Inventory Turnover and Company Efficiency

Inventory turnover is a statistic that a lot of investors ignore when it comes to evaluating a company. While it is not the most commonly used ratio, it can still tell you quite a bit as a key measurement of the efficiency of a company. Here are the basics of inventory turnover and how it relates to company efficiency.

Inventory Turnover

Inventory turnover is a statistic that is used to gauge how quickly a company is getting its merchandise off the shelves and into the hands of its customers. Ideally, you would like to invest in companies that have a high inventory turnover. This means that they are not keeping a lot of their capital tied up in inventory and they are quickly getting it to the people that need it. By selling the inventory that they have, the companies can generate cash and use that money to pay their suppliers as well as to make a profit. If a company is good at collecting the money that it is owed by customers, they are known as an efficient company.

Inventory Days

Determining the inventory turnover is not as simple as looking at a statistic on a balance sheet. This is something that you will have to calculate on your own or with the help of a financial advisor in most cases. However, all of the information that you need will be available on the financial statements of the company.

In order to determine the inventory turnover, you need to calculate the inventory days. This is the average amount of days that a company's inventory sits on the shelves before being sold. To calculate this number, you will take the average cost of goods sold and divide that number by the average inventory. Once you have that number, you can take 365 days and divide it by the number that you got from the first calculation. This will tell you the inventory days that a company averages. 

What it Tells You

Once you have done is calculation, you can use this information to your advantage. When you are looking at the result of this calculation, you should try to find companies that have a low number of inventory days. If a company has a low number of inventory days, it means that they are getting their products out of the warehouse and to the customers quickly. They keep a minimum amount of their capital tied up in inventory costs. 

When you look at this number by itself, it does not really tell you much. In order to get anything out of this figure, you need to compare it to other companies in the same industry. When you are trying to find a company to invest in, you should usually lean towards putting your money into companies that are highly efficient. This is one tool that you can use to separate the inefficient companies from the efficient ones.

blog comments powered by Disqus
Scottrade