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Inventory Turnover Ratio and QuickBooks 2013

You can use several activity ratios to help manage your assets in QuickBooks 2013. The inventory turnover ratio measures how many times in an accounting period the inventory balance sells out. The formula is as follows:

cost of goods sold/average inventory
A Simple Balance Sheet
Assets
Cash $25,000
Inventory 25,000
Current assets $50,000
Fixed assets (net) 270,000
Total assets $320,000
Liabilities
Accounts payable $20,000
Loan payable 100,000
Owner’s equity
S. Nelson, capital 200,000
Total liabilities and owner’s equity $320,000
A Simple Income Statement
Sales revenue $150,000
Less: Cost of goods sold 30,000
Gross margin $120,000
Rent 5,000
Wages 50,000
Supplies 5,000
Total operating expenses 60,000
Operating income 60,000
Interest expense (10,000)
Net income $50,000

In the example business described by the balance sheet and the income statement, you can use the following formula to calculate the inventory turnover:

$30,000/$25,000

This formula returns the inventory turnover ratio of 1.2.

Technically, you shouldn’t use just an ending inventory balance. You should use an average inventory balance. You can calculate an average inventory balance in all the usual, common-sense ways. For example, you can use the inventory balance both from this year’s balance sheet and the previous year’s balance sheet and then average them.

The inventory turnover period, as you may have noticed, depends on the period measured in the income statement. If the income statement is an annual statement and, therefore, the cost of goods sold amount is an annual cost of goods sold amount, an inventory turnover ratio of 1.2 means that a firm sells 120 percent of its inventory balance in a year.

If the inventory turnover ratio uses the cost of goods sold amount reported in a monthly income statement, the inventory turnover period is a month. For example, with a monthly cost of goods sold amount, a firm with a 1.2 inventory ratio sells 120 percent of its inventory in a month.

No guideline exists for inventory turnover ratios. A good inventory turnover ratio depends on what your competitors are doing within your industry. If you want to stay competitive, you want an inventory turnover ratio that at least comes close to your competitors’ ratios.

Dell’s competitors, to make a long, sad story short, found out the hard way not to compete with someone who turns around inventory much more quickly than they could. (Imagine soft, sad violin music playing in the background. . . .)

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