Financial Analysis: Inventory Turnover Ratio and Business Performance

This report delves into the significance of the inventory turnover ratio as a crucial accounting metric for assessing a company's inventory management efficiency. It explains how the ratio is calculated, using either the cost of goods sold or sales/revenue, divided by average inventory. The report highlights that a high inventory turnover ratio often indicates efficient sales and less capital tied up in working capital, potentially leading to higher profitability. However, it also acknowledges potential drawbacks, such as sales on credit leading to higher debtors. The report emphasizes the importance of analyzing the ratio over time and considering external factors like promotional campaigns. It also references the implications of high and low turnover ratios, emphasizing the need for a comprehensive financial statement analysis considering both advantages and disadvantages and provides references to academic sources.

Running head: INVENTORY TURNOVER RATIO
Inventory Turnover Ratio
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Table of Contents
Implication of High Inventory Turnover Ratio:.........................................................................3
References:.................................................................................................................................5

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Implication of High Inventory Turnover Ratio:
The inventory turnover ratio is an accounting term and measure for the level of
inventory which is present with a company. The ratio is known by many names such as Ratio
of stock turnover, ratio of turnover of merchandise and many more. The ratio is calculated by
dividing the cost at which the goods are sold by the level of average inventory which is
present in the firm. However, at times the cost at which the goods are sold is not present,
hence the sales or revenue is taken in place of the cost at which the goods are sold. The
average inventory can be calculated by dividing the inventory at the start of the financial year
and inventory at the end of the financial year with 2. Thus, however due to simplification and
ease of calculation the inventory at the end of the financial year is taken as the average
inventory (Kesavan, Kushwaha and Gaur 2016).
This ratio is used to calculate the number of days at which the inventory of the
company is turned around to sales. This is called the day’s inventory turnover ratio and is
represented in days while the inventory turnover ratio is denoted in times. This ratio is
important when analysing the financial statements of a company as it highlights the level of
inventory which is present with the company. This ratio belongs to the efficiency ratio and
highlights how efficiently the firm is able to handle its inventories (Hançerlioğulları, Şen and
Aktun 2016).
A high Inventory turnover ratio may help in analysing the efficiency and profitability
of a firm. This is because a high inventory turnover ratio implies the inventories of the
company are sold quickly and efficiently and company has less money stuck in the working
capital management. This may be due to various reasons such as a promotional campaign
which has been initiated by the company has led to the rise in sales. Thus the ratio needs to be
analysed over a period of years and if there is a sudden spike in this ratio, the cause of the

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spike in the ratio needs to be analysed. However, if the company has consistent high turnover
ratio over the years it implies that the company is creating demand for its product. Thus as
soon as the product is developed by the company it is sold to the consumers, thus indicating
fast turnover of cash of the company and rise in profitability (Sunday and Joseph 2017).
However, a high inventory turnover ratio also has a few drawbacks which should also
be analysed by the analyst of the financial statement. The sales which are being made by the
company are on credit or on cash is an important factor which should be analysed by the
analyst. This is because if the sales are made on credit, it would lead to rise in the debtors of
the company and thus leading to rise in the cycle of the working capital management (No
2018).
Thus high turnover ratio of the company has advantages and disadvantages which
needs to be considered by the analyst when analysing the financial statements.

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References:
Hançerlioğulları, G., Şen, A. and Aktunç, E.A., 2016. Demand uncertainty and inventory
turnover performance: An empirical analysis of the US retail industry. International Journal
of Physical Distribution and Logistics Management, 46(6-7), pp.681-708.
Kesavan, S., Kushwaha, T. and Gaur, V., 2016. Do high and low inventory turnover retailers
respond differently to demand shocks?. Manufacturing & Service Operations
Management, 18(2), pp.198-215.
No, J.K.S., 2018. Decision Table with Inventory Turnover Ratio to Solve Operational and
Strategic Issues. Journal of Information Systems Engineering and Business Intelligence:
Volume 4 Number 1, April 2018, 4, p.32.
Sunday, O. and Joseph, E.E., 2017. Inventory Management and SMEs Profitability. A Study
of Furniture Manufacturing, Wholesale and Eatery Industry in Delta State, Nigeria. Journal
of Finance, 5(3), pp.75-79.

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