Definition
The rate of turnover, or turnover ratio, represents the frequency, expressed in annual terms, with which some part of the assets of an organization is turned over (replaced by others of the same class). It is an important measure used to assess the efficiency with which a company is utilizing its assets to generate sales or revenue.
Calculation
Inventory Turnover Ratio
In order to calculate how frequently stock or inventory is turned over, the following formula is used:
\[ \text{Inventory Turnover Ratio} = \frac{\text{Cost of Goods Sold (COGS)}}{\text{Average Inventory}} \]
Where:
- Cost of Goods Sold (COGS): Total cost incurred to produce the goods that were sold during the period.
- Average Inventory: (Beginning Inventory + Ending Inventory) / 2
Fixed Assets Turnover Ratio
To measure how effectively fixed assets are being used to generate sales, use:
\[ \text{Fixed Assets Turnover Ratio} = \frac{\text{Net Sales}}{\text{Net Fixed Assets}} \]
Where:
- Net Sales: Total revenue from sales minus returns, allowances, and discounts.
- Net Fixed Assets: Gross fixed assets minus accumulated depreciation.
Examples
Example 1: Inventory Turnover Ratio
- Cost of Goods Sold (COGS): $500,000
- Beginning Inventory: $50,000
- Ending Inventory: $70,000
\[ \text{Average Inventory} = \frac{50,000 + 70,000}{2} = 60,000 \]
\[ \text{Inventory Turnover Ratio} = \frac{500,000}{60,000} = 8.33 \]
This means the company turns over its inventory about 8.33 times per year.
Example 2: Fixed Assets Turnover Ratio
- Net Sales: $1,000,000
- Net Fixed Assets: $250,000
\[ \text{Fixed Assets Turnover Ratio} = \frac{1,000,000}{250,000} = 4 \]
This indicates the company generates $4 in sales for every dollar invested in fixed assets.
Frequently Asked Questions (FAQs)
What does a high inventory turnover ratio indicate?
A high inventory turnover ratio typically indicates efficient management of inventory, as it implies that inventory is being sold and replaced frequently.
What does a low fixed assets turnover ratio signify?
A low fixed assets turnover ratio may suggest underutilization of fixed assets or overinvestment in fixed assets relative to sales generated.
How often should companies calculate their turnover ratios?
Companies should ideally calculate their turnover ratios quarterly or annually to monitor their operational efficiency and financial health.
How does the rate of turnover affect a company’s liquidity?
A higher rate of turnover, particularly in inventory, can enhance a company’s liquidity by accelerating the conversion of inventory into cash.
Is the turnover ratio relevant for all types of businesses?
While turnover ratios are particularly relevant for retail and manufacturing sectors, they can provide useful insights for any business involved in sales and asset management.
Related Terms
- Capital Turnover: Measures the efficiency with which a company generates sales from its capital employed.
- Inventory Turnover: A specific type of turnover ratio that focuses on how often inventory is sold and replaced.
- Current Assets: Short-term assets that are expected to be converted into cash within a year.
Online References
- Investopedia - Inventory Turnover
- Investopedia - Fixed Asset Turnover
- Corporate Finance Institute - Turnover Ratios
Suggested Books for Further Studies
- “Financial Analysis with Microsoft Excel” by Timothy R. Mayes and Todd M. Shank
- “Financial Intelligence for Entrepreneurs” by Karen Berman and Joe Knight
- “Financial Accounting: A Business Process Approach” by Jane L. Reimers
- “Accounting Made Simple” by Mike Piper
Accounting Basics: “Rate of Turnover” Fundamentals Quiz
Thank you for exploring the concept of the rate of turnover with us and for engaging with the sample exam quiz questions. Keep enhancing your understanding and application of financial principles!
