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Inventory Turnover Ratio Formula | Calculation | Excel - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
of WallStreetmojo friends today we
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are going to learn a topic inventory
turnover ratio from the packet that's
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called ratio analysis so ratio analysis
is like a book and of that this is one
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page or one chapter so inventory
turnover ratio one of the very important
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part of any business I mean it's a very
important component let's understand
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what exactly goes in about inventory
turnover ratio formula it involves the
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cost of goods sold right divided by the
average inventories which are there in
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the which of which is there in the
business so inventory turnover ratio
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formula is important efficiency ratio
it's important efficiency ratio right
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and it dictates how fast a company is
able to replace a current batch of
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inventory and transforms the inventory
into sales this is what exactly means so
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the formula goes something like this
inventory turnover ratio is equal to
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your COGS cost of goods sold divided by
your average inventory's right now let's
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take an example of average inventory of
ABC Inc this is just for to understand
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how the formula operates the cost of
goods sold that's the first component
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that we are going to have which is let's
say 6 lakh this is just for you a crude
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example 6 line right then we have the
picnic inventory which is let's say
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$110,000 we will try and interpret the
the formula and the ending inventory is
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let's say $130,000 so let's
try and evaluate the formula over here
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the force in the foremost thing we are
going to write the answer over here the
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force of the foremost thing that we need
to start with is the average inventory
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of ABC Limited that's going to be as
followed the average inventory is equal
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to open the bracket the beginning
inventory and the closing inventory
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divided by two
- once you do that you have your average
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inventory which is the first thing
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actually it's your denominator and I'll
just write denominator and this
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is numerator right what's about
numerator cost of goods sold so after
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this we can easily find the inventory
turnover ratio inventory turnover ratio
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ITO is equal to your cost of goods sold
divided by your average inventory that's
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going to be five times so by comparing
the inventory turnover ratio of similar
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companies in the similar industry we'd
be able to conclude whether the
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inventory issues of a ABC limited over
here is higher all over let's understand
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this with the help of an example a
real-life company this was just a a
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hypothetical company let's understand
what the real-life company Colgate's
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inventory turnover ratio okay in the
inventory turnover example you know we
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have a real-life example of Colgate and
I'll show you a snapshot of inventive
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turnover ratio calculation you may you
may download or by going on the website
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okay Colgate's inventory turnover
inventory consists of three types of
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inventories one is called the raw
materials the another is called sorry
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raw material supply the another is
called the work-in-progress
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WIP and the third is called the finished
goods FG let me show you now as you can
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see there are a couple of things the
inventories of December 14 and 15 is
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taken and that of COGS taken so
historically cold days and went to
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turnover ratio has been in the range of
5 X - 6 X so if we observe closely colgate's
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inventory turnover ratio has been
bit lower in 2013 to 2015
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so as you can see 5.1 7 X 5.1 X right so
it's it's decreasing now this indicates
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that Colgate is taking a bit longer to
process its inventory into the finish
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goods now let me show you the graph of
the same if you can see over here this
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is the inventory turnover ratio right
there is been significant decrease in
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the ratio you can see 5.1 7 x 5.1 1x 5.1
8 X that's what we just and we just saw
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in the balance sheet we tried and
analyzed the ratio this is just a
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graphical
Meishan now let's go to the explanation
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portion of the inventory turnover issue
now there are two significant components
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of the ratio the first component is the
cost of the cost of goods sold if we
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look into the income statement that is
the P&L right the profit and loss of the
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of the company we would find that the
cost of goods sold is quite easily I
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mean the you can find the cost of goods
sold quite easily all that we need to do
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is to look at the fourth item on the
income statement and that's it we will
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get the data I'll give you a snapshot of
TCL company at the end of year 2017 now
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this is the data for TCL and company ok
the second component of the formula you
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know is basically the cost of goods sold
as you can see of the formula is average
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inventory I mean to find out the average
inventory we need to use a simple
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average method so we need to find out
the beginning inventory and the ending
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inventory for the period and then we all
need to do is to divide the sum by two
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like for example if the beginning
inventory is $40,000 and the ending
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inventory is $50,000 to find out the
average inventory we just need to add
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this to ok and divide this by 2 so we'll
have 45,000 as the average inventory now
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let's understand the significance and
the use of the inventory turnover ratio
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what exactly is a use C inventory
turnover ratio is a great indicator of
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how a company it is is handling its
inventory so if investor wants to check
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how well the company is managing in
inventory he or she should look at how
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higher or lower the inventory turnover
ratio of the company is now for example
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let's say the the inventory turnover
ratio of the company is very high it
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means that if the inventory turnover
ratio is high that means the company has
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been managing its inventory quite well
right and the lessor you can say the
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holding cost and fewer the chances of up
Salons
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on the other hand if the inventory
turnover ratio is let's say lower then
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the company is not able to manage its
inventory quite well and there's a lot
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of risk of oxidants but how would you
understand whether the ratio is higher
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or lower that's a question so you would
understand it by looking at the
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inventory ratio of the similar company
in the industry which is called the comm
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company local so if you take that comp
means comparable companies look out if
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you take an average of the inventory
turnover ratio you would understand the
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pace and on the on this page you can
measure whether the inventories of the
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company is higher or lower go to the
website if you want you can you can
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check out this kind of a calculator over
here try and make your own into
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interpretation I'll give you a few
example over here how can you do things
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about and trying learn things in a
really good fashion now let's say your
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cost of goods sold is $500,000 okay and
your average inventory is 2 lac 50
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so what does that mean
your inventory average inventory
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turnover ratio formula is 2x but as you
increase your average inventories that
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means the inventory turnover ratio is
going down so what we discussed the
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lower the inventory turnover ratio the
company is able to manage the inventory
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quite well okay in this scenario and
there is also a risk of absalons sorry
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is not able to or managed its inventory
quite well and as this amount goes down
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your inventory turnover ratio goes up
and that means that it means that the
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company has been managing its inventory
turnover ratio oh right well and there
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is a lesser holding cost and fewer
chances of the Occident so in this
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fashion you can keep changing the
numbers and you can see how things are
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changing how the ratio is changing and
try and make your own interpretation out
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of the same thank you everyone
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