a move.
These companies have stopped asking why and started asking how. They know that in July national unemployment was at 9.7%. They're aware that it's the highest it has been in decades. They know that the GDP is down. They know this stuff already and have turned from focusing on the problem to focusing on a solution. These companies haven't become numb to the numbers; they keep them in mind while driving business forward. They know that in order to fix the problem they can't lose focus on key performance indicators like liquidity, solvency and cash flow.
A solvent company is aware of its performance indicators and are better equipped to not just survive, but also thrive in the economy. They're doing their research looking for new growth opportunities, forging new partnerships, and taking time to focus on what they do best. Don't sit in the corner waiting out the recession. Focusing in on mere survival will make you lose sight of your overall business plan. Keeping track of your financials will give you a leg up in competition and give you time to sharpen your focus.
