Question

We can also look at this ratio using dollars instead of units. Assume your sales for the month are averaging $200,000. This means your annual sales are $200,000 X 12 months = $2,400,000. If you hold $300,000 in inventory on average, how do we calculate the inventory turnover? We use the same basic formula in dollars instead of units. The rules are the same though, the higher the inventory turnover, the better.

Inventory Turnover (In $)

= (Average Monthly Sales in $ X 12) / Average Inventory in $

= Average Annual Sales in $ / Average Inventory in $

1. Calculate your inventory turnover in dollars.

2. Calculate your inventory turnover in dollars if you add $50,000 coins to your inventory and you sell $25,000 more coins per month.

3. Based on your answer, does it make sense to add the additional inventory? Please explain why.

4. Calculate your inventory in dollars if your annual sales were only $700,000 and your inventory was still $300,000. Explain why this scenario is worse than your original scenario.

Answer 1

Inventory Turnover = Average Annual Sales / Average Inventory

Annual Sales = 12 X 200,000 = 2,400,000

Average Inventory = $300,000

1. Inventory Turnover = 2,400,000/ 300,000 = 8

This means, Inventory is turned around 8 times during the year.

2. If we add $25000 to monthly sales. Monthly sales = $200000 + $25000 = $225,000

Average Annual sales = $225000 x 12 = $2,700,000

Average Inventory = $300,000 + $50,000 = $350,000

New Inventory turnover = 2,700,000/ 350,000 = 7.714

Additional inventory has reduced the inventory turnover from 8 to 7.714, which means inventory takes more time to be liquidated. This inventory addition is resulting in decreased turnover and is not suggested. (although the sales has increased by $300,000)

3. If the average sales were $700000 and average inventory were $300000,

Inventory turnover ratio = 700000/ 300000 = 7/3 = 2.33

which is even lesser than original scenario.

This means that Inventory is turned around only 2.33 times during the year. The higher the inventory turnover, the better for business.