selling it! a look at the inventory turnover ratio

Selling It!A Look at the

Inventory Turnover Ratio

Meet Nathan “Nate” Smith

Nate Smith works for Esperante Music Sellers (EMS). After four years he’s learned a lot about the “alternative music” scene, often visiting backstage at local concerts and clubs.Recognizing his expertise, EMS has promoted Nate to Buyer. In this role, he

Identifies new artists and labels.Develops relationships with regional suppliers. Maintains a “hot inventory” for EMS stores.

Nate’s Better Idea

One of Nate’s first actions was to convince the owner to use some of the floor space for three new sections:

Alternative Rock

Hip-Hop/Rap

Latin

But after a few months, Nate noticed that some of the new sections aren’t selling as well as he’d hoped.

Question 1

Nate wonders if the new sections are selling better or worse than the rest of the store. How can he be sure? Which of the following would be the best course of action?

A. Compare the present inventories with the initial stock amounts for the new and old sections.

B. Compare the profit from the new sections with that of the old sections.

C. Survey new customers entering the store.

D. Call a competing music store and see how their sales are going for these types of music.

What Should Nate Do?

To better understand the actual sales, the best thing Nate can do is to compare the inventories: what’s left versus what was stocked.Or even better, what has sold versus what was stocked.

A. Compare the present inventories with the initial stock amounts for the new and old sections.

Sales During a Quarter

Nate checked the numbers on a few bands…

Three Deuces Stocked: 20 CDsRemaining: 4 CDSold: 20 – 4 = 16 CDsRatio: 16/20 = 0.80

Raunchy Rockets Stocked: 18 CDsRemaining: 5 CDSold: 18 – 5 = 13 CDsRatio: 13/18 = 0.72

Off Center Band Stocked: 12 CDsRemaining: 3 CDSold: 12 – 3 = 9 CDsRatio: 9/12 = 0.75

Question 2

Which of these three bands has the best (highest) sales ratio?A. Off Center BandB. Three DeucesC. Raunchy Rockets




Sales Ratio

The larger the ratio, the better the sales!

0.80 > 0.75 > 0.72




Which of these three bands has the best (highest) sales ratio?A. Off Center BandB. Three DeucesC. Raunchy Rockets

(0.75)

(0.80)

(0.72)

Question 3

DownRight was initially stocked with 24 CDs. After three months, there are 8 CD’s remaining. What is the ratio of number sold to number stocked?

A. 0.33

B. 0.67

C. 0.75

D. 1.33

Sales Ratio

DownRight was initially stocked with 24 CDs. After three months, there are 8 CD’s remaining. What is the ratio of number sold to number stocked?

A. 0.33

B. 0.67

C. 0.75

D. 1.33

Stocked: 24– Remaining: 8

Sold: 16

16: 0.67 (rounded)

24Sold

RatioStocked

Question 4

So, DownRight’s sales ratio is 0.67. What percentage of DownRight’s disks have sold?A. 33%B. 57%C. 67%D. 75%E. 133%

Ratio to Percentage

So, DownRight’s sales ratio is 0.67. What percentage of DownRight’s disks have sold?A. 33%B. 57%C. 67%D. 75%E. 133%

100%

0.67 100%67%

Percentage Ratio

A Better Way

We’ve been calculating a ratio based simply on a count of the CDs.

In reality, the store owner is more interested in costs and income:

The cost to stock the shelves.

The cost of stock remaining.

The income from sales of those CDs.

Ratio of Costs

Using costs (rather than counts):

Cost of Goods SoldInventory

Rat ot

iCos

where the costs can be calculated:

Cost Number of Items Cost per Item

whether it’s cost of items sold, or cost of items in inventory.

This ratio is known as Inventory Turnover Ratio.

Question 5

Recall Nate initially stocked 24 of DownRight’s CDs, and now there are 8 left. If the CDs cost Nate $4 each, what is DownRight’s Inventory Turnover Ratio?A. $4 per CDB. $3.33C. 75%D. 0.67

= $4


The “cost of good sold” is the number sold times the cost of each: 16 x $4 = $64.

The “inventory cost” is the number stocked times the cost of each: 24 x $4 = $96.

Thus,

D. 0.67

=

0.

$64 (rounded

$966 )7

Cost of Goods SoldInventory Turnover Ratio

Inventory Cost

Nate Takes Inventory

Nate’s consults his paperwork from stocking the shelves with $4 CDs, and also counts the number of unsold CDs in each section.

Latin :Stocked: 156 Unsold: 31

Alternative Rock:Stocked: 262 Unsold: 123

Hip-Hop/Rap:Stocked: 398 Unsold: 33

Question 6

What are the inventory turnover ratios for the three sections, respectively?

A. 0.20, 0.47, 0.08 C. 0.20, 0.13, 0.23

B. 0.31, 1.23, 0.33 D. 0.80, 0.53, 0.92

Latin: Stocked: 156, Unsold: 31 ($4 ea)

Alternative Rock: Stocked: 262, Unsold: 123 ($4 ea)

Hip-Hop/Rap: Stocked: 398, Unsold: 33 ($4 ea)

Inventory Turnover Ratios

For each category, calculate the ratio of number sold to number stocked.

For Latin: Stocked: 156, Unsold: 31 ($4 ea)

D. 0.80, 0.53, 0.92

156 31 125

Number Sold Number Stocked Unsold

125 (rounded)

1560.80

Number SoldInventory Turnover Ratio

Number Stocked

Question 7

Based on the inventory turnover ratios above, which new section is selling the fastest? Which is selling the slowest?

