Inventory Turnover

This column covers fundamental analysis, which involves examining a company’s financial statements

and evaluating its operations. The analysis concentrates only on variables directly related to the

company itself, rather than the stock’s price movement or the overall state of the market.

Inventory

Turnover

Ratio analysis forms the cornerstone of fundamental stock analysis.

There are a variety of ratios that

analysts use to judge the attractiveness of a company as an investment.

Ratios can help evaluate a company’s

liquidity, profitability, debt levels,

cash flow, valuation, and operating

performance.

Operating performance ratios

look at how well a company turns

its assets into revenue as well as

the efficiency by which it converts

merchandise into cash. When using

these ratios, it is important to consider both short-term assets, such as

inventory and accounts receivables,

and long-term assets such as property, plant and equipment. In general,

the better these ratios, the better the

company is and the better it is for

shareholders.

In this column, we take a closer

look at one operating ratio: inventory

turnover. Table 1 provides a quick

look at the formulas used to calculate

inventory turnover.

Overview

As an investor, you would like to

know how much money a company

has tied up in its inventory. This

is because companies have limited

funds to invest in inventory and cannot stock an unlimited supply of the

items they sell. Furthermore, companies must sell merchandise to generate the cash needed to pay bills and

turn a profit.

Inventory turnover measures how

quickly a company is moving inventory off the shelves to customers. It

indicates how many times, during the

course of a quarter or year, a com-

pany sells and replaces its inventory

of component parts, materials and

final products.

Inventory turnover is calculated by

dividing cost of goods sold by average inventory.

On occasion, this ratio is calculated

using...