Average inventory turnover period

accounting

The ratio of the average period of inventory rotation informs us about the average number of days in which the stock in inventory is depleted and it is replenished again.

During the operating cycle of a company and depending on the sector, the inventory will be depleted and renewed a certain number of times.

Companies have to do a good management of their inventory to avoid a stock-out or the obsolescence of their inventories (among others). Based on the calculation formula, the ratio of the average inventory turnover period will allow us to know the frequency in days with which a company empties and completely renews its warehouse.

Formula for average inventory turnover period

Its calculation formula is the following:

Average inventory turnover period = 365 / inventory turnover

The importance of good stock management

Finding the optimal amount of inventory is vitally important to companies for two reasons:

  • The first is that if the company maintains more units in the warehouse, it will have an idle capacity that will not generate any profit.
  • The second reason is that the longer the units take to leave the warehouse, the greater the opportunity cost that the company faces. Therefore, a high inventory turnover and a low number of days in inventory turnover will minimize both the idle capacity and the opportunity cost.

Although, on the other hand, having a very high turnover and a very low average inventory turnover ratio can have negative effects. If the number of units in stock is too low, the company is exposed to not being able to fulfill large volume orders. In addition to the above, if any of its suppliers fails in their deliveries, the company could find itself without enough units to fulfill its orders.

Hence the importance of maintaining optimal stock management. This must allow the company to meet its order rate while immobilizing the least amount of resources and being able to serve its customers in a timely and appropriate manner.

In any case, it should be noted that the average rotation period will be different for each type of company. That is, mainly, depending on the sector in which it operates. A company that sells luxury yachts will not have the same rotation period as a butcher shop.

Example of calculating the average inventory turnover period

During the year 20X7 Company Y has had an inventory turnover of 10 times. On the contrary, company X during the same year has had an inventory turnover of 20 times.

Average inventory turnover period (company Y) = 365/10 = 36.5

Average inventory turnover period (company X) = 365/20 = 18.25

A priori, company X would be more efficient than company Y, given that its entire warehouse rotates in half the days. Although, as mentioned in previous paragraphs, having this ratio so low could lead to company X having problems with its orders. Always bearing in mind that companies X and Y are comparable (they belong to the same sector and carry out the same activity).

Average collection period (PMC)

Tags:  history Business USA 

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