A. Hip-Hop/Rap is fastest; Rock is slowest

B. Latin is fastest; Hip-Hop/Rap is slowest

C. Hip-Hop/Rap is fastest; Latin is slowest

D. Rock is fastest; Hip-Hop/Rap is slowest

Latin: 0.80Alternative Rock: 0.53

Hip-Hop/Rap: 0.92

Inventory Turnover Ratios

The largest ratio (0.92) indicates the greatest turnover, or the fastest selling CDs.

The smallest ratio (0.53) indicates the least turnover, or the slowest selling CDs.


Hip-Hop/Rap: 0.92

A. Hip-Hop/Rap is fastest; Rock is slowest

What’s a “Good” Turnover Ratio?

Nate is a little worried about the Alternative Rock section—at least compared to the other new sections.But, how do these ratios compare to the rest of the store’s CD sales?To answer that question, he consults Esperante’s quarterly income statement and balance sheet.

A Quarterly Inventory Turnover Ratio

From Esperante’s “financials” for the last quarter, Nate finds the “cost of goods sold” on the income statement.

A Quarterly Inventory Turnover Ratio

And from the balance sheet, he finds the inventory cost (or value) for the same quarter.

Question 8

What is Esperante’s Inventory Turnover Ratio based on the previous quarter’s statements?

A. 0.42

B. 0.85

C. 1.17

D. 2.54

Esperante’s Inventory Turnover Ratio

C. 1.17

(rounded)

$232,710$198,718

1.17

Cost of Good SoldInventory Cost

Question 9 Regarding the inventory turns ratio, which of the following would the store manager most like to see?A. More sales, and a higher

ratio.B. More sales, and a lower

ratio.C. More inventory, and a

lower ratio.D. Less inventory, and a

higher ratio.


A business always wants more sales!

More sales will yield a higher inventory turnover ratio.

Note: a lower inventory will also cause a higher ratio.

A. More sales, and a higher ratio.

Question 10

How do the turnover ratios of Nate’s new sections compare to Esperante’s quarterly turnover ratio (1.17)?

A. They are all doing better than the rest of the store.

B. None are performing as well as the store average.

C. Latin and Alternative Rock are more popular; Hip-Hop/Rap is worse.

D. Hip-Hop/Rap is a hit; the other two are worse.


Hip-Hop/Rap: 0.92

Comparing Ratios

All the new types of music have a lower turnover ratio than the store’s quarterly value of 1.17.

0.53 < 0.80 < 0.92 < 1.17

So, all the new types of music are selling worse than the rest of the store’s music offerings.


Hip-Hop/Rap: 0.92

B. None are performing as well as the store average.

Interpreting the Inventory Turnover Ratio

Should be compared against your industry averages.

Some businesses have a very high turnover; others have a very low turnover.

A low turnover ratio generally implies poor sales and/or large or excessive inventories.

A high ratio implies either strong sales or insufficient inventories.

Question 11

In general, which of the following businesses do you think would have a relatively low inventory turnover ratio?

A. Bakery

B. Auto Parts

C. Florist

D. Cellular phone company

Low Inventory Turnover Ratio

A typical automotive parts store has a large inventory of parts for many different car makes and models.

The sales rate of any given part is relatively low.

Low sales and large inventory lead to a low inventory turnover ratio.

B. Auto Parts

Another Comparison

When comparing turnover ratios, be sure to compare like time periods (e.g., monthly sales, quarterly sales, or annual sales).To make comparisons easier, a related measure is often used: Days to Turn the inventory.

AverageInventory

Days to TurnAverageCost of GoodsSold per Day

Days to Turn Inventory

Using Esperante’s quarterly data, calculate Days to Turn. To get the result in terms of “days,” convert the “quarter of a year” to days by using unit ratios.

AverageInventory

Days to TurnAverageCost of GoodsSold per Day

$ Days to Turn

198,718

$232,710 per qtr

0.854 qtr

78 days (rounded)

1 yr4 qtr

365 days

1 yr

Question 12

If Esperante had a “going out of business sale,” approximately how long do you think it would take to sell most of it’s inventory of music?A. 1 weekB. 1 monthC. 3 monthsD. 6 monthsE. 1 year

Days to Turn Inventory

We calculated that Esperante’s “days to turn” was 78 days. That’s a little less than 3 months.

“Days to Turn” is how many days it takes to sell through your business’ average inventory.

C. 3 months

Practice Problems

Examine the financial data on the following slide and calculate the inventory turnover ratio and days to turn for each.If possible, find up-to-date financial information on the Internet for these (and other) companies.

For example: http://finance.yahoo.comEnter the “stock ticker” (or use “Symbol Lookup”) for the company.Look for the links to the “financial statements.”

Real World Financial Data*

* from Yahoo! Finance

Annual Data Annual Data

(in thousands) (in thousands)

Safeway Inc (SWY) Kroger Co (KR) Cost of Revenue $25,018,900 Cost of Revenue $39,637,000 Inventory $2,642,200 Inventory $4,169,000

ChevronTexaco Corp (CVX) Exxon Mobil Corp (XOM) Cost of Revenue $72,154,000 Cost of Revenue $129,928,000 Inventory $2,648,000 Inventory $8,957,000

Home Depot Inc (HD) Lowes Cos Inc (LOW) Cost of Revenue $44,236,000 Cost of Revenue $21,231,000 Inventory $9,076,000 Inventory $4,584,000

Microsoft Corp (MSFT) Apple Computer Inc (AAPL) Cost of Revenue $5,686,000 Cost of Revenue $4,499,000 Inventory $640,000 Inventory $56,000

Wal-Mart Stores Inc (WMT) Target Corp (TGT) Cost of Revenue $198,747,000 Cost of Revenue $31,790,000 Inventory $26,612,000 Inventory $5,343,000

SOLUTION

selling it! a look at the inventory turnover ratio

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