The prompt response can only be possible if your product is ready well in advance so that whenever your customer demands that product you can supply it on time. It means that you have to maintain a certain quantity of stock in your warehouse which is called as inventory to meet your customers demand in time.
The amount of inventory you keep depends on your expected demand and it has to be calculated carefully and predicted by taking into account all the relevant parameters or a wrong estimation may result in under or over sizing of the inventory.
The rate at which the product is getting out of your inventory determines the efficiency of the management. This rate is determined by the ratio called as Inventory turnover ratio. It determines that how many times the company’s inventory is sold and replaced over a period of time. It can be written as:
COGS is Cost of goods sold
Understanding the concept
Let us understand all this with the help of a simple example, considering the financials of two auto companies as on March 2016:
Obviously, it is one of the important indicators to evaluate the performance of any company. The growing value of the inventory turnover over the years shows the improving efficiency of the company in converting its inventory into sales. You should compare the inventory turnover of any two companies which belong to the same industry or sector. You cannot compare the inventory turnover of a perishable goods company with that of a durable goods company.
Managing the right inventory levels is very important for the growth of any company and any under or an over sizing of the inventory levels results in a loss of the customers and the deterioration of the inventory quality as it is kept in the warehouse for a longer period.