How to calculate the inventory turnover ratio?
A common ratio that is tested on the BEC exam is the inventory turnover ratio. The inventory turnover ratio is calculated by taking cost of goods sold and dividing by average inventory. The inventory turnover ratio tells us how many times a company sells through or flips their inventory each year.
In general, a company wants to have as high of an inventory turnover ratio as possible. The lower the inventory turnover ratio the company has, the longer they have cash tied up in inventory that isn’t be sold.
Let’s go through an example inventory turnover question you could see on the BEC section of the CPA exam.
Example Question
The company had beginning inventory of $17,000, purchases of $56,000, and ending inventory of $13,000. What was the company’s inventory turnover ratio for the year?
Solution
Step 1) Since the question doesn’t give us cost of goods sold, we are going to have to solve for cost of goods sold. We can prepare an inventory rollforward and this makes it easy to solve for cost of goods sold of $60,000.
Step 2) We need average inventory, and the question only gives us beginning and ending inventory. To calculate average inventory, we simply add the beginning and ending balance and then divide by 2. This gives us average inventory of $15,000.
Step 3) Now that we have both inputs for the formula, we are able to calculate the ratio. Take cost of goods sold of $60,000 and divide by average inventory of $15,000, which tells us the company turned their inventory 4 times during the year.
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