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What Should the Inventory Ratio Be for Manufacturing?

The number of times that a business turns over or depletes its inventory in a given year is known as its inventory ratio. The inventory ratio can tell a small business owner how fast its products are moving out of the factory, providing an indication of company cash flow. The inventory ratio varies by industry.

Calculation
The inventory ratio is a comparison between the cost of goods sold and the average inventory level. The calculation requires dividing the cost of goods sold by the average inventory level of a company throughout the course of a year. If the cost of goods sold for a company was $100,000, and its average inventory value was $50,000, it would have an inventory ratio of 2.0 or $100,000/$50,000.

Manufacturing
The inventory ratio for manufacturing typically ranges from 1 to 2 on a national scale. According to the Census Bureau, the inventory ratio in all manufacturing sectors ranged from 1.21 to 1.39 from 2000 to 2010. The turnover ratio in the durable goods sector ranged from 1.40 to 1.82, while the ratios were lower in the nondurable goods sector at 0.91 to 1.14. Therefore, manufacturers should expect to maintain ratios in these general ranges.

Fluctuations
Fluctuations in the inventory ratio can occur throughout the course of the year, so there is no definite way to ensure or predict what the ratio will be at any given time. The yearly figures provided by the Census Bureau provide a more accurate indication because they are based on a 12-month span of ratios. However, month-to-month fluctuations can help business owners see during which months inventory tends to move faster. For instance, higher ratios during summer months may indicate greater demand for a product during the warm months of the year.

Cash Flow
With turnover ratios ranging from 1.0 to 2.0 as a broad general range, manufacturers can keep an eye on their own inventory ratio to conduct cash flow analysis. The more that the manufacturer sees its inventory ratio approach the 2.0 mark, the more likely it is that company cash flow is good. Moving inventory means that money is changing hands and that the company does not have excess funds tied up in slowly moving products that are not being sold. Inventory ratios nearer to or under 1.0 may indicate some cash flow difficulties brought on by inventory that has piled up.

Reference: http://smallbusiness.chron.com/should-i ... 38030.html


How to Calculate Inventory to Sales Ratio

Efficiently maintaining your inventory is an important aspect of running a small business. If you keep too much stock, then you risk having stock go unsold. Measure the efficiency of your inventory by calculating the inventory to sales ratio. In general, you will want to keep this ratio low. If the ratio rises, it indicates either that your sales are falling or that you are keeping too much inventory on hand.

1. Add up the value for all your recorded sales during the period to get your gross sales.

2. Subtract the value of any returns, allowances for damaged goods and sales discounts from your gross sales. This gives you your net sales.

3. Divide the gross sales by your ending inventory. This gives you the inventory to sales ratio.

Reference: http://smallbusiness.chron.com/calculat ... 19297.html



What Does the Inventory Turnover Ratio Tell You About the Company?

A company’s inventory turnover ratio refers to how quickly goods enter and leave storage at the business. It’s most often used in relation to companies that deal in perishable goods, such as foodstuffs, or high-demand retail items. It’s easy to calculate in theory, but it’s not always easy to interpret.

Calculation
You can calculate a company’s inventory turnover ratio by dividing the cost of goods sold by the value of its inventory. This inventory figure can either be averaged over a period of time such as a year, or it can refer to one particular time, giving a snapshot.

Low Ratio
A company’s inventory turnover ratio can give you an idea of how well it manages its resources. If its ratio is very low, it may mean the company has much more inventory than it really needs at any one time. Therefore it has too much of its capital tied up in goods or raw materials that it will take a long time to sell or make a profit on. Generally speaking, a business with high profit margins on its finished goods can worry less about a low turnover ratio.

High Ratio
A high inventory turnover ratio is a little harder to interpret. It could mean the company has had unexpectedly strong sales -- a good sign. Or it could mean the firm is not managing its buying as well as it might and is having difficulty in administering its inventory.

Change
You can track inventory turnover ratio change over time to see whether a company’s turnover is going up or down significantly. However, you would need more information about the company itself and its circumstances to determine what this meant about its sales or financial health. Seasonal factors, such as weather or consumers’ buying habits, can lead to swings in inventory turnover. Desirable turnover ratios may be different in different industries.

Reference: http://smallbusiness.chron.com/inventor ... 22305.html

Does High or Low Inventory Turnover Ratio Depend on the Industry?

Reducing excess inventory holdings lowers overhead and makes a firm more efficient. Whether a company has a high or low rate of turnover depends partly on the industry in which it operates. Some industries, such as luxury goods, sell few items but reap large profits on each sale.

Identification
Inventory turnover ratio equals the cost of goods sold divided by the average value of a company's inventory. For instance, a company that sells $500,000 worth of goods that have an average value of $50,000 restocks its entire inventory 10 times during year. The inventory rate sometimes depends on the company's' industry. For instance, manufacturing companies average about six turns per year, but a high-volume industry, such as a grocery store, averages about 12 turns per year, according to Supply Chain Metrics.

Variation
Most companies aim for a turnover ratio between six and 12, according to BusinessKnowHow. Turning inventory too many times means a company misses out on potential sales because it does not keep enough product in stock. An extremely low turnover ratio means the company purchases too much inventory, which indicates the company wastes money on merchandise that could soon become obsolete.

Other Factors
Companies can have turnover ratios that are higher than average because the businesses have poor cash flow and cannot afford to keep too much stock. Alternatively, some businesses have an extremely high turnover rate because they can quickly reproduce a product. For instance, the software industry has an average turnover ratio of 53.5 because it can press compact discs within days, according to Business Accounting Guides.

Reference: http://smallbusiness.chron.com/high-low ... 35977.